Inside Insights 15 June 2009

Investment Intelligence|Inside Insights

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

Added on 15 June 2009 @ 12:00 PM

A familiar feeling as oil climbs again

Insights 15 June 2009_Brent crude oil price

The crude oil price has been shooting up again, reaching the level of $72/barrel last week. On the one hand, this has raised concerns that it could eventually lead to a spike in world inflation; especially given how low interest rates are currently. A rising oil price also acts as a tax on consumers and businesses, and thus threatens to derail the fragile economic recovery. On the other hand, the oil price seems to be rising precisely because of that recovery. To being with, while the oil price of $147/barrel might have been out of line with the fundamentals of supply and demand for petroleum, so was a price of $37/barrel, which is the level crude oil plunged to in December. Given factors such as insufficient new production capacity and OPEC's ability to manipulate output through quotas, plus a sliding dollar, oil at $37/barrel was simply too cheap. On the demand side, this week also saw news out of the US that oil inventories declined unexpectedly. The International Energy Agency noted that it had raised its demand estimates for the OECD countries, the world's richest economies. It also noted that some of the activity in the oil market at the moment might be speculative, which means we could see a pull-back from current levels. Strong support for this ‘green shoots' camp came from US retail sales which rose in May for the first time in three months, while initial jobless claims have also continued to decline to ‘only' 601000 a week. Meanwhile, China's economy seems firmly on the road to recovery, with industrial production and retail sales jumping by more than expected in May, at 8.9% and 15.2% month-on-month respectively.

Equity markets seemed mostly unperturbed by the rise in oil prices, and risk appetite remains generally high, as evidenced by the rand briefly strengthening to below R8/$ again on Thursday. In other words, most market players seem to be buying into the idea that the oil price is a barometer for the improving health of the global economy.

Export sectors continue to bleed

Inside Insights 15 June 2009_SA Manufacturing sector

The manufacturing sector had another dreadful month in April, but the high number of public holidays during the month was a key contributor to the 21.8% year-on-year fall in production. The motor vehicles and parts industry was particularly hard hit, declining by 49% during the month compared to April 2008. Mining production also felt the impact of more public holidays. Mining production in April fell 10.6% year-on-year, accelerating from March's -4.6% year-on-year figure. Global demand conditions also continued to weigh on mining production, as evidenced by the diamond sector's -61.5% year-on-year decline.

The further contraction in these two key exporting sectors will further highlight the issue of (perceived) rand strength. Put simply, a rand that is too strong will reduce the export competitiveness of these sectors. This has led to calls for the Reserve Bank to intervene on foreign exchange markets. Doing so will conflict with the Bank's primary mandate, given that a strong rand will help it to contain inflation, and also given the lessons learnt from previous attempts at intervening (although during that episode in the late 1990's the Bank tried unsuccessfully to stop the currency from depreciating, not appreciating). But Governor Mboweni has indicated that the Bank would build its foreign exchange reserves. This suggests that, while they won't intervene to dramatically weaken the rand, they would purchase forex when the rand is strong, possibly preventing it from strengthening further. The weak data out of the manufacturing and mining sectors should also convince the Bank's Monetary Policy Committee to cut interest rates once again when they meet later this month.

Fairbairn Capital | Old Mutual

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