I reported a few days ago on my recent interview with the South African media on a number of issues regarding the global economy and markets. This post provides the second part of the interview, focusing on the rand and the South African investment outlook.
Not so long ago some economists were punting the U.S. dollar to move below R6 but we saw the rand (ZAR) under severe pressure lately, with the U.S. dollar rising to R8.50 at some stage. What went wrong? Have investors lost faith in South Africa due to talk of nationalization?
PdP: The fall in the value of the rand should be seen in the broader global context. The current debt crisis in the Eurozone and the likelihood of Greece defaulting on its sovereign debt, together with a collapse in U.S. business and consumer confidence as well as the stalling of global manufacturing production, have led global investors to cut their exposures to risk assets.
Emerging markets are on the receiving end, resulting in a flight of capital out of emerging economies to significantly lower risk assets such as hard currencies and mature-market bonds. Yes, some emerging markets such as China have been unaffected thanks to an effective peg of the yuan against the U.S. dollar. But others, especially those that are highly dependent on commodity exports such as South Africa, are taking the heat with their currencies depreciating in unison against hard currencies. So, while the nationalization debate may be to blame to some extent, this time around it is a global phenomenon.
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How far will the rand drop or have we seen the worst?
PdP: Our studies indicate that the rand is currently correctly priced given the global anxiety or volatility levels that we measure. If global capital becomes more concerned about the global economy or another black swan emerges from somewhere, anxiety levels could approach those during the peak of the great liquidity crisis of 2008/2009. In that case I will not be surprised to see the rand trading above 10 against the U.S. dollar.
I do, however, think that 8.50 may have been a bottom of the rand in the short term. I base this on our research that indicates risk assets such as U.S. equities are again approaching value territory that will attract major market players. In the past, low valuations led to anxiety or volatility levels dropping gradually afterwards. Do not be surprised to see the U.S. dollar falling back to the R7 level in coming months. But, as I said, there is a real risk that the U.S. dollar may peak at above R10 should the current global financial crisis take a turn for the worse.
Inflation – here we come!
PdP: Unfortunately, yes. Fuel prices will rise strongly, as will the prices of other imports. Worst of it all is that the rand prices of foodstuff we export will rise, resulting in the domestic prices rising as well.
But a weaker rand is not all bad to us, is it?
PdP: Excellent point! In my opinion we lived in a false sense of comfort with an overvalued rand trading below its purchasing power parity of approximately 8 to the U.S. dollar due to short-term foreign capital inflows. Yes, we may have benefitted from lower inflation rates as a result of the inflows but they had a severe impact on job creation in this country as industries had to close doors or cut staff. What we need is long-term capital inflows and a reasonably competitive currency instead of fickle short-term capital inflows that are there when it suits them and gone the very next day, as the current global crisis has demonstrated again.
If the Monetary Policy Committee of the SA Reserve Bank wants to make a serious statement that would be beneficial to all and especially with the aim of upliftment through job creation, the time is now. Such a statement could entail a peg to the euro or U.S. dollar.
The weak rand is also benefitting domestic investors who invested abroad?
PdP: Yes, investors in funds that invest in developed-country equities have at least retained their rand values while those invested in foreign bonds got the benefit of rising bond prices in terms of hard currencies plus the rand depreciation. But investors in domestic equities have benefited as well, as the dual-listed foreign companies on our market and primary rand hedges such as resource-related equities have stemmed the decline.
What asset classes do you prefer at this stage of the crisis and which are your least preferred?
PdP: I prefer a well-balanced domestic equity portfolio at this stage with a composition similar to the weightings of equities in the FTSE/JSE All Share Index. The latter is again offering value but I like to keep some powder dry and retain hedges and some foreign equity exposure as there is a real threat of a further major pullback in equity prices and the rand if the crisis deepens. My least preferred assets are listed domestic real estate (particularly offices and retail) and bonds in the developed countries.
What about gold?
PdP: Gold was perhaps the major beneficiary from July when anxiety levels started to rise. It climbed $400 from the end of June to peak at $1900 in early September but has given back $250 since. The action is similar to what happened in 2008 when the top of anxiety in financial markets coincided with a major sell-off in gold. I still like gold in the long term, though.
When financial markets imploded in 2008 I got scared and took cash offshore at the worst levels of the rand. The collapse of the rand this time around is easing the pain somewhat but I am still significantly down on my investment. What must I do now?
PdP: I think you ought to think of why you took the money out in the first place. If it is part of a well-balanced portfolio you should consider it in that way. My advice would be to retain it at the moment, especially in light of the possibility of the crisis deepening. If your decision was a once-off investment abroad to protect you from further depreciation of the rand, I suggest you reconsider your investment.