4 ways cheap oil helps emerging markets

The low cost of oil, though detrimental for developed countries, is benefiting some emerging market economies.

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“The reality is we’ve seen oil go from $140 down to a low of about $45 and bounce back from there,” says Michael Reynal, a portfolio manager at Sophus Capital (formerly called RS Investments). Sophus Capital sub-advises the Renaissance Emerging Markets Fund.

That price drop helps emerging markets in four ways.

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1. Inflation

Most significantly, “Lower oil prices mean lower inflation for a number of these economies, whether they’re Chile, who’s a net oil importer, or even oil exporters like Mexico or Argentina.”

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That’s important because, “in a number of these [developing] economies — Indonesia, Thailand and some of the Latin American countries in particular—inflation has been running somewhat higher, even in an environment where the developed world is seeing very low inflation and, arguably, deflation.”

In those poorer economies, energy and oil form a large portion of that high inflation, meaning people pay more for heat relative to their salaries than those in developed economies, and therefore benefit from lower energy costs.

2. Terms of trade

“The second way low oil prices help emerging markets is through terms of trade,” says Reynal. “In other words, the capital account of some of these countries looks better because their oil import bill is reduced.”

For every country that’s a large exporter of oil (like Mexico or Brazil), there’s an emerging market that’s a large importer (like India, China, Korea or Taiwan). “Importers have had negative-looking terms of trade, negative-looking capital and current accounts, because of that oil price.”

He says the biggest beneficiary, relative to GDP, is Turkey, followed by India.

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3. Manufacturing

“Lower oil and energy prices help margins for a lot of manufacturing. And [thanks to] globalization, we have shifted a lot of manufacturing into the emerging markets,” says Reynal.

China is the best example, but “we’re finding manufacturers and industrial companies not just in China, but also in Korea, Taiwan, Thailand, et cetera.”

In terms of manufacturing sectors, “Margins will expand particularly in the chemical space, and in areas that use oil as a heavy input.”

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4. Grain commodities

“The last one is probably one many people don’t think about,” says Reynal. A number of soft commodities, such as grain, are highly correlated with oil.

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That’s because some grains are interchangeable for alternative energy. “So soybean prices, corn prices through ethanol, and other elements are highly correlated to oil. And as we see oil prices come up, we see soft commodity prices come up.”

For example, Egypt and Indonesia both subsidize bread through lower grain prices, while the latter also subsidizes oil and energy. And, “lower energy [and] lower grain prices mean lower inflation [and] a lower cost of living in a number of volatile countries around the globe.”

Where to invest

Reynal suggests looking for sectors that benefit from low oil prices, such as manufacturing, chemicals and consumer stocks.

“In manufacturing we’re interested in the auto sector; the consumer discretionary and auto space continue to be strong, [as] chemicals and energy are relatively high inputs in there.”

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He also mentions base metals that use a high amount of energy in production, such as aluminum and steel. “Those do normally pass on energy costs to their clients and is reflected in the price, but at the margin it can be helpful.” The same can happen in the chemical space, “but there is a gap where you’ll see earnings pick up.”

Reynal says the biggest beneficiaries of lower oil prices are consumer stocks, since lower inflation means a lower cost of living.,” So we’re happy to look at low-end consumer stocks across the globe, whether it’s food manufacturers in Mexico or cosmetics companies in India or Korea.”

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