ZAR the facts
The Rand tends to command a lot of coverage and in our experience can severely impact an investor’s outlook based on the short term trajectory.
It seems quite difficult to convince someone to externalise funds when the Rand is very strong but there aren’t too many objections when it goes through a difficult period. Just to avoid any disappointment, this article will not attempt to forecast the short term movements of the Rand as it is an impossible task and largely a guess. What we will do is try and provide some context to the movements of the Rand in recent years, and give you some insight into where the Rand is going long term, without getting caught up in the emotion dominating the current news cycle.In order to objectively view what has happened to our currency we must start at the beginning or near enough (to our mind), which the chart below attempts to do.
The “beginning” is a debatable departure point, but from near parity to now gives us a sense of the long term devaluation. Why we say it’s debateable is largely due to the fact that the economy today, which benefits from global trade. is severely different to the isolated economy of the 80s. South Africa operates within a flexible exchange rate regime, the value of the Rand, like any commodity, is determined by the market forces of supply and demand. The demand for a currency relative to the supply will determine its value in relation to another currency. In theory, the demand for a floating currency (Rand) and hence its value changes continually based on a multitude of factors, many of which are beyond our control.The main determinants of a currency’s value include demand for a country’s goods and services. This is closely linked to the growth and national income of its main trading partners.
Domestic interest rates and a buoyant stock market have the potential to attract foreign capital, causing the exchange rate to strengthen, but can work against the Rand when the opposite is true. There are a number of other factors that can impact the short term movement, but long term, the inflation rate differential with that of our major trading partners should ultimately determine the direction our currency moves.
The above chart shows long term depreciation which is consistent with our average rate of inflation relative to a developed markets like the US.Since 1970 the Rand has devalued by approximately 6.5%, the 10 year number is slightly less around 5.6% and the 5 year number again nearer the 6.5% mark. The last 3 years have been considerably worse, averaging around 13% but when you consider the 15 year number still sits around 4.4% as illustrated in the chart below, it is understandable that the short term number is largely addressing a prolonged period of unprecedented Rand strength between 2007 and 2011. This was closely correlated to a raging stock market attracting foreign buyers. As valuations lost appeal and inflows dried up, some natural order was restored.Although the long term numbers suggest a fair degree of predictability around the Rand, the short term numbers create a high degree of anxiety and can contribute to the general sentiment in the country at any point in time. Short term predictions are impossible and in addition to that, being a small emerging market, means we are easily caught up in the ongoing troubles of the world and other smaller emerging market economies like ours.During the course of the last 11 years the Rand has suffered 10 major collapses, a large number of which were a result of external factors. We have briefly listed these below:
47% Global financial crisis From 29 September 2008 (R8.05) to 22 October 2008 (R11.87)
5% Fallout of global financial crisis From 9 February 2009 (R9.53) to 5 March 2009 (R10.73)
25% Eurozone crisis From 28 July 2011 (R6.62) to 22 September 2011 (R8.49)
2% Grexit fears From 3 May 2012 (R7.69) to 1 June 2012 (R8.71)
4% US Fed contemplates the end of quantitative easing 6 May 2013 (R8.91) to 11 June 2013 (R10.37)
7% Nenegate From 9 December 2015 (R14.51) to 11 December 2015 (R16.05)
7% Chinese market turmoil From 6 January 2016 (R15.62) to 11 January 2016 (R17.92)
2% Pravin Gordhan arrest rumours From 19 August 2016 (R13.17) to 31 August 2016 (R14.65)
3% Pravin Gordhan fired From 27 March 2017 (R12.31) to 11 April 2017 (R13.96)
0% Turkey turmoil From 9 August 2018 (R13.41) to 13 August 2018 (R15.55)
When reviewing the above list of events, you will note that only 3 were a direct result of actions or decisions taken within South Africa. Whilst this does not help an already difficult situation, the reality is that our currency is still likely to be subjected to severe bouts of volatility.
With all investment decisions, one must accept a degree of volatility in order to generate above average returns and when additional volatility is expected, one should be compensated with additional returns. This is where we become uncomfortable, as the current economic situation in South Africa indicates a prolonged period of sub par returns. Although it is true to say that a large component of the SA bourse now consists of more global based businesses, SA incorporated does not inspire confidence. High levels of unemployment, current account deficit and stagnant growth rates are not a conducive environment for a strong stock market. Whilst valuations certainly appear more attractive following the most recent sell off, we still see a number of challenges ahead.
Looking abroad, a number of opportunities remain attractive so the decision to externalise becomes a major discussion point. I started by saying that we have no idea around short term movements, so provided we are happy that the rate of exchange is somewhere near fair value we are comfortable buying Dollars. As we know, long term it is likely the Rand will be at a weaker level, if our decision to invest offshore is in keeping with long term sound investment objectives, the decision takes sense.
Of course the only obvious question remaining would be what then is fair value and like a true economist I will say this, there are many ways of determining this but it is not far off where it is currently trading. Like any investor though, when buying Dollars we would always prefer a slightly stronger level than today which is always possible with a currency as volatile as the Rand.