Inside Insights 12 October 2009

Investment Intelligence|Inside Insights

A weekly, in-depth yet concise report on the most important recent market movements and economic developments.

Added on 12 October 2009 @ 9:58 AM

GOLD!

Equity markets advanced last week as the US third quarter earnings season kicked off with the likes of Alcoa, Goldman Sachs and JP Morgan producing better than expected results. But the big story of the week was the spot price of gold surging to an all-time high of $1055/oz, spurred by investor demand for bullion, as the dollar fell to a 14-month low against a basket of major currencies on concerns about future inflation caused by the enormous amounts of fiscal and monetary stimulus injected into the US economy.

With interest rates as low as they are, the opportunity cost of holding physical gold (which pays no income) is also very low. The dollar was also hurt by a rumour that oil-producing countries were planning on pricing crude oil in a basket of currencies, rather that in the dollar (sparking fears that the greenback could lose its status as the world's reserve currency). Lastly, the Fed's commitment to keep US interest rates low, along with a revival in risk appetite, has also led to a pick-up in the carry-trade, with investors borrowing in dollars and investing in higher-yielding commodity and emerging market currencies. The Australian dollar is up 23.4% against the US dollar, the Brazilian real has appreciated 25.3%, while the rand is up 20.4% year to date.

The rand shrugged off the wobble caused by the cancellation of the proposed MTN/Bharti deal the previous week, ending the week 3.8% stronger at R7.35/$. While the higher gold price is, of course, great news for South Africa's struggling economy (SA being the world's third biggest gold producer after China and the US), much of the recent gains from the dollar gold price were eroded by the strengthening rand. Indeed the rand gold price peaked in February and has since lost about 20%. This is one of the reasons why local gold shares have not exactly shot the lights out over the past few years (see graph). Other reasons include rising input costs, deeper shafts, labour disruptions and poor allocation of capital by management.

Manufacturing data disappoints

After the previous week's encouraging purchasing managers' index (PMI) data, local manufacturing production data out last week was disappointing, showing a 15% year-on-year fall in August. The market expected a 11.1% decline, which would have been an improvement following July's 13% decline. Why the discrepancy with the PMI? One reason is that the PMI is based on survey data, and has a forward- rather than a backward-looking bias. Another is that the production data gives a bigger weighting to iron and steel, and motor vehicles, the fastest falling sub-sectors. Lastly, there is a timing difference, with the latest PMI data from September.

Nonetheless, the latest production data is particularly disappointing as it breaks the improving momentum of the past few months. The data confirms that domestic demand remains very weak, and while global demand has improved (as evidenced by global PMI and industrial production data), the strong rand would have eroded much of this impact. The rand averaged R7.93/$ in August, suggesting that further pain could show up in the September and October data (the rand averaged R7.49/$ in September).

Mining production also continued a declining trend in August (-11.5% year-on-year) after posting a surprise increase in July. However, mining production increased by 2.6% in the three months to August compared to the previous three month, meaning there is still some upward momentum. Gold mining production decreased by 2.9% year-on-year in August despite the firm dollar gold price, while non-gold production fell by 12.7%. Declining production of platinum group metals (PGMs) was the main reason behind the latter. Diamonds were also a big contributor to the 11.5% decline, amidst very weak global demand for luxury items. Demand for certain industrial commodities (coal, nickel etc.) has picked up, especially from China, but the stronger rand would have impacted on this area too (the rand having also strengthened against the Chinese yuan, which is pegged to the US dollar.)

The Week Ahead

The only big local data release this week will be August retail sales. Year-on-year growth in retail sales improved from June to July (-6.9% to -3.9%) and the market will be looking for signs that this improving trend continues into August with lower interest rates reducing the debt burden on consumers. Consumer inflation has also slowed down, improving real disposable income (income less inflation) for those lucky enough to get a decent annual salary increase mid-year. However, recent credit data suggests that consumers are still reluctant to borrow (or banks aren't lending), something which will hold back retail sales growth. Rising unemployment will also put a damper on consumer spending, even as the key Christmas season approaches.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights