...The greatest threat to the emerging markets is China, where a crash landing would have far-reaching implications beyond Asia. We could then expect global risk appetites to plummet, emerging market currencies to fall and interest rates to rise - and the dollar to strengthen. A number of factors tend to precipitate emerging market crises. A slowdown in the global economy, falling global liquidity, rising interest rates in the US and a crisis in a specific country that spills over to other emerging markets. Conditions for such a market dislocation are now falling into place.
..snip..
A rising dollar is likely to have negative ramifications for both gold and emerging markets over the same period. Further, the likely increase in downside volatility for emerging markets could be expected on account on unwinding of "reflation carry trades" by hedge funds as well. A significant portion of these market participants has funded their investments in emerging markets - stocks, bonds and currencies - along with commodities by borrowing at low interest rates in the US. The primary assumption is that the underlying asset for this trade (emerging market stocks) would give superior returns and this along with emerging market currency gains would provide a healthy carry (after netting out the cost of funding) as profit. Unfortunately, a likelihood of dollar appreciation, a poor environment for commodities and emerging markets and rising interest rates in the US are forcing these funds to have a re-look.
While an appreciating dollar is a big enough reason for commodities to decline, it is not the only one. Interest rates and import of primary raw materials from major consumers also have significant power in explaining commodity movements. One such attempt to explain commodity movement is a plot between the metals lead indicator along with the growth in the CRB metals index.
It is evident from the chart that the leading indicator does a fair job in predicting the growth in the metals index with a lead time of six to 12 months (see the shaded regions). The lead indicator takes into account global monetary conditions, global exchange rate policy and the import of primary raw materials by China.
It is evident from the chart that metals look set for a significant setback as global growth slows. Analysis of the CRB-raw materials index suggests similar results. Further, an increase in spreads in US high-yield bonds over US Treasuries by more than 50 basis points over the past month is suggestive of increasing risk aversion. The bottom line: investors are finally starting to dump riskier asset classes such as commodities and emerging markets in favor of much safer assets. Does the downward trend in commodities signal an end to the rise in crude oil, at least cyclically? Most likely. With rising crude oil inventories in the US and elsewhere, and potential increases in the same due to a global slowdown in growth, it is likely that crude oil has peaked for some time till financial conditions become more sanguine for a pickup in global demand.
Doesn't a decline in crude oil merit another round of rallies in stocks worldwide? Sounds logical, but unlikely. Studies suggest that a rise in crude oil prices is driven primarily by increasing demand, as supply remains relatively static (as global oil production has more or less peaked in 2005). Therefore, a slowdown in global demand is likely to result in a setback for both stocks and oil. Historically, the most important peaks in the S&P 500 have coincided with peaks in crude oil as well. Sounds counter-intuitive but true. This is bad news for Middle East stock markets, which looked set to peak in the first half of 2005.
The world economy has been kept afloat by the aggressive expansion of the US budget deficit and Chinese investment growth. Any reversal in these two trends has pretty serious outcomes for the rest of the world.....>
http://www.atimes.com/atimes/Global_Economy/GD22Dj01.html
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