Many have compared today’s economic recovery to the slow, stagnant growth Americans lived through in the 1970s. I argue there’s at least one significant difference: Four decades ago, the world couldn’t depend on emerging market growth like it can today.

Take a look at Macquarie Research’s chart comparing industrial production (IP) following the 1970s with the output after the downturn in late 2008. The output during the mid-1970s and today’s cycle looks very similar over the first two years. The decline experienced around the 31-month mark today also mirrors the drop of the 1970s.

However, in 2011, advanced economies fell quicker and steeper than the IP in the 1970s. For the developed markets, the U.S. and Japan have had to bear the extra weight to make up for the lack of the European Union’s output. After the earthquake in 2011, Japan’s IP fell to a low of 90 but quickly recovered. In the chart, you can see that the combined current cycle of advanced economies has remained pretty stagnant following its trough.

Emerging markets came to the global rescue, with “Asia powering global growth,” says Macquarie. Over the past year, the world IP has crept higher than the output during the 1970s. “The emerging world continues to gain share of industrial activity, and continues to grow at rapid rates to keep global growth rates close to a healthy 4 percent year over year rate,” says Macquarie.

Back in the 1970s, emerging markets such as China and Russia had no global footprint and were isolationists. China was just beginning to build its modern economy. The world population back then was 4 billion; today it’s 7 billion. As millions of people in emerging countries are expected to move to urban communities in the coming decade, their governments have been pursuing policies that emulate America and promote growth.

Also read: China—The Great Stabilizer

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

There was a strong reaction yesterday to the elevated debt crisis in Europe, with commodities and equities being indiscriminately sold. Gold fell 3 percent this week, losing its safe haven status as the dollar grew stronger and the 10-year government note headed lower.

The markets generally overreact to negative news, however, investors should keep in mind gold’s normal monthly historical volatility. Throughout the past 20 years of monthly returns, the precious metal generally increased only 0.5 percent in May, and has historically declined in June and July.

Facts don’t thwart the short-term pain, yet as contrarian investor Baron Rothschild said, “the time to buy is when there’s blood in the streets.” Here are five reasons we believe today’s sell-off sets up a buying opportunity for gold:

1. It is precisely the debt strangling the eurozone which will drive gold demand over the longer term. The side effect to the abundance of printing by central banks in the U.S., Europe, Japan and England is bloated balance sheets amounting to nearly $8 trillion. This is double the amount that it was only three and a half years ago.

   

2. Several developed markets have negative real interest rates and these rates are anticipated to remain negative for years to come. Historically, when the inflationary rate is greater than the current short-term interest rate, gold prices rose.

   

3. Emerging market central banks continued their gold buying spree in March. UBS Investment Research says that Mexico bought 16.8 tons, Russia bought 15.6 tons and Turkey added 11.5 tons. Additional small purchases were made by Tajikistan, Kazakhstan and Belarus. We wrote a few months ago that central banks have begun accumulating gold reserves since the Federal Reserve cut interest rates in 2007, and HSBC Global Research expects this buying trend to continue for another five years.

   

4. In March, China’s gold shipments grew to 62.9 tons, which is the third largest volume of gold in a decade from Hong Kong to the mainland, according to UBS. With ongoing rising demand, China may overtake India this year as the world’s largest gold buyer.
5. India’s government abolished the excise duty on gold jewelry. This was one of the reasons for the jewelers’ strike, which drove gold imports to decrease 55 percent in India a few months back. Getting rid of the tax should encourage the restocking of gold and bring Indian gold buyers back to the market. UBS reported on May 9 that Indian buying on yesterday’s dip was nearly twice the average daily volume and the “strongest since April 17.”

Over the past decade, these Fear Trade and Love Trade drivers have spurred gold higher, even as the yellow metal experienced short-term corrections along the way. Only hindsight could show how these corrections set up buying opportunities.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

Since the stock market’s gate opened at the beginning of 2012, emerging countries were off to a fast start. Stocks in Brazil, Colombia and India galloped to the lead, increasing more than 10 percent within the first few weeks of the year.

By the time the end of April came around, Colombia had sprinted to the lead, followed closely by Thailand and the Philippines. All increased more than 20 percent in the first four months of 2012.

However, rather than focusing on the leaders of the pack, spectators seemed to have directed their attention toward the S&P 500 Index, as it galloped to its best first-quarter gain since 1998.

The recovery in U.S. stocks is significant and helps restore confidence in equities. We’re pleased to see markets improving, especially following a rough finish in 2011. Yet there lingers a persistent negativity toward emerging markets growth and commodities that prevents many investors from jockeying their portfolios into a position for growth. Rather, they remain spectators on the sidelines, with equity fund outflows continuing.

In contrast, Eastern Europe exploded on the upside and far outpaced not only the U.S. market, but also Europe. The chart below shows investment results across three different markets. Since the beginning of the year through April 30, the iShares S&P Europe 350 ETF has trailed, while the SPDR S&P 500 ETF has placed second. Among these three investments, the Eastern European Fund (EUROX) has kept the lead for most of the quarter and took first place as of April 30.

You can see above that EUROX and the European market were climbing steadily since the beginning of the year, but by April, began to fall because of the eurozone’s debt grief and concerns over China.

Over the past four months, Russian stocks, which are heavily weighted in energy companies, have underperformed many emerging markets, increasing only about 6 percent. HSBC Global Research believes that the low valuations seem to be “pricing in a lot of political risk” surrounding the protests against Russia’s newly elected presidential candidate. Investors need to see the opposition movements against Vladimir Putin as very different from the Middle East discontent, says HSBC. The firm says Russia’s protests are “largely liberal” without “religious dimension” which suggest future reforms to reduce the political discontent are more likely.

HSBC also thinks that the government will try to improve the investment climate. Putin suggested in a recent speech that he would like to increase Russia’s rating in the World Bank’s Ease of Doing Business report. Currently, Russia ranks 120th; Putin would like to set a goal of 20th place.

What may be hurting investor sentiment toward Russia in the short term is the political strain that has recently surfaced between Russia and the U.S. and NATO involving missile defense installations in Europe. This is precisely the reason we believe investors need to hold actively managed investments with experts who understand the political situation to skillfully maneuver around emerging Europe.

China, the Workhorse of the Global Economy
While China did not win, place or show among major markets during the first few months of the year, its H shares gained nearly as much as the S&P 500. Yet, the negativity that I’ve frequently discussed continues, even though the country is the Clydesdale of our global economy.

In the first quarter, China’s GDP growth was 8.1 percent, a likely trough for the year, according to a Merrill Lynch-Bank of America conference call recently. The firm listed several reasons that China will see an improved GDP over the next three quarters:

1. Although spring made an early appearance in many parts of North America, this past winter in China was the coldest in 27 years. This extremely chilly weather slowed down economic activity.
2. Credit growth has bottomed out and bank lending has been reaccelerating. BCA Research echoed this thought in its China Investment Strategy this week, saying there’s been a “sharp turnaround in bankers’ confidence in recent months, which is also being reflected in rising bank lending of late.”
3. Home developer price cuts and lower mortgage rates offered to first-time buyers have driven a significant recovery in home sales. In our recent webcast on China, Andy Rothman from CLSA made some excellent comments related to mortgages, agreeing with ML-BofA, saying that each month it was getting easier for new home buyers to get mortgages, and along with lower interest rates for mortgages, this was a clear sign of “the government’s process of easing up on the housing sector.”
4. With leadership transition close to conclusion, local infrastructure construction activity is poised to increase.
5. As shown below, crude steel, steel products and cement output has shown initial signs of recovery in the recent month.

While China’s Government Purchasing Managers’ Index (PMI) for April came in slightly below market consensus, the number remains above the three-month number for the fifth consecutive month since December 2011. We believe the government’s PMI is a far better indicator of overall manufacturing activity than the HSBC data because it takes into account domestic demand.

From the PMI’s inception in January 2005, the majority of the time the PMI is above the three-month average, Chinese and U.S. stocks, as well as copper and WTI crude oil, all see gains over the following three months. So far this year, each has proved true.

BCA Research says that the latest PMI substantiates that the “Chinese economy may be reaccelerating,” pointing to three trends: Monetary easing is working, external demand seems strong and may be accelerating, and the government has increased fiscal expenditures on social housing and infrastructure projects, which is supportive of ML-BofA’s view above.

The race in the stock market isn’t over until it’s over. While a top contender may ultimately win in the Run for the Roses, the assumed “long shot” might come from behind and race to first place. Rather than place all your money on the market you believe will win, place or show, we believe diversification among markets is the way to go.

Which countries are you betting on to top markets in 2012? Email us at editor@usfunds.com.

See Our Popular Periodic Table of Emerging Markets.

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