After a week of steady declines, the emerging markets are losing faith in the decoupling argument. Industrial commodity prices plunged. Copper prices fell more than 23% in less than 2 months. Aluminum prices dropped more than 20% since August. Oil is down 8% from its highs. Not surprisingly, the decline in commodity prices is weighing heavily on many of the emerging market countries. The Brazilian Bovespa is down almost 10%. The Peruvian equity market lost 30% since the mid-year point, surrendering almost 5% yesterday. The same is occurring on the exchange front, with many of the emerging market currencies in negative territory. In a defensive move, Colombia eased some of its capital controls. Soft commodities were the only exception to the rout. Wheat, soybean and corn prices continued to march higher, posting new highs. The market picture underscores our fundamental view. The deceleration of the U.S. economy will have an adverse effect on global demand, forcing a reduction in output. This will reduce the demand for industrial commodities. Unfortunately, most emerging market countries are commodity producers. Most of them, particularly in Latin America, failed to take advantage of the commodity boom to improve their fundamental conditions. Therefore, the decline in the prices of their primary exports will be reflected in their asset prices. In other words, there is no decoupling.
The decoupling argument was predicated on the belief that a rise in Chinese demand would substitute the U.S. as it decelerated. This scenario will eventually materialize, but not yet. We still need to go through a lengthy transition period. The size of the Chinese economy is only one-fifth of the U.S. and its per-capita income is one-twentieth. Therefore, a marginal contraction of the U.S. economy will not be offset by a corresponding expansion in China. The latter needs to inflate the size of its economy, several times, in order to reach a similar scale. This process can be assisted through a revaluation of the yuan. However, this option is not on the table. The Chinese are easing some of their capital and currency controls, but a major adjustment of the currency peg is not in the works. Moreover, a slowdown in the U.S. seems to be a welcomed development for the Chinese economic authorities. With more than 11% y/y GDP growth, the Chinese economy is overheating. China’s inflation rate rose to 6.9% in November, with no signs of abating. The Chinese monetary authorities are putting the clamps on credit expansion in a desperate attempt to slow domestic demand. Therefore, the deceleration of the U.S. could help ease some of the export growth and investment that is driving the Chinese economy.
While the outlook for industrial commodities is gloomy, the demand for soft commodities remains robust. This is due to a structural shift in the demand for grains. The growing prosperity in China is allowing its population to improve its dietary consumption. A decade ago, China’s per-capita income was similar to sub-Sahara Africa. Today, it is several times higher. The first thing that changes when a country emerges from abject poverty is to raise its consumption of food. This is followed by an improvement in the demand for energy and shelter. Likewise, the last thing that a society modifies, as its economic activity decelerates, is the demand for basic food products. The performance of the different commodity groups could underscore the ongoing changes in global demand. Metal prices, which are used in the construction of shelter, were the first to react to the decline in global demand. This was followed by energy. Meanwhile, food prices were the most resilient. The persistent demand for grains was exacerbated by the water shortages in China. Another way of importing water is through the acquisition of foodstuff from abroad. This puts agricultural-intensive countries, such as Argentina, Paraguay and Namibia, on the vanguard of the emerging countries. Although the latter two may not have much in the way of market instruments, Argentina does. The market may take some time to realize the true extent of Argentina’s comparative advantages, but the situation will become apparent as soft and industrial commodities diverge.