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Cape Town - The rand has broken key resistance at R13.00 to the green back, pointing to further gains towards R12.50$ and thereafter R12.00/$.
This is according to Overberg Asset Management in this week's overview of the economic landscape.
It also noted that after the run in the mining resources stocks in 2016 the sector underperformed the broader market since the start of the year. (See bottom line)
"Speculative support for commodity prices evaporated amid concerns over China’s slowdown and a lack of delivery on US infrastructure spending," it said.
South Africa economic review
• GDP unexpectedly contracted in the first quarter (Q1) by 0.7% quarter-on-quarter annualised in sharp contrast to the 1.0% consensus forecast expansion. The figure was worse than even the most pessimistic forecast. The main culprits were the secondary and tertiary sectors of the economy.
The manufacturing sector contracted 3.7% on the quarter annualised, and the trade sector, which includes retail, wholesale, vehicle sales, accommodation and tourism, shrank 5.9%. The financial, insurance and real estate services sector, fell 1.2% its first decline since the 2008/09 global financial crisis.
As expected the mining and agricultural sectors performed well with growth of 12.8% and 22.2% but not sufficient to arrest the broader economic slowdown. Following on from the 0.3% contraction in Q4 the 0.7% contraction in Q1 means South Africa is technically in recession, defined as two straight quarters of negative growth.
• The expenditure side of the GDP accounts paints a similar picture with contraction in the first quarter (Q1) of 0.8% quarter-on-quarter annualised following the 0.1% contraction in Q4. Household expenditure shrank 2.3% in sharp contrast to the 2.2% growth in Q4. Encouragingly private sector fixed capital formation increased 1.2% on the quarter after contracting for five straight quarters.
However, despite rising external demand exports shrank 3.2% on the quarter compared to 12.5% growth in Q4. Net exports subtracted 1.9 percentage points from overall GDP. The surprisingly weak economic growth data reinforce the need for monetary easing.
Although the Reserve Bank remains circumspect due to the uncertain political outlook and the threat of further credit rating downgrades, the GDP figures will bring forward the start of the interest rate cutting cycle.
• The Reserve Bank quarterly trade data shows the merchandise trade surplus increased slightly to R57.4bn in the first quarter (Q1) up from R55.7bn in Q4. Meanwhile, the deficit in net service receipts narrowed from R13.3bn to R4.0bn.
The trade data is consistent with a further narrowing in the current account deficit from 1.7% of GDP in Q4 to around 1.5% in Q1. A further narrowing in the current account deficit would add stability to the rand further emboldening the Reserve Bank to initiate its much-needed cycle of interest rate cuts.
• Manufacturing production fell in April by a steeper than expected 4.1% year-on-year worse than the 0.4% decline in March and the 1.6% consensus forecast.
Eight of the ten manufacturing sectors experienced declines. The worst offenders were the “motor vehicles, parts, accessories and other transport equipment” sector losing 17.7% on the year, “electrical machinery” down 16.8%, “glass and other non-metallic mineral products” falling 10.9% and the “petroleum, chemicals, rubber and plastics” with a decline of 6.9%.
The latest rebound in the manufacturing purchasing managers’ index back above the expansionary 50-threshold suggests manufacturing activity may be past its worst. In contrast to the dismal year-on-year contraction manufacturing output increased in April on a month-on-month basis by 2.3%.
• Mining production decreased in April by 1.6% month-on-month, which was not unexpected considering the high base established in March. On a year-on-year basis growth in mining production slowed from 15.4% to 1.7%. Despite the softer April number mining output is expected to maintain its positive trend over the remainder of the year, boosted by strengthening global growth and rising international commodity prices.
By mining category, iron ore showed the strongest year-on-year growth at 29.9% followed by chrome at 20.5% and diamonds 12.7%. By contrast platinum and coal shrank by 8.9% and 9.2% on the year. Month-on-month figures show the strongest growth in the building materials, nickel and iron ore categories with growth of 9.4%, 8.6% and 5.8%.
The week ahead
• Retail sales: Due on Wednesday 14th June. Retail sales contributed to the first quarter’s 0.7% GDP contraction. The April numbers will indicate if the trend is likely to persist into Q2. The figures will be distorted by the Easter effect due to the public holiday appearing in April rather than March this year.
Nonetheless, retail sales are still expected to be subdued due to weak consumer confidence stemming from poor employment growth, an increased taxation burden and tight lending standards.
• RMB Bureau of Economic Research (BER) Business Confidence Survey: Due on Wednesday 14th June. The second quarter BER confidence survey is unlikely to show any improvement due to the additional impact of the credit rating downgrades amid rising political, administrative and regulatory uncertainty.
The survey has remained stubbornly below the key 50-level for over two years, indicating depressed confidence.
Technical analysis
• The rand has broken key resistance at R/$13.00 pointing to further gains towards R/$12.50 and thereafter R/$12.00.
• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
• Following the announcement of the snap election the British pound has broken above key resistance at £/$1.25 which has now become a key support level and should promote further near-term currency gains. Recent strong gains have diminished prospects for a £/$1.18-1.22 target.
• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.
• The US 10-year Treasury yield has broken back below the key resistance level of 2.0% providing continued support for the multi-year bull trend in US bonds.
• The benchmark R186 2025 SA Gilt yield is trading in a tight trading range of 8.5-9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.
• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdqaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.
• The Brent oil price is trading in a range of $50-55, which if broken to the downside could lead to a sharp decline to the $40-45 range. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5 500 per ton.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• A break above 54 200 on the JSE All Share index would project an upward move to 60 000 marking a new high for the JSE.
Bottom line
• Following the spectacular run in the mining resources stocks in 2016 the sector has underperformed the broader market since the start of the year. Speculative support for commodity prices has evaporated amid concerns over China’s slowdown and a lack of delivery on US infrastructure spending.
The iron price, which more than doubled in 2016 to $80 a ton rising to a peak of $89 in mid-February, has slumped back to the $55 region. With speculative excess removed from the metals market positive supply-demand fundamentals can once again reassert themselves. The outlook for global metals demand remains strongly positive.
• China dominates global demand for metals. China’s economic data and policy initiatives signal continued upward momentum in commodity prices. China’s authorities will be keen to ensure robust economic growth ahead of the 19th Communist Party Congress at the end of the year.
New initiatives from China including the Xiongan New Economic Area and the Silk Belt and Road will add significant infrastructure spending growth. Infrastructure spending increased by 23% year-on-year in the first four months of the year. Chinese President Xi jinping has pledged a further $124bn to the Silk Road Project.
• Demand for metals is gathering momentum in other economies besides China in South Asia and the Far East. Economic growth in the ASEAN-5 group of nations including Indonesia, Malaysia, Philippines, Thailand and Vietnam, is now almost equal to China’s growth.
India’s GDP growth has exceeded China’s for several years. Modi’s government was elected on pledges of economic reform and infrastructure spending. In this year’s State Budget Modi announced record spending of $59bn to build and modernise the country’s railways, airports and roads.
• Earlier excitement over US infrastructure spending, which followed President Trump’s election, has all but evaporated. However, Trump has finally scored his first major legislative breakthrough with the planned repeal of Obamacare passing the House of Representatives.
This will help the main pillars of Trump’s reflationary policy, comprising tax reform, de-regulation and infrastructure spending, to gain traction. Key US infrastructure spending programmes are likely to be passed in 2018 with the prospect of a significant impact on metals prices. Trump has pledged to invest $550bn on infrastructure spending.
• While flagging the diminishing effectiveness of monetary stimulus organisations such as the IMF and World Bank have long argued in favour of greater fiscal spending around the world, as a means of boosting global economic growth. According to Torsten Slok, chief international economist at Deutsche Bank: “Fiscal policy is coming back big-time relative to what we have seen in the past five or six years.”
• Citi global head of commodities research, Edward Morse, reported that the copper price could rise from its current level of $5 700 per ton to $7 000 by year-end. The price surge would be propelled in the short-term by continued shutdowns at key mines in Chile and Indonesia and in the long-run by the structural shortfall, potentially pushing the copper price above $8 000 by the end of the decade.
The refined copper market is likely to go into deficit in 2017 for the first time in six years. According to Morse the bullish copper price outlook is “tied to longer-term supply dynamics, which include not just issues related to mobilisation of capital but also a lack of a pipeline of discoveries of richer ores.”
• The mining industry is in the best health it has been in for years. According to the PwC Mine 2017 report, the world’s Top 40 miners have recovered from the mining slump in 2015 with bolstered balance sheets and a return to profitability.
Debt repayments have increased, gearing ratios have declined and the aggregate Top-40 net profit rebounded to $20bn in 2016 compared with a loss of $28bn in 2015.
• However, increased metals supply is still a long way off. Total capital expenditure fell in 2016 by 41% to a record low $50bn. Half of the amount was allocated to sustaining existing activities with very little allocated to future growth. For the fourth year running the mining industry cut spending on exploration to just $7.2bn in 2016 a third of the record $21.5bn allocated in 2012.
• The mining industry faces long development cycles. Weak new mining investment combined with rising global demand for metals, provide the foundation for a favourable sector outlook. While the mining resources sector is unlikely to repeat its massive gains enjoyed in 2016, the recent lull historically represents the best entry point in the cycle.
For the full report, including a look at international markets, click here.
* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
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