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How the commodity cycle affects the Rand and South Africa

by Anton Van Teylingen | Apr 29, 2016
  • In part two of my three-part series on the Rand, I will focus on the commodity cycle in an attempt to shed some light on the recent volatile movements of the Rand.

     To find out how the Rand is affected by emerging markets, read part one here.

    When trying to understand why the Rand has moved the way it has over the first quarter of 2016, you need to consider three major influencing factors: Emerging market performance, the commodity cycle, and our Republic’s national politics. Let’s take a look at the commodity cycle.

    The commodity cycle

    South Africa has long been a resource-based economy. Ever since the Witswatersrand Gold Rush of 1886 and the founding of the City of Gold, Johannesburg, commodities have paved the way forward for our economy. Currently, however, we find ourselves in the “trough” of the commodity cycle, which has been trending down for the past five years. The previous peak was experienced in 2011 after a brief recovery from the 2008 financial crisis.

    The below graph shows the commodity cycle for the past 12 years. As you can see from the below, the sharp decline in 2008 was as a result of a global slowdown in growth and consumption. This is also referred to as what some economists call the “Commodity Super Cycle”.

    Graph via Bloomberg

    China and the super cycle

    The commodity super cycle describes the rise and fall of many commodity prices during the 2000s up until 2011. This decline came after sustained periods of depressed prices in the 1980s and 1990s. The boom was mostly due to the rising demand from emerging markets such as China and the other BRICS countries.

    Now, however, China’s GDP growth rate is currently on a downward trajectory as you can see by the below graph.


    Graph via Trading Economics

    What’s the problem?” You might ask, maybe even adding: “Total growth for China is still above 6%!

    While this is true, it should be noted that the growth appears to be trending down for the foreseeable future. More concerning for commodity producers is that Chinese demand for copper, a metal which is used as a proxy when gauging demand for other metals and commodities, is expected to slow to around 2% in 2016.

    These numbers are bad news for commodity producers when you consider that copper demand in the PROC between 2000 and 2015 has grown at rate of 12% per annum, on average. The Chinese economy accounts for of 44% of the world’s metal consumption and this is why these numbers are cause for concern.

    What does this mean for South Africa?

    Overall, the impact is negative. Whilst we are net importers of oil, which currently sits near record price lows for the decade, we are still net mineral exporters. We are among the globe’s highest producers of gold, diamonds and platinum. A weakened currency, such as the Rand has become, should help the situation, but the lack of demand for commodities worldwide means this positive currency effect doesn’t come into play.

    Mining contributes massively to South Africa’s job market, and GDP and depressed prices can only lead to a downward adjustment in our output projections. Many analysts predict the cycle to bottom out in the next few years. Some figure that in today’s modern economy super cycles won’t have the long term erosive impact we have experienced in the past. Others are of the opinion that the cycle has already turned, and these analysts point to the very recent rally which has seen mining houses in South Africa rebound in dramatic fashion from their early 2016 lows when the market seemed to go into capitulation. Only time will tell who has called it correctly.

    Thus, much of the Rand’s weakening in 2015 can be attributed to the China slowdown and subsequent lowering of commodity prices. Most expect the growth rate in China to steady, while the People’s Bank of China has predicted a 6.8% growth rate in 2016, only 0.1% down from 2015. Their medium term view sits at a comfortable 7%, lower than their historical averages, but solid nonetheless. So there is some long term hope there for a Rand stabilisation, if not a slow recovery.

    Iron ore, oil and the Rand

    Recently there has been a rebound in iron ore prices on the back of renewed orders from Chinese steel mills. Unfortunately, some banks expect this reversion to be short lived as demand, on the whole, remains muted.

    Oil remains a key component to the performance of commodities. Multiple volatile trading sessions have seemed to support the uncertainty around the production of oil going forward. These price fluctuations have a complicated effect on the South African economy.

    Ultimately, low oil prices are a good thing for individual South Africans as lower prices should stem current inflationary pressures. However, if low oil prices are as a result of a reduction in global production and economic activity, the knock-on effect this will have on commodity currencies, like the Rand, Canadian Dollar and Australian Dollar, will be negative.

    Greater demand is needed

    The only hope going forward is that renewed signs of demand from China and other commodity hungry countries begin to show.

    Earlier this year, listed mining companies were trading near annual lows and this presented a unique buying opportunity for foreign investors looking to pick up shares at depressed prices. Markets will, however, remain cautious as commodity cycles have been known to move extremely slowly. Some economist suggest declines may last up to 15 years, however with today’s modern technological advancements anything can happen.

    Please note the above piece serves as opinion and should by no means be received as advice.

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