Key Highlights

• Precious metals continue to weaken as yields react to inflation.
• Rate hike pricing is weighing on the precious metals and industrial commodity theme.
• EM high-yielders could provide some shelter, but pressure to hike will grow.

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FX: Direct precious metals proxies are clearly struggling

EXHIBIT #1: WEEKLY SMOOTHED FLOW, PEN AND ZAR 

_Source: BNY

Our take

Precious metals continue to decline as global yields push higher amid inflation expectations. At the beginning of the year, when gold and silver prices were surging, the main thematic driver was so-called “debasement.” Concern about global easing, despite evident supply pressures (mostly in labor markets), fed fears that real rates would run too low relative to core inflation. Therefore, precious metals and even industrial commodities were considered the best hedge.

There’s some inconsistency in current price action: moves in industrial metals would have gradually fed through supply chains, generating headline inflation effects. But market behavior now underscores the importance of sequencing when choosing inflation hedges. During the January metals surge, prices were reacting to policy that was too loose – inflation was the consequence. Now, a sudden supply shock is driving headline inflation and triggering the stronger policy response that was absent earlier in the year. This is leading to a different reaction function in markets.

Forward look

In FX markets, ZAR (platinum group metals and gold) and PEN (silver) are the best proxies for precious metals, while other LatAm currencies have also benefited from gains in industrial metals. ZAR and PEN both saw a strong purchase phase toward the end of January and early February on the back of stronger terms of trade. Both currencies benefited from central banks with credible inflation-targeting frameworks at the time. However, flows have materially declined, and there was clear liquidation during the most intense phases of the conflict. Interest is currently flattening, and both currencies risk joining the broader liquidation in carry names.

Much will depend on how the dollar behaves. Markets are repricing the Fed, away from easing and toward tightening. If future decisions disappoint and markets shift back into a poor real-rates environment – independent of the inflation drivers – then the associated trades in FX and elsewhere could return.

Equities: LatAm finds bids, but metals and miners falter

EXHIBIT #2: EM AMERICAS AND GLOBAL METALS & MINERS (GICS L3) EQUITY FLOWS

_{Source: BNY}

Our take

Before the U.S.–Iran conflict, as silver prices surged, PEN was heavily bought and Peruvian equities led global equity performance. Peru’s holdings figures were even stronger than the semiconductor-driven themes of South Korea and Taiwan – until the conflict knocked the “debasement” theme off course. iFlow shows LatAm equities and metals and miners globally (GICS Level 3) performed exceptionally well in the run-up to the conflict. A divergence is now emerging: national-level equities continue to hold up, but metals and miners face a more difficult situation. Precious metals and industrial metals may yet see price gains due to supply constraints – from production in the Gulf being taken offline to transportation issues. Aluminum producers are one of the best examples.

There are other AI-related secular factors that are boosting copper prices. However, since metals and mining is an energy-intensive industry, the cost base is rising too – especially compared to pre-conflict levels, when the world was still facing an oil glut. Equity investors may worry about headline inflation, but if energy is the main driver, margin protection is cleanest within the sector – no need to diversify into finished goods or non-energy raw materials whose extraction costs are also climbing.

Forward look

LatAm economies are also exposed to higher energy prices, but there’s a clearer case for terms-of-trade improvement due to better supply resilience and increased demand for their own raw exports. This helped LatAm currencies withstand the shock from the first weeks of the conflict. There’s even a case for stronger real rates: currency resilience reduced imported inflation, while regional central banks largely held firm. Consequently, the region is still seeing strong inflows into equities, but we’re mindful that equities normally have an inverse relationship with real rates. The region’s policymakers had plenty of capacity to cut, but that was swiftly eroded by the global rise in inflation expectations. Corporates and households will face tight financial conditions in the near term. If this starts to weigh on earnings, we’d expect some softness or at least a pickup in currency hedging.

Fixed Income: EM credibility holds, but the Fed is the test

EXHIBIT #3: MONTHLY SMOOTHED FLOWS, EM SOVEREIGN AND CORPORATE CREDIT

_Source: BNY 

Our take

The flip side of pushing real rates higher is a more favorable environment for duration to perform. LatAm government bonds and much of EMEA benefited from a good real-rate profile in Q1, whereas APAC was expected to rely more on currency gains than rate hikes to achieve the same disinflationary effect. The conflict has upended all the usual drivers, but there’s no sign yet of a comprehensive exit from either sovereign or corporate EM bonds. We have highlighted how developed-market sovereign debt is seeing good domestic inflows, as long as breakevens remain anchored. Given EM real rates have enjoyed a higher starting point, domestic demand will likely remain high, but international demand may soften as onshore duration grows more attractive.

We generally see EM Americas and EMEA fixed income continuing to perform well, with scope for a further lift if APAC leans more on domestic savings while pushing for currency strength. However, we believe a more hawkish profile is needed, especially in Southeast Asia, where energy-based inflation pass-through is stronger.

Forward look

For EM bonds, the biggest challenge will likely arise from U.S. policy, as is typical in global cycles. Initial EM bond holdings were built on the prospect of lower U.S. real rates – a theme that lifted assets globally in Q1. Similar to our concerns over precious metals-related positions, a sudden tightening in U.S. financial conditions would sharply curtail the initial advantages in EM duration. Coupled with an even stronger dollar, financial conditions will tighten across the board and threaten flow performance.

We are closely tracking global corporate credit, but alignment with sovereign debt is quite robust. The bar for market talk of Fed hikes is high, but challenges will escalate if supply pressures persist and EM central banks are forced to follow the Fed, with clear implications for duration.

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