Two Ways To Profit from Frontier Markets

May.30.08 | About: SPDR S&P (GAF)

Many people are in sticker shock thanks to high gas prices and oil that punched through the $135-a-barrel level recently, before sliding back.

And many investors are feeling left out because they haven’t been part of the incredible bull run energy companies have enjoyed in the last few years.

But have no fear. It’s not too late to grab a piece of the pie.

The trick is that you’ll have to look beyond the obvious choices like major oil companies, drillers and other sectors that are hopelessly bid up right now. And you can play various types of funds, as well as stocks, as we’ll demonstrate.

The Four Factors Giving Life to the Commodity Bull

But before we tackle the how, let’s tackle the why:

  • First, it’s important to understand that high oil prices are simply going to go higher, still. There will be inevitable pullbacks, but as we’ve written so many times in the past, the math is very simple - people are simply using more oil than at any time in history and worldwide demand is accelerating.
  • Second, it’s also important to note that we haven’t had a major new discovery of any substantial size in the last 30 years. And by substantial, we mean big enough to change the balance of supply and demand and, by implication, to reverse the runaway increase in prices. The lack of any new discoveries, then, also points to higher prices.
  • Third, absent an immediate, cost-effective and widely available substitute, oil is increasingly nationalistic in nature. This means that oil producers - and particularly the tyrants with spigots - will begin holding back production for their own use. That will reduce the supply available on world markets, further enhancing the upward pricing pressure.
  • And fourth, while higher prices are finally inducing some drivers in modern industrialized countries to drive less, developing nations don’t give damn about conservation and are guzzling gasoline like there’s no tomorrow - which, for them, is entirely true. For these nations, access to energy and to petroleum is the literal equivalent to survival and they’ll do everything they can to ensure it. So any drop in demand we’re experiencing is almost immediately offset by higher consumption in such markets as China, India and many parts of South America. And that offsetting consumption may well persist for years.

That’s a very painful reality to face. But it does bring us to the fun part of this commentary: The profits.

New Markets = New Profit Opportunities

Any time you have sustained supply-and-demand imbalances, you also the potential for huge profits. And what’s happening now is no different.

Viewed in that light, higher oil prices can actually be a good thing for the stock markets, just as the rising price of such “commodities” as gold, copper, cotton, silk and spices have been for various nations since the dawn of time.

The reason is that excess profits that would ordinarily flow to Caracas, Moscow and Riyadh, are being recycled into the best global stocks on the best first-tier global stock exchanges, including the New York Stock Exchange, the Tokyo and Hong Kong stock exchanges, and the Frankfurt, Euronext and London exchanges.

But that may be coming to a head as trillions of dollars are chasing a diminishing number of high-quality stocks, which over time will propel those shares to excessively high valuation levels.

So what’s an investor to do? Savvy investors will once again have to go with the (global money) flow, ferreting out markets that haven’t yet hit “mainstream” radar screens, but that still are likely to benefit from rising oil prices.

We refer to them as “frontier” markets and they include such mineral- and resource-rich places as Nigeria, Sudan, Egypt and Bangladesh among others. They’re obviously beyond the same old BRIC choices that have become so popular in recent years.

Most of these markets are so small that many investors overlook them altogether - but they’ll soon become very popular because of the tremendous upside they offer.

Even with political upheaval, hyperinflation, open warfare and catastrophic human and natural disasters, frontier markets are piling on stunning returns. Most are benefiting significantly from rising commodity prices that, in turn, produce higher corporate profits.

As a case in point, consider the Standard & Poor’s/IFCG Frontier Markets Composite Index posted a mouth-watering 43.3% return last year. And individual markets did even better. Bangladesh turned in 128.3% while Cote d’Ivoire nailed down a 122.7% gain. The index’s worst performer, Estonia, plunged -14.2%.

Clearly with a range like that, so-called frontier markets aren’t for everybody especially since they’ve gotten so expensive as more money has flowed into them. Data shows that many are trading at Price/Earnings [P/E] ratios that range from a high of nearly 100 for Vietnam to a “mere” 35.9 in Slovenia.

Still, even at these valuations, we can make the case that higher commodity prices will allow these markets to grow for years to come - especially given that they are starting from such a small base.

Which makes them a logical choice for adventurous investors who want to get in before they become hot on the country club cocktail circuit.

Two Moves to Make Now

Unfortunately, the path to them is not as easy as we’d like to see and investment choices remain extremely limited for now.

If you’re part of the über-wealthy set, you can probably get first dibs via high-net-worth asset-management plans and institutional offerings. And you will reap the greater rewards of having invested early.

If you’re part of the normal working class - like us - here are two very solid possibilities:

  • The T. Rowe Price Africa & Middle East Fund (MUTF:TRAMX), which carries a $2,500 minimum investment.
  • The SPDR Standard & Poor’s 500 Emerging Middle East and Africa (NYSEARCA:GAF) exchange-traded fund [ETF], which tries to closely match the performance of the S&P®/Citigroup BMI Middle East & Africa Index.