Inside Insights 7 March 2011

Investment Intelligence|Inside Insights

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

Added on 07 March 2011 @ 10:20 AM

WILL OIL PRICES END EASY MONEY?

Global investors are still nervously eying the oil price as unrest in Libya escalates, while data showed US oil inventories falling. They will also keep a close eye on how central banks respond. Jean-Claude Trichet, the European Central bank president, warned on Thursday that the ECB would be exercising "strong vigilance" on inflation, signalling that interest rates could rise by 25 basis points as early as next month. The ECB has held rates at a record low of 1% since May 2009. In contrast, US Federal Reserve chair Ben Bernanke, testifying before Congress, insisted that accommodating monetary policy would remain in tact. As the prospect of a higher interest rates differential between Europe and America increased, and the euro has strengthened against the US dollar. A weak dollar has historically lead to higher dollar commodity prices, raising even more concerns.

The prospect of more expensive money will be of concern for peripheral European countries. The ‘core' economies of France and Germany are growing strongly and will not be hugely impacted by a rate hike. But Portugal, Spain, Greece and Belgium have inflation above 3% and would be the hardest hit, especially since fiscal policy is also tightening (higher taxes and less government spending).

Unsurprisingly, gold hit fresh record highs last week on safe-haven and inflation-hedging demand. The big swing factor in the oil market remains Saudi Arabia, who has the world's largest crude oil reserves and enough spare capacity to cover lost Libyan production. Saudi authorities have indicated they may increase production to calm the oil market down. However, should unrest spill over to Saudi Arabia, oil prices could spiral out of control.

CONTINUED MANUFACTURING IMPROVEMENT

The local Kagiso purchasing managers' index (PMI) improved in February for the sixth month in a row, edging up to 54.8 from 54.6 in January. The PMI measures activity and sentiment in the manufacturing sector, and any index reading above 50 points indicates that the sector, which constitutes around 15% of the local economy, is expanding. The sector is benefiting from the recovery in domestic spending, while a weaker rand in February would also have helped (so far in March, though the rand has strengthened again to below R7/$). While most sub-components (new sales orders, business activity, expected business conditions, inventories) of the PMI performed well in February, the surging oil price has pushed the prices sub-index to 81.7, the highest level since late 2008. In other words, factories' input costs are rising rapidly.

While the upward trend in the local PMI is encouraging, the local sector is lagging behind other countries'. The JPMorgan global manufacturing PMI was at 57.8 in February. The US manufacturing sector, in particular, gave a very strong reading with the ISM index (the US equivalent of the PMI) hitting 61.4, the highest level since mid-2004. As in South Africa, the prices sub-index reflected a significant rise in input prices which could pose an inflationary risk. However, despite the recent growth of the US manufacturing, excess capacity in the sector is still a problem, meaning that firms cannot really afford to pass costs on to consumers. One country that has been battling inflationary forces even before the recent surge in the oil price is China. The Chinese PMI continued to pull back in February, falling to 52.2 from 52.9 in January. Chinese authorities have been tightening monetary policy (hiking interest rates and bank reserve requirements) in an attempt to fight inflation and cool the fast-growing economy. However, the prices sub-index continued to rise to 70.1 from 69.3 in January, suggesting that further monetary tightening could occur.

THE WEEK AHEAD

• The Reserve Bank releases gold and foreign exchange reserve data for February on Monday.

• StatsSA releases mining and manufacturing production data for January on Thursday. Mining production improved substantially towards the end of 2010, culminating in a 12.2% year-on-year increase in December. Foreign demand for commodities remains strong, and the rand weakened somewhat during January, which would have encouraged increased production. However, the industry continues to be plagued by cost pressure, skills shortages, infrastructure bottlenecks and regulatory uncertainty.

• Manufacturing production declined by 0.2% on a year-on-year basis in December, partly due to the impact of a higher base. As indicated by the PMI (see above), the underlying momentum in the manufacturing sector is positive - though uneven across sub-sectors - and production should grow over the coming months.

Fairbairn Capital | Old Mutual

Investment Intelligence|Inside Insights