Commodity Rally Puts Focus on Key Correlations to Watch

Commodity Rally Puts Focus on Key Correlations to Watch

The rally in commodity prices is bolstering the outlook for emerging-market currencies but the backdrop it provides for stocks is more nuanced due to the risks from higher inflation, strategists said.

The is at the highest level since 2012 and more gains are expected as the world pulls out of the pandemic. The trend is a big help for some emerging-market currencies, Bloomberg Intelligence’s Gaurav Patankar said. said the climb signals economic strength that overall supports stocks despite risks to profit margins.

“Broadly, certain emerging markets and emerging-market currencies are massive beneficiaries,” said Patankar, BI’s head of EM equity strategy. He cited commodity-heavy equities and currencies of countries like Brazil, Mexico, South Africa, Malaysia and Indonesia, adding these are value markets too.

The cost of everything from copper to corn has surged, adding to inflationary pressures and forcing investors to weigh up the implications for other assets. Complicating the outlook is the possibility that further big jumps may lead policy makers to taper the exceptional stimulus buoying markets in general.

The Bloomberg index of commodities is up 65% over the past year, while a gauge of global stocks has advanced 48% and the MSCI Emerging Markets Currency Index some 10%. Vaccine rollouts and government policy support are stoking the global economic recovery.

The raw materials index and the currency gauge are moving in tandem more now than at the start of 2021, when a measure of 30-day correlation between the two came close to turning negative. In contrast, the correlation between global stocks and commodities is declining.

Still, the traditional though sometimes disputed role of equities as an inflation hedge continues to draw strategists and investors.

Stock Outlook

“Equities, especially those with strong pricing power and reasonable valuations -- to avoid the valuation impact of higher rates -- are clearly better positioned than asset classes that do not provide inflation protection,” said Joshua Crabb, a senior money manager at in Hong Kong.

One key question is whether profit margins are vulnerable, leaving shares exposed amid rich valuations. Societe Generale’s Head of Asia Equity Strategy Frank Benzimra argues equities can still move up alongside commodities.

“Yes, you can see input prices rising, but bear in mind why it is the case -- because growth is bouncing,” he said. “The net effect for corporate earnings is positive.”

In bonds, benchmark 10-year Treasury yields have climbed more than 70 basis points this year. But the debt selloff paused in April despite a strong month for commodities, as investors mulled whether price pressures will be transitory.

“The global output gap remains wide which should help keep inflation in check,” said Mary Nicola, portfolio manager, globalasset with PineBridge Investments.

Some analysts see room for at least a moderate rise in yields from the current 1.6% level.

“The ongoing recovery will factor into bond yields,” said John Woods, Asia-Pacific chief investment officer at , who expects the 10-year U.S. yield to climb 1.8% in three months.

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Raw materials gauge has climbed to highest levels since 2012

Market-based expectations of inflation around multi-year highs