29 Jan 2018

Gold note: further to rise?

Annabel Bishop

Chief Economist

Risk-averse behaviour and US dollar strength see the rand weaken back to R12.00/USD level

  • The gold price has largely continued to rise this year, reaching US$1 357/oz from a recent low in 2015 of US$1 046/oz on the global surge in commodity prices and US dollar weakness (although this week has seen some retracement).
  • However, in rand terms the gold price has moderated to R16 050/oz this year on the domestic currency’s general strength against the US dollar from an all time high of R23 341/oz in 2016 at a rand of 16.97/USD. The movements of the rand have a substantial impact on rand commodity prices.
  • The US dollar has seen some strength this week ahead of the US President’s speech, which is expected to show support for a strong dollar, and the upcoming FOMC meeting, as the Fed is expected to outline further improvements in the economy supportive of normalisation of monetary policy. Some risk-off has recently developed towards EM portfolio assets.   
  • The US is expected to hike interest rates at least twice this year by 25bp each, as informally targeted inflation is expected to rise gradually in the world’s largest economy, reaching 2.0% by 2019 with the Fed moving to normalise interest rates alongside it. 
  • Risks to US economic growth (see “Economic outlook 2017–2023”, 5th January 2018  and “Economic outlook 2017–2022”, 9th October 2017, website address below) remain, as elevated non-financial corporate and household debt levels are still of concern.
  • Specifically, higher interest rates in the US mean that high debt levels cause households to cut back on consumption to service their debt, slowing economic growth, and hence subduing the outlook and investor sentiment. Higher rates could increase corporate stress, adding to a weaker economic growth outlook. 
  • The US dollar could see further weakness as the Fed could hike rates by less than is expected in both its dot plot trajectory and by markets, and as future ECB interest rate hikes are yet to be fully factored into the markets, meaning the euro could strengthen (see Rand note: dollar collapse powers rand to R11.85/USD, 25th January 2018.)
  • US dollar weakness is supportive of higher commodity prices, with a 20% y/y ascent from the recent low (late 2015) in the economist’s commodities index. On its own, the economist’s metals commodities index has risen by 48% y/y and the gold price by 25%, from recent lows (late 2015).
  • The USD dollar index weakened over the period by 11%, accounting for some of the rise in the price of commodities on the inverse relationship, along with strengthening global demand. Expectations of further US dollar weakness over the medium to long term would support commodity prices.
  • The rand has appreciated to R11.80/USD this year from R16.97/USD in early 2016, although about R2.00/USD of the domestic currency’s weakness was driven by political events at the end of 2015, while political developments in late 2017, have seen the rand gain by almost R2.00/USD.
  • Other commodity currencies have also appreciated over the period, with the Canadian dollar 13% stronger, the Australia dollar 11% and the New Zealand dollar 9%. The rand has also been boosted by global risk-on which has spurred EM asset purchases by foreigners, although weakening this week on some risk-off.
  • SA has seen net equity outflows of US$17.0bn IIF (International Institute of Finance) data on heightened political uncertainty since 2015, negatively impacting the rand. Over US$3.0bn is likely to have returned on the recent up swell in political confidence since the 2017 ANC elective conference, with another US$1.0bn in positioning ahead of the conference.
  • Foreigners have been substantial net purchasers of EM debt since 2016 on risk-on, totalling US$348bn, chiefly into emerging Asia region, of US$198bn as per the IIF. The net portfolio inflows into EMs have chiefly been into debt, specifically US$218bn, with US$130bn into equities.  
  • SA’s debt markets have benefitted from the prevailing global risk on sentiment which has driven portfolio  inflows for EMs, with SA recording net debt inflows of US$6.1bn since 2016, although since October 2017 these flows have turned negative (US$1.0bn on a net basis) on some likely portfolio rebalancing into SA equities. 
  • The commodity (metals) boom in 2011 saw South Africa, a key gold (and other commodities) exporter, experience its fastest economic growth rate in the last eight years (in 2011), at 3.3% y/y. Exports accelerated by 3.5% y/y and fixed investment by 5.5% y/y led by the private corporate sector. 
  • In 2011 internal economic growth reached a robust 5.6% y/y in SA as incomes lifted by 4.6% y/y in real terms (above the inflation rate) and household consumption expenditure rose 5.1% y/y. An open commodity economy which follows free market reforms benefits from commodity booms, on the back of investor confidence and the private corporate sector spurs job creation.
  • SA’s Davos team recognised this, adding the need to resolve the impasse between the private sector and government to its list of issues to find workable solutions to, which include the governance of the SOEs, and Eskom’s looming debt obligations in particular. 
  • While the rand was cheered by team SA’s performance in Davos, and convincingly broke through the R11.90/USD level, even briefly piercing R11.80/USD overnight, it has weakened recently on perceived little new positive SA news, US dollar strength and worries over Eskom’s results presentation today.