How commodities can juice bond returns

Natural resource-driven countries are going to benefit from an expanding global economy and so too will their currencies. As the currencies rise, bondholders get a boost.

In the foreign exchange market, commodity currencies are usually associated with developing countries—such as the South African rand, Brazilian real, and the Chilean peso.

Of these countries, Brazil and Chile are expected to flourish most in the current global economy.

“Their currencies are commodity-based, causing their valuation to rise as the global economy improves,” says Patrick Bradley, product specialist, global fixed income at Brandywine Global Investment Management, which manages the Renaissance Global Bond Fund.

Chile’s growth will be driven by its copper production; the metal is very sensitive to economic activity and will be a source of opportunity as global growth picks up.

Brazil, already benefiting from a boom in biofuels and manufacturing, has recently discovered oilfields off its coast.

Bradley is confident that any demand for these countries’ commodities will boost the currency. For example, if China wanted to buy Chilean copper, it would have to settle the contract by buying the Chilean peso. As a result, the value of the peso would increase as well.

“We are focusing on commodity-based currencies and favour commodity based countries,” says Bradley. “An economic upturn is inevitable and these countries will benefit.”

He recommends holding Chinese currency as a long-term play, but the market for

Speaking of China, he admits that it represents an attractive long-term investment, but because Chinese bonds are relatively illiquid, they pose problems for global bond managers. Instead, he had held the currency to gain exposure to the growing economic giant.

“We’re not looking at a Chinese economy that is concerned about its growth prospects,” he says. “China is not going to experience average economic growth of 10% per year, as it had been.”

That suggests to him the yuan will not rise much in the near future, as policymakers are more interested in sparking renewed growth. To achieve this, reserve requirements for banks have been relaxed.

“It’s managed currency,” he says. “Chinese policymakers are not going to allow their currency to increase in value because that would raise the cost of Chinese exports, relative to, say, Mexican exports.”

As a result, he has closed out his holdings in the yuan.

He adds, “Since appreciation is not expected over the short term, China is a country that we’ll only look at again in the future.”