Commodities, Gold And Overlooked Emerging Markets

Summary

• Emerging market equities are down by around 10% YTD, and a handful of frontier and emerging markets are becoming too cheap to ignore.
• Markets such as Nigeria and Russia are trading below book value and offer a 6-9% dividend yield.
• Gold mining stocks have underperformed gold on a 10-year basis, but will likely outperform in the coming years due to heightened geopolitical risks.

Finding Value in Emerging Markets

Emerging market equities are down by around 10% YTD, and a handful of frontier and emerging markets are becoming too cheap to ignore. Notably, the sell-off in emerging market equities has produced an attractive entry point for equities in countries that rely on commodity exports for growth. Underperformers such as Chile, Colombia, Nigeria and Russia are well worth examining, as they would be major beneficiaries of a bull market in commodities. All of these stock markets collectively trade at an approximate 40% discount to MSCI emerging markets. At the moment, it is better to avoid general emerging market ETFs, such as the Vanguard FTSE Emerging Markets ETF (VWO), and to instead focus on selective shopping for emerging markets where there is currently deeper value.

Data by YCharts

Selective Shopping for Emerging Market Equities

Emerging market equities currently trade at around 14.2x P/E, which is not very cheap given the heightened political and economic risks that have occurred this year. The greatest pockets of value can currently be found in frontier and emerging markets that have underperformed this year due to concerns about the future prospects of commodity prices. The four markets below all trade at around 8x P/E, and the dividend yield exceeds the bond yield found in many frontier and emerging markets in Asia.

	P/E	P/B	Dividend Yield	Commodity Exports
Chile	13.24	1.20	4.4%	Copper exports account for around 50% of total exports
Colombia	8.32	1.90	5.20%	Crude petroleum and coke briquette exports account for 57% of its total exports
Nigeria	4.93	0.85	8.97%	Petroleum exports account for 87% of total exports
Russia	6.23	0.84	6.77%	Crude oil and petroleum exports account for nearly 70% of total exports
Average	8.18	1.19	6.34%	___________
MSCI Emerging Markets	14.26	1.50	2.84%	__________

Click to enlarge

Source: MSCI/CEIC/various

Sovereign Debt Vs. Precious Metals and Cash

With yield collapsing in global bond markets, it is increasingly difficult for investors to build a hedge against declines in equity markets by investing in sovereign debt. Retail vehicles to access emerging markets debt, such as the Vanguard Emerging Markets Bond Fund Investor Shares Inv (VEMBX), are overly diversified and offer exposure to problem child frontier and emerging markets or markets that have lower bond yields.

Source: Vanguard as of April 2020

Emerging Market debt still yields around 7%, which is attractive given that debt in developed markets is approaching 0% and even offering negative yields in places such as the United Kingdom and others. However, further rate cuts have even pushed emerging market debt in Europe to negative yields. This will make sovereign debt even more unattractive if rates continue to head in this direction. It is difficult for US investors to gain access to individual sovereign debt markets, which makes it ideal to instead invest in frontier and emerging market equities that have high dividend yields.

Gold Mining Stocks

Gold mining stocks have declined by over 30% during the past 10 years, even though the price of gold has advanced by more than 40%. It is really only in recent months that gold mining stocks have really begun to advance and outperform equity markets.

Data by YCharts

However, gold mining stocks typically perform much better during times of heightened political and economic risks, as seen by the much swift advance in gold mining stocks during the past six months. In my view, other alternatives such as bitcoin and sovereign debt are inferior due to 1) limited history and mixed sentiment (bitcoin) and 2) declining yields and increased geopolitical risks (sovereign debt). The rapid increase of the price of gold in the past 10 years will also improve the financial performance of gold miners, as the all-in sustaining costs for gold miners was around $1,000 during 2019 and slightly below $1,000 in previous years.

Data by YCharts

Emerging Markets

It is ideal for investors who are long-term bullish on emerging markets to increase exposure to gold mining stocks and to hold cash, while decreasing their exposure to emerging market equities. I am only investing around 10% of my portfolio in frontier and emerging market equities, as I am waiting for a further drop in the overall market. My ideal target would be for emerging market equities to account for 25% of my total investments, and this amount would also include other frontier and emerging markets, such as Vietnam, Greece and Egypt.

Data by YCharts

Markets such as Colombia, Chile and Nigeria still trade more than 40% below their 5-year highs, which makes now an ideal entry point.

Nigeria: The only way for US investors to gain exposure to Nigeria through US exchanges is to invest in the Global X MSCI Nigeria ETF (NGE), which invests directly in Nigerian equities, including banks, consumer companies and construction companies. Banking stocks in Nigeria are intriguing on a global level, given that some of these banks trade at less than 2x P/E and around 0.2x book value.

Chile: I covered Chile's economy and stock market in an article on Seeking Alpha in January this year. A bull market in copper would bode well for equities in Chile, particularly banks. I like to avoid ETFs when possible due to potential tracking errors, and also because certain sectors, such as banking, can be better long-term bets. Banco De Chile (BCH) has significantly outperformed the iShares MSCI Chile Capped ETF (ECH) on a 5-year basis, and is a solid long-term, high-dividend yielding stock.

Data by YCharts

Colombia: Colombia offers investors exposure to another market that is undervalued due to declining oil prices. Colombia has also always commanded a significant premium to Nigeria, and has also been able to outperform Nigeria significantly in the past 5 years. However, there is still an opportunity to buy the crash and to receive a multi-bagger return with Colombia, which is down by nearly 40% in the past five years.

Data by YCharts

Analyst’s Disclosure: I am/we are long GXG, NGE, RSX, BCH, GDX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.