The weekend brought a sobering warning from the Bank for International Settlements, which suggested that the emerging markets are facing their own version of the boom and bust cycle that brought the developed world to its knees three years ago.

As we have observed, many developing countries benefitted from substantial foreign capital flows in recent years, as exports soared and overseas investment poured in. Emerging markets as disparate as Turkey, Thailand, Brazil, Indonesia, Argentina, and China saw credit balances expand more quickly than gross domestic product.

In its annual report, the BIS highlighted the fact that this has left many sectors vulnerable to a change in external financing conditions, and elevated the risk of a widespread emerging market bust.

In a sense, the Bank's warning may have come too late.

Over the past year, many emerging markets began to sink beneath the waves. Growth rapidly decelerated as exports fell and rich-world investors withdrew their capital -- putting borrowers and financial systems under severe stress.

The real, ruble, and rupee are all among the world's worst-performing currencies this year, and the yuan has also weakened.

Sentiment on the emerging markets has soured, and bulls have lost enormous amounts of money in the process.

However, it is important to note that many governments built extensive defenses after the Asian currency crisis in the late 90s, and are now better prepared to weather changes in global economic conditions. With direct control of lending institutions and access to vast foreign exchange reserves, they are positioned to pump money back into the system -- and offset capital flight.

These defenses are not impregnable, but they should ensure that the Bank's worst fears go unrealized.

Further weakness in the emerging markets is very likely: expectations and investment flows have simply been too high for too many years. Disappointment was inevitable, and substantial risks still exist.

Some of the most important risks lie in the commodity currencies. We may be seeing the end of the hard commodity supercycle that has dominated market activity over the last decade. Without accelerating emerging market growth to underpin speculative bets, the case for further upside has been materially weakened. Currencies like the Canadian dollar and the Aussie have room to slide.

Interestingly, soft commodities face a more complex outlook. As the flow of money into the emerging world slows, and households take the reins from credit-fueled businesses, appetites will change -- literally. We may be seeing the emergence of a longer term soft commodity supercycle.

If so, the implications for currency valuations will be significant. Watch this space.

The BIS report is well worth reading. Email us, and we'd be happy to forward you a copy:

Have a great week!