My Personal Strategy for Investing in the Emerging Markets

Let me level with you. This year has been real doozy for the emerging markets.

Rising inflation and unrest in the Arab world have seriously spooked emerging market investors.

This is reflected in the chart below. It plots the iShares MSCI Emerging Markets ETF (NYSE:EEM) against the S&P 500.

As you can see, the MSCI Emerging Markets Index (red dashed line on the chart) started to dip below stocks in the S&P 500 (green line on the chart) in January. And last month a big gap opened up between the two indexes.

The question many readers want to know is: What should you do about it?

I want to share with you the strategy I’ve been using this year to profit from the emerging markets despite the relative weakness in emerging stocks.

But first a word on investing psychology.

Most amateur investors think stock picking and market timing are all there is to investing. This is utter nonsense.

Stock picking and market timing are probability games. Every investor tries to pick stocks that are going to go up, and buy and sell them at the right moment. But the truth is you’re never going to get these calls right all of the time.

Nobody does.

The best you can hope for is to be right most of the time. And even that takes a huge amount of work and good fortune.

What separates successful long-term investors from investors who lose money in the markets over the course of their career is an understanding of the importance of investing psychology.

And rule #1 is: Your emotions have no place in your investing decisions. If you let fear and greed guide you, don’t be surprised if you end up taking on major losses.

Seasoned investors understand that markets correct from time to time. And you need to be able to handle them when they come along.

In fact, according to emerging markets veteran Marc Faber, “If you can’t handle a 30% correction when you buy something, don’t even get out of bed in the morning.”

Now, we haven’t seen anything like a 30% correction in emerging market stocks. The MSCI Emerging Markets ETF, EEM, is down just over 6% from its 52-week high. But even a correction of this size is enough to shakeout some rookie investors.

So the first thing I’d say is don’t let fear shake you out of your emerging markets positions. The emerging markets are still far outpacing the U.S., Europe and Japan in terms of GDP growth. And they’re in much better shape in terms of their national debt loads.

How to Capture Emerging Market Growth in 2011

That said, my preferred strategy this year is to steer clear of the broad emerging market stock indexes and focus on the rising demand for natural resources that’s being driven by growth in the emerging economies.

As you can see from the chart below, commonly traded commodities (as measured here by Thomson Reuters/Jeffries CRB Index) remain in an impressive uptrend despite weakness in the big emerging market stock indexes.

And according to a new report by the Organization for Economic Cooperation and Development, increased global demand, not speculation, is responsible for the rise in wheat, sugar, corn, cotton, metals and other commodities that we’ve been seeing lately.

The truth is that as resources are becoming scarcer, more and more people in the emerging markets join the ranks of the middle class. And this trend is not about to end anytime soon.

Consider adding commodities exposure to your global portfolio. Oil and oil stocks are looking particularly tempting right now, as macro forces and supply and demand dynamics drive oil prices higher.

One easy way to add exposure to international oil stock is through the SPDR S&P International Energy Sector ETF (NYSE:IPW). This tracks a basket of European, Canadian, Australian, South American and Asian oil stocks. And it’s close to breaking through its 52-week high.

The emerging world is hungry for oil. And the companies tracked by IPW are ready to fill that need.