Courtesy of The Financial Times, an interesting article on how the upsurge in commodities has resulted in over performance in a number of markets:

Ten years ago the mood among emerging market investors was one of despair. After a series of crises, EM equities had gone nowhere for a decade.  All they seemed to offer was risk without reward.

The rebranding of the asset class as Brics was welcome and timed the bottom of the market perfectly. However, the cyclical upsurge in commodities has been so powerful that it has revealed a split in both emerging and developed markets: commodity producers – EM and DM – have outperformed in equities to such a degree that it is time to reorganise our labels. Out with the Brics and in with the Carbs.

We believe that for equity investors the world is most usefully divided into three groups of markets: high-growth emerging (such as China and India); low-growth developed (the US, Europe and Japan); and commodity producers both DM and EM – headed by Canada, Australia, Russia, Brazil and South Africa – which we will call the Carbs.

Emerging markets are able to grow rapidly and consistently from a low base; developed markets are mired in debt and face the prospect of a lost decade; the Carbs are driven by the commodity cycle.

As recently as 2003, Russia had a GDP per capita of just $3,000, Brazil was still emerging from crisis, and Australian GDP per capita was just 70 per cent of the US’s. After many years of low commodity prices, commodity economies were largely off investors’ radar screens and many seemed to struggle from one crisis to the next. They made up as little as 5 per cent of the MSCI global equity index and their total GDP added up to barely a fifth of the US’s.

The commodity cycle has changed all this, transforming economies and markets out of recognition. If we look at the five largest commodity producing countries with liquid markets (the Carbs), their GDP has increased fourfold from $2tn to $8tn since the start of the commodity cycle in 2003, while the real value of their currencies against the dollar has nearly doubled. Governments have paid down debt, built up reserves of over a trillion dollars, and face the current crisis in a much stronger position than the developed markets. Equity markets are up fourfold on average, and daily trading has increased twentyfold.

The Carbs now account for 12 per cent of the MSCI Global equity index and their GDP is equal to 52 per cent of the US’s.

The key driver of this was the change in the price of their key export commodities, up between 280 per cent (for oil) and 520 per cent (for iron ore) over the period. These price changes – and the volume growth that followed as spare capacity was put to work – are sufficient to explain the earnings growth of the commodity stocks as well as the real currency appreciation and half of the earnings growth of the domestic sector.

The performance of the Carbs’ equity markets has followed the commodity cycle, and has far outpaced those of Asia and the US. Moreover, the Carbs economies have enjoyed many similar drivers as consumption has tripled, housing prices have doubled, manufacturing has been damaged by ‘Dutch disease’, and unemployment has fallen.

Thanks to this transformation, we believe that the Carbs have emerged as a separate asset class: countries where the commodity sector makes up a large share of GDP and the equity index and the currency is linked to commodity prices. Between them, the five Carbs alone control 29 per cent of the world’s landmass (with only 6 per cent of global population) and are responsible for the production of between a quarter and a half of most commodities. Taking fairly conservative valuations, we calculate that the value of the commodity assets of the Carbs is nearly $60tn, over seven times the level of their GDP. The list could easily be extended to include other commodity-exporters including Saudi Arabia, Chile, or Kazakhstan.

However, the investment story for the CARBS is changing as the commodity cycle matures. We believe that the era of rapidly-rising commodity prices is now over as global economic growth slows; the story has moved on to volume increases, with Brazil and Canada planning to double oil production, and Australia to triple gas production, over the next decade.

The opportunity thus lies in infrastructure companies that will make this possible, in those commodity companies able to exploit the growth, and in non-tradeable services such as retail and banking in markets where these sectors are underdeveloped such as Russia or South Africa.

The risk to this asset class is of course that commodity prices fall significantly. But here we believe investors should make a distinction within the markets. If China shifts from infrastructure to consumption, from building roads to driving on them, then we anticipate outperformance from the energy markets of Russia and Canada.