It is hard to ignore the amount of attention commodities have received over the last few weeks, with energy and agricultural prices soaring. A lesser known beneficiary of this trend has been emerging-market equities. For the first time in the last few years, they look ready to move higher.
iShares MSCI Emerging Markets Index (EEM) - Get iShares MSCI Emerging Markets ETF Report , an exchange-traded fund that tracks emerging-market equities around the world, has begun to form a head-and-shoulders bottom pattern that signals a potential reversal higher. The strength has come amid a myriad of factors that had previously held down emerging-markets stocks.
The first changing trend has been the weakening of the dollar. PowerShares DB US Dollar Index Bullish (UUP) - Get Invesco DB US Dollar Index Bullish Fund Report , an ETF that tracks the value of the greenback against other major currencies, strengthened significantly from 2014 until the beginning of last year as investors bet that the Federal Reserve would begin to tighten monetary policy.
Although the Fed has raised rates, continued economic weakness domestically and abroad in 2016 has limited the number of hikes available to policymakers without roiling markets. For this reason, investors are now pushing the dollar lower, viewing previous levels as too expensive.
As the U.S. currency has weakened, commodity prices have been given more room to move higher. Commodities are priced in dollars, meaning that when the dollar weakens, it gives a natural boost to all commodity classes. Although supply and demand factors have contributed price increases in both energy and agricultural products, the dollar has become a tailwind in recent months.
With commodity prices rising, and the value of the dollar declining, emerging-market assets have received renewed interest by the investing community. Many emerging economies are reliant on production of commodities, and thus the health of their economies is tied closely to commodity prices. This has been a negative factor in recent years as commodity prices collapsed. With the reversal in commodities, however, emerging markets are beginning to strengthen again.
Additionally, for U.S. investors, holding foreign assets can be dangerous when the dollar is rising, which traditionally leads to selling pressure on foreign equities. When the dollar rises, it diminishes the return of foreign assets. As the dollar weakens, however, it acts as a tailwind, increasing return potential.
The return of commodity prices, the falling dollar, and the bargain prices of emerging-market stocks make buying ETFs such as iShares MSCI Brazil Capped (EWZ) - Get iShares MSCI Brazil ETF Report or VanEck Vectors Russia ETF (RSX) - Get VanEck Russia ETF Report look attractive.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.