Investment Adventures in Emerging Markets

Urbanization: Driving Commodity Demand

Increasing economic activity in emerging markets has continued to push up the demand and prices for key resources such as metals and oil. Infrastructure spending is a key factor driving this rising demand, as more of the working population in emerging markets move from rural areas to the cities, increasing consumption and putting upward pressure on both hard and soft commodities. I think long-term commodity prices are likely to be driven by rising global demand as well as increasing costs to obtain these commodities.

Over the next decade, global demand for natural resources is projected to rise by at least a third.[1] With their rapid economic growth, emerging markets are becoming bigger consumers of natural resources, particularly energy resources. China and India, each with over one billion people, are requiring more electric power, water and fuel for a growing army of automobiles and trucks. China is the world’s largest energy consumer, the world’s third-largest net importer of crude oil, and also the second-largest energy producer in the world after the U.S.[2]  Over the years, we have seen many countries that were originally energy independent or even energy exporters, like Indonesia, themselves become significant importers of energy. 

These are some of the reasons we see a lot of potential in the energy sector over the long-term. In general, we have found many opportunities in energy and mining companies, and in particular, in diversified oil companies, which we think could weather the volatile commodity cycles that take place from time to time. In our view, a diversified company with operations in exploration, development, refining and retailing has more potential to weather these cycles.

We see exciting opportunities in countries that are net exporters of commodities and rich in natural resources, such as Russia and Brazil. Many frontier markets are also leading producers of oil, gas and precious metals, and they, too, have benefited from the high global demand for these resources from their larger emerging counterparts such as India and China. As the economies of frontier market countries expand, they usually continue to increase investments in infrastructure, offering investment opportunities in the construction and transportation industries, among many others.

Even in smaller markets like Laos, for instance, demand for the country’s hydropower and mineral resources has boosted economic growth. In addition, I think the country is an exciting investment destination as it increases its investments in infrastructure-related industries such as construction and telecommunications. Kazakhstanis another country that is not only rich in oil and other natural resources, but also has a lot of potential and significant investments in infrastructure development. In Vietnam, where infrastructure growth appears to be only a fraction of other emerging market giants, continued economic expansion and investment in infrastructure could open up many sound investment opportunities in industries such as construction and transportation, among others.

We believe the key challenge for countries that are net exporters of commodities is diversification. Many countries with abundant natural resources greatly depend on the earnings of these commodities to fund government programs.  This could make their economies lopsided, with not enough development of value-added industries that could bring about value-added employment. Thus, the result is often an economy too dependent on natural resource exports and not enough development of local industries. Another key concern is the lack of increased productivity in the long-term. Also, commodity prices often have substantial corrections and can be more volatile than other securities, which, although they are unlikely to impact the long-term trend in prices, they could hit a country’s export earnings and produce government deficits, excessive borrowing and related problems.

However, we take a long-term view on commodities, and we believe they have long-term potential due to the dynamics of supply and demand. For instance, resource-rich countries like those in Latin America have benefited from global demand for soft commodities, as a result of growing populations and increasing urbanization. Meanwhile, factors such as the massive reduction of agricultural land, bad weather and export controls in some countries have pushed up the prices of these commodities. Therefore, going forward, we are optimistic about the long-term potential of commodities, and although the sector is susceptible to economic and regulatory developments, we believe there should be plenty of good investment opportunities.

[1] Source: McKinsey Quarterly, Pricing The Planet, as of June 2010.

[2] Source:U.S. Department of State, Background Note,China, as of August 5, 2010.

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