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Two Ways to Play a Commodities Rebound
01/22/2009 10:26 am EST
Alec Young, Standard & Poor’s international equity strategist, says commodities are due for a bounce and two global markets in particular should benefit.
Equity prices have fallen in both developed and emerging markets overseas on a bleak earnings outlook. The consensus expects developed overseas markets to post only 4.4% earnings growth in 2009 and a mere 0.2% for emerging market profit growth.
[Yet] our analysis suggests select hard-hit individual countries and regions are beginning to look compelling, [although] we recommend [they] comprise only a satellite weighting within portfolio allocations.
We believe commodity-sensitive markets like Canada, [represented by the iShares MSCI Canada Index] (Amex: EWC) and iShares Latin America 40 Index (Amex: ILF), are beginning to look appealing on a relative basis.
Their profits and performance are highly leveraged to raw materials. As prices soared in the first half of 2008, these markets outperformed strongly. Conversely, since commodity prices peaked in July, they have underperformed global benchmarks.
[But] the significant toll of the global recession on raw material demand has been exhaustively chronicled, increasing the odds, in our view, that this factor is now largely discounted in depressed commodity prices.
The Standard & Poor’s GSCI Commodity index declined 61% since its July 2008 all-time high versus a 44% drop for the S&P Global 1200 index from its October 2007 apex through January 8th. Influential commodities like oil, nickel, and copper are down even more, falling [as much as] 71% respectively from their 2008 highs.
Crude oil is the most influential raw material, and more Canadian and Latin American companies are tied to it than any other raw material. S&P analysts forecast West Texas Intermediate crude oil will average $43.08 a barrel in 2009 and $56.75 a barrel in 2010. Should this forecast be borne out, we believe commodity-sensitive equity markets are likely to outperform as current earnings estimates assume continued raw material weakness.
Other major industrial and agricultural commodities are highly correlated to crude, meaning they are likely to recover in unison, only magnifying the upside potential.
Currency is often an important driver of international equity performance, by our analysis. A weak dollar adds to US investors’ dollar-denominated returns in this asset class, while a stronger greenback has the opposite impact. Commodity price fluctuations have affected not only Canadian and Latin American corporate earnings, but also their currencies.
The sharp raw material rally of 2007 and early 2008 propelled strong gains in the Canadian dollar and Brazilian real versus the US dollar. This inflated US investors’ dollar-denominated returns in these countries. Conversely, the recent commodity bear market coincided with big drops in these currencies compared with the greenback, hurting US investor performance.
Should commodity prices begin to stabilize, we would expect both the Canadian loony and Brazilian real to reclaim lost ground against the dollar, boosting dollar-denominated US investor returns in these markets. (EWC closed above $16 Wednesday, while ILF closed below $25—Editor.)Subscribe to The Outlook Online Edition here…
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