Commodities in Emerging Markets: Opportunities and Risks

Book: Commodities: Markets, Performance, and Strategies
Editors: H. Kent Baker, Greg Filbeck, Jeffrey H. Harris
Publisher: Oxford University Press, 2018
ISBN: 9780190656010

What Even Is an Emerging Market?

Before we get into the data, it helps to nail down what “emerging market” actually means. According to the definition used in this chapter, adapted from Jormanainen and Koveshnikov (2012), emerging markets are countries that have undergone major transformation recently. They have rapidly growing economies, industries going through dramatic structural changes, and they hold promise despite volatile and weak legal systems.

That last part is important. These are not stable, well-regulated markets. They come with political risk, currency risk, and institutional risk. But that is also what makes them interesting for investors.

The Gold Reserve Connection

One of the more fascinating parts of Chapter 19 is the analysis of gold reserves across emerging countries. Why does this matter? Because gold is among the most liquid and widely followed commodities, and central bank gold reserves tell you something about a country’s economic confidence and hedging behavior.

Central bank reserves follow a mandate of safety, liquidity, and return. If central banks are buying gold as insurance for their country’s reserves, that signals something. It means emerging-market investors might also expand their positions in gold to hedge their equity portfolios. This is the “safe haven” argument in action.

The data shows some striking differences:

• Iraq, Mexico, and Turkey had the highest changes in gold reserves, between 20 and 52 percent
• Venezuela decreased its gold reserves by 11.5 percent
• Venezuela held 65.2 percent of its total reserves in gold, which is far above the normal 10 percent threshold
• South Africa (10.9 percent), Egypt (19.9 percent), and Turkey (14.9 percent) also held gold reserves above the 10 percent threshold

Countries with a high proportion of gold in their reserves are particularly vulnerable to drops in gold prices. Any negative movement in gold could have sizable effects on their economic outlook and their equity and bond markets.

World Gold Council statistics for early 2016 show where gold demand comes from: about 37 percent for jewelry, 48 percent for investments, 6 percent for industry, and 8.5 percent for central banks and other institutions. Almost half of all gold demand is for investment purposes. That is a lot of financial weight sitting on one commodity.

Commodities and Emerging Market Business Cycles

Here is where the chapter gets into the heavy empirical analysis. Smimou tests how commodity futures affect the business cycles of emerging market groups, while controlling for the U.S. dollar index, policy interest rates, and inflation.

The study uses panel estimation, which has advantages over looking at individual countries one by one. Panel data increases statistical power and can reveal common patterns across countries that might be hidden at the individual level.

The results tell a clear story:

Energy futures show a positive impact on economic growth for all emerging groups except the African group. The coefficient ranges between 0.12 and 0.18, meaning that 12 to 18 percent of the economic growth in those emerging countries is attributed to energy futures movements. For MENA countries, the effect is even stronger and more consistent, which makes sense given that many MENA economies depend heavily on crude oil production.

The U.S. dollar has a strongly negative effect on emerging market growth across all groups. A stronger dollar hurts emerging economies. The coefficients are large and statistically significant, ranging from about -0.50 to -0.82 depending on the group and model specification. This is one of the most consistent findings in the chapter.

The lagged effect of energy is interesting too. For MENA and the special emerging group, last year’s energy prices still affect this year’s growth. But for Latin America and Africa, there is no significant lag effect. The impact is more immediate or it does not exist at all.

Metals and agricultural commodities also show positive effects on growth, though the patterns vary by region. Agricultural commodities have a more pronounced and stronger impact on Latin American nations than on other countries, which lines up with the importance of agriculture to those economies.

Not All Emerging Markets Are the Same

This is a crucial point that the chapter hammers home. Researchers like Sensoy, Ozturk, Hacihasanoglu, and Tabak (2016) found that after the 2007-2008 financial crisis, correlations among emerging market debt indexes increased. But that increase came from clusters of countries showing high within-cluster co-movement, not between-cluster co-movement.

In plain English: MENA countries move together, Latin American countries move together, but MENA does not move like Latin America. This matters for anyone trying to diversify across emerging markets. Just because Brazil and Qatar are both “emerging markets” does not mean they respond to the same forces in the same way.

Some emerging markets are commodity exporters (Russia, Brazil, Venezuela, Saudi Arabia). They benefit from rising export revenues when commodity prices go up. Others are net importers. The impact of commodity price changes is fundamentally different depending on which side of the trade a country sits on.

Political Risk and Other Factors

The chapter acknowledges that commodities are not the only thing driving emerging market performance. Political risk, economic slowdowns, currency regimes, changes in monetary policy, economic growth prospects, equity market volatility, and global economic factors all play a role.

This is honest and important. A regression model can show you that energy prices are correlated with GDP growth in a certain region. But it cannot tell you that a coup, a currency crisis, or a trade war will not override that relationship entirely.

For investors, this means commodity analysis is necessary but not sufficient for understanding emerging market risk. You need the full picture.

My Take

What stands out to me is the asymmetry. Rising energy prices help most emerging economies, but not African ones. Agricultural commodities matter most for Latin America. Metals have the broadest positive impact. And the dollar is universally negative for emerging markets.

This asymmetry is actually useful information. If you are an investor thinking about commodity allocation alongside emerging market exposure, knowing which commodities affect which regions lets you be more intentional. Instead of broad commodity exposure, you could match specific commodity tilts to your specific emerging market positions.

The gold reserve analysis is also a good reminder that countries are not just passive recipients of commodity price movements. Their central banks make active decisions about gold holdings, and those decisions create feedback loops that affect their vulnerability to gold price changes.

In Part 3, we will look at the evidence on how commodities affect emerging equity and bond markets specifically.

This is Part 2 of a three-part series on Chapter 19. Continue to Part 3: International Commodity Markets: What the Research Shows.

Previous post: Commodities in International Markets: A Global Perspective

Next post: International Commodity Markets: What the Research Shows