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Cape Town - Foreigners have sold in excess of R13bn worth of South African bonds during December as they avoided some downgrade risk and this has placed significant pressure on the flows in the rand market, according to George Herman, head of South African portfolios at Citadel.
The rand has experienced several headwinds during December and a general wave of "risk-off" sentiment washed over all asset markets as fears of deflation became elevated, said Herman.
"Oil is dominating the economic landscape at the moment, reminiscent of an old saying: 'When elephants fight…it is the grass that dies'. It is now a war between sheiks and shale for dominance in the global oil markets in a spectacular game of ‘chicken’," he said.
"The shale-industry, still in its infancy, is bound to lose this war as Opec is determined to kill off marginal suppliers to the market."
This has ramifications not only for oil supply dynamics, but also for corporate or high yield credit markets and the level of the dollar.
From a rand perspective, the drop in the oil price has led to a stronger dollar and hence weaker commodity prices in general. This has weakened all commodity exporting currencies, not just the rand, explained Herman.
One of the major losers in this oil-war is Russia and so, with a combination of Western sanctions and export earnings crashing, the rouble has tanked.
Credit rating assessments
Both S&P and Fitch - somewhat surprisingly in Herman's view - left South Africa’s ratings and outlooks unchanged.
"This must be seen as a best-case scenario at this point in time. Both cited the government's commitment to structural changes as the reason for keeping the ratings at their current level," he said.
"Both agencies cite the risk to their rating as labour, growth and energy. In fact, they assumed no public worker strikes, a doubling of GDP growth over the next two years and no general shortage of electricity that impedes on growth. These assumptions are very forgiving and very optimistic."
Outlook for the rand
Very little of what is happening with the rand right now is reflective of domestic issues, Herman explained.
"The fact that a rating downgrade has been averted does, however, remove a major event-risk from the rand and does thus create the environment within which it can recover some of its recent losses."
A pullback to R11.20 to R11.30 against dollar would be entirely plausible within the context of the recent moves, in his view.
"The outlook for the oil price, amidst the oil-war is very difficult. Oil can go as low as $40 again, and this still presents a major risk for risk-assets and the rand," said Herman.
"The overall bearish trend in the rand is, however, very well entrenched and there is nothing currently that argues or a turnaround in this major trend."
The long term outlook, within a stable political environment, is that South Africa’s current account and budget deficits should see some improvement by 2016, at which time a material improvement in the rand can be expected.
"As one can appreciate, this is a complex and dynamic environment that has an influence on markets and consequently. One of the biggest challenges for an individual is understanding how these different factors affect investment classes and their portfolio," said Herman.
"In addition, it is necessary to determine which of these items listed above are short or long-term trends. In other words, which are the tides and which are the waves."
All investment decisions should be made within a framework that takes the tide - or long-term trend – into account and ignores the short term waves as far as possible, in his view.
"This is easier said than done. It requires a plan to be formulated that takes an individual’s situation into account, understands the time frame of investment and can then allocate to appropriate asset classes," he said.
"Once the plan has been implemented, it is essential to revisit it to see if changes need to be made, but unless the tide has changed, the best advice is to stick to the plan for the long term."
