Article / November 8, 2020

Emerging Market Currencies: Where’s The Opportunity?

There’s been a good deal of chatter lately about big opportunities in emerging market (EM) currencies. For example, Morgan Stanley said it’s time to go “all-in” and take full advantage of EM currencies, noting several that are especially appealing, including Brazil’s real, Mexico’s peso, and Colombia’s peso, along with Russia’s ruble and South Africa’s rand. What exactly is the opportunity here for savvy investors?

A Weaker US Dollar Presents Specific Investment Opportunities

The US dollar was strong just before the pandemic hit, but the Federal Reserve’s continued cutting of interest rates and other actions to mitigate the pandemic’s negative impacts on the economy have significantly weakened the greenback.

Low interest rates and higher debt levels are prompting many to tolerate high risk in their investments. If the dollar continues to remain weak, it opens up a range of investment opportunities make more sense than when the dollar is strong.

The State of Emerging Market Currencies

While emerging market currencies tend to be subject to wider fluctuations and more volatility, the resulting dramatic changes in exchange rates can make for big wins, as well as big losses.

Make no mistake, emerging market currencies were hit hard by the novel coronavirus and COVID-19 global pandemic, dropping sharply across the board, often to the tune of 20-35% relative to the US dollar. This also sets the stage, however, for a dramatic rebound that presents a huge opportunity for EM investors if those EM currencies are substantially or severely undervalued.

It should come as no surprise that the economic upheaval caused by the pandemic led many investors to flee from volatile EM currency markets to put their money in safer havens given the instability that is one of primary features of emerging markets. As a result, forex investors retreated into the safer US dollar and gold during the initial rise of the pandemic and the dramatic economic shutdowns that took place around the world.

Gold Futures Trading, YTD

For example, Goldman Sachs puts the Mexican peso at the top of its list even while the dollar is on the move and the pandemic continues to impact economies around the world. It is also eyeing up the South African rand and the Russian ruble as being seriously undervalued and having plenty of room to make more gains.

The reason now might be the right time to make your move in emerging market currencies is because the central banks of many of those countries are not engaging in the drastic quantitative easing measures that will be holding back developed nations. This gap between monetary policies puts emerging markets in a position to experience the biggest rebounds in their currencies.

Direct Foreign Investment in Emerging Market Equities

Emerging markets tend to be poised for significant growth, but their capital markets also tend to be less mature, which can make identifying investment opportunities more of a challenge in terms of getting the kind of information needed on specific companies to make wise investment decisions.

A weak dollar makes emerging market equities more attractive. Lists of specific EM stock picks, however, tend to be dominated by Chinese tech companies, which is probably just a reflection of decent data about them being more readily available than other types of firms.

A weak dollar may spur a flight to EM equities

Especially attractive right now are commodities, which are poised to recover from the tumble commodity prices took at the height of the pandemic in March when futures for a number of commodities crashed hard, including corn, beef, and especially crude oil.

A more fruitful approach might be something like the SPDR S&P Global Natural Resources ETF (GNR) based on how attractive commodity equities are in the current environment. Around 70% of the companies it includes are in foreign markets such as Brazil and India.

Emerging Market Debt Investment Opportunities

Tolerating higher risk to reap potential higher yields also makes investing in emerging market debt more attractive when the US dollar is weak. You’d want to be careful to focus on debt such as emerging market bonds denominated in US dollars because a weak dollar results in easier servicing of the debt. It’s the same currency translation benefit that’s making some emerging market stocks attractive right now.

A specific avenue for this type of investment is the iShares J.P. Morgan USD Emerging Markets Bond ETF (EMB), which is heavily weighted with debt holdings that include Russia and the Philippines, among other emerging markets.

Making Sense of Emerging Market Investment Opportunities

The nature of the opportunity here for people willing to put the time and effort into the homework factor is this: use EM currencies to your advantage by investing at a discount. You can think of the relationship between EM currencies as a pathway to steeply discounting direct foreign investment, not only in equities, but in a wide range of vehicles.

One of the most attractive of these vehicles is real estate. It is possible to enter the market at a time when the dollar or euro is strong against the currency of an emerging market, leading to discounts on real assets of anywhere from 5%-15% in some cases. Buying a discounted property in a foreign country can be an attractive option for those looking to diversify – especially if there are signs of a boom in the selected region.

EM Farmland  Comes at a Discount

In emerging markets, the agriculture space is often ripe for systemic improvement. In terms of logistics, technology, best practices, genetic resources, and more, an opportunity exists to generate hands-off returns through savvy investment in farmland. Emerging market farmland is ideal for anyone looking for the long-term income and appreciation that is becoming increasingly difficult to find in developed-world real estate.

Learn more about how you can grow your wealth through turnkey farmland ownership. 

 

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