Posts tagged ‘Africa’

First we link, then we delink

Written September 6th, 2011

As the Swiss peg their currency, the question for money flows is where is the next safe haven? For now, gold seems to be the only answer, but certainly long term, gold will go back to being a currency rather than a wealth creator. So investors are left wondering:

  1. How long can bonds go? I’ve been early and wrong, as I neglected the strength of fund flows into bonds, believing instead that the underlying sovereign debt problems will drive investors into cash rather than long dated maturities.
  2. Will equities be the new safe haven? Valuations have come down, and have come down significantly for some countries.
  3. Will the emerging markets actually delink and provide the stewardship of wealth that developed market investors crave, while developed market governments act more like emerging markets of yesteryear?

I’d like to focus on the last question – delink has been all the rage for years. The theory behind delinking is that emerging markets have come into their own, have large account surpluses, and lower foreign currency denominated debt. Additionally, some have started developing an internal middle class, sophisticated manufacturing, and deep infrastructure, both physical and legal, all of which make them more desirable places to do business. Lastly, with vast stores of natural resources, emerging markets were well placed to supply China’s unending quest for supply. Sounds like a great place to invest, and certainly sounds like the fate of the developed world might be avoided by these newly shrewd regimes.

I hate to be the bearer of bad news, but it’s a facade. The entire world has been raised by a global debt surge that made ALL assets mispriced. The emerging markets became global suppliers of resources to a China that was growing at 9%. China in turn was fueling growth with an underpriced currency that depended on sales to Europe and the US, in return for which, it bought those regions’ debt. Well, Europe is falling apart and demand from Europe will fall.

The US debt that China holds suddenly looks like a brilliant investing move. Granted. However, demand from the US is going to fall, which in turn means that if China doesn’t have the internal demand, which it doesn’t, manufacturing, jobs, and resource consumption will all decrease. It also means that China’s demand for access to those resources will decrease. Don’t get me wrong, it won’t dissipate completely, and in fact, China may continue to secure long term resources, but the pace and rate of FDI in Africa, for example, will diminish. The trumped up land prices in the African continent may come down precipitously.  This is before we get into the risk of internal social unrest from a sharp decrease in wealth and trade. A true test of emerging markets’ development will be when social unrest tests the legal structures of businesses and bankruptcy.

Emerging markets are inextricably linked to the global economy. More so now than in the past due to increased global trade and money flows. That means that short term, the emerging markets will be a levered play to world growth – worked well on the way up, but probably won’t work out so well on the way down. Long term, though, the test of internal policies toward legal protection, property rights (resource countries tend to appropriate property land rights during times of unrest), and social unrest will determine the winners and losers. Lastly, flexible exchange rates that allow investors to go in and out will be a long term advantage for those countries that are confident in their prospects.

Relevant ETFs: AFK, EZA, VNM, EPU, EPI, GXG, EEM, VWO, EWZ