Rising Commodity Prices Bode Well for the Rand and Emerging Markets Assets

The South African Rand outperformed in the last twelve months, fueled by rising commodity prices and a declining US dollar

In April last year, for the first time ever, the clearinghouses let the oil futures price settle below zero. This decision triggered huge losses for some market participants. But from that day, the price of oil rebounded sharply, along with the entire commodities spectrum.

Emerging market economies and their local currencies are strongly dependent on faith in the US dollar because most of the debt issued by those countries is denominated in dollars. Higher commodity prices driven by a lower dollar have led to a rise in emerging markets assets. The South African Rand, for example, had a tremendous rise during the pandemic as the dollar declined.

Emerging Markets Currencies and the US Dollar

One of the investing 101 principles tells us that, to obtain diversification benefits, an investor should add uncorrelated assets to a portfolio. This was easier said than done in a world where all economies were in a recession due to the pandemic, therefore correlations increased considerably.

Emerging economies don’t trust the international financial markets enough to issue their debt in the local currency because investors fear inflation will eat into their future cash flow. Thus, it is preferred to issue debt in a developed country’s currency.

As the world’s reserve currency, most debt is issued in American dollars. When the dollar rises, emerging market economies have a hard time repaying their debt because they have to buy dollars to pay the coupons and principal when due. When the dollar declines, it’s easier for emerging economies to repay their debts.

Rising commodity prices also help, which is why the South African Rand has put in one of the best 12-month performances. It remains to be seen if the trend can continue, but conditions favour even stronger emerging market currencies.