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A perfect storm is defined as a rare combination of circumstances that aggravates a situation drastically. Well I think that the end of 2015 and this year served as a perfect storm for South Africa. We had, especially at the start of the year, a very rare combination of events for South Africa, all unfortunately bad.
When you get such a rare combination, and especially when they are all negative, they are very unlikely to occur again in the near future. Simply put, 2017 must be better than 2016, because it is highly unlikely that these circumstances will occur again in the near future.
The unusual circumstances were:
- Very low point in the commodity price cycle
- Excessively undervalued rand
- Drought
- Political upheavals
As always in economics, these items are interrelated and should not strictly be seen in isolation. The commodity cycle leads to a weaker rand, for example. I have also excluded the interest rate/inflation cycle, as this is a normal occurrence. Even this cycle also possibly holds better news for SA next year. It is very possible that interest rates are at a peak and there is a fair possibility that they may even fall next year.
Commodity cycle
South Africa is a commodity producing country and our economic state is probably influenced the most by this cycle. It is primarily the driver of our economy, exchange rate, interest rates etc. After a massive bull market, driven by Chinese growth, from 2002 to 2007, commodity prices reached a cyclical low at the start of this year. This happens probably on average every 8-10 years.
While demand remains reasonable, all the supply planned in the “China years” came on stream and caused prices to collapse. Iron ore, for example, peaked at +-$150 per tonne in 2007, fell to around $30 per tonne at the start of the year and has subsequently recovered to around $70 per tonne. This is because mining companies have decreased high-cost supply at the low prices prevalent at the start of the year. This continues and as a result most commodity prices have recovered from their lows.
Therefore it is unlikely that we will see the low point of the cycle as we did in January, in the near-term future. So 2017 should be better than 2016. We must not expect a surge like we did in the China years. To get this you need a surge in demand. This may occur in the medium term (India, Africa?) but is unlikely over the next few years. The current price recovery that we are seeing is driven by supply cutback and not a demand surge.
Rand
There is no really accurate methodology to measure the “fair value” of a currency, but most valuation methods will indicate an excessive over- or under valuation. I tend to use a Purchasing Power Parity basis. This simplistically assumes that any currency should, over long periods of time, alter by the difference in inflation between the country and its major trading partners.
In January this year, the rand hit a cyclical low (undervaluation) point, as low as what is has been in the past. This also happens on average every 8-10 years.
This valuation was probably 30% lower than the fair value as determined by this method. To date this year the rand has recovered about half of this undervaluation.
We should also not expect the rand to appreciate to a level above fair value. You need another China for this to happen. So what we are seeing is a recovery, driven by some stabilisation/recovery in the commodity cycle, from a very undervalued level. This may last a bit longer and the rand may get a bit stronger, but it is not the start of a major rise, as what happened when Chinese demand surged.
Drought
This was the worst in 15, 20, 50 or 100 years, dependent on your source. In any event is was severe and is most likely behind us. The farmers are out there planting!
Political upheavals
While this seems to be continuing and many will argue differently, in my view the “low point” was the firing of the then finance minister in December last year. While plenty of other events have occurred subsequently, the re-appointment and retention of Pravin Gordhan indicates to me that we are also past the worst in this respect.
2017
I am not for a moment saying that 2017 will be a good year, it will just be better than 2016. Hopefully going forward our situation as a country will continue to improve. Who knows, we may start to see economic growth upgrades starting to come through for 2017.
Wayne McCurrie is a fund manager at Ashburton Investments.
