Yuan devaluation bad news for rand

Cape Town - The yuan devaluation is bad news for the rand and for the mining resource sector and the problem is likely to get worse, Overberg Asset Management said in its weekly overview of the SA economic landscape.

"The once-off currency devaluations are the first since the yuan was pegged to the US dollar in 1994 raising questions over the severity of China’s economic slowdown," OAM said.

"The currency devaluation will help reflate China’s economy but at the same time will export deflation to the rest of the world," according to OAM.

The yuan devaluation will cause commodity prices, which have already suffered sharp declines since the start of the year, to fall even further.

South Africa economic review

Foreign investors were net sellers of –R0.3 billion worth of bonds and –R1.0 billion worth of equities in the past week. While turning negative towards SA’s capital markets foreigners’ contribution to total market traded volume remained stable at 35.6% only slightly below the year-to-date average of 38.8%. Foreign equity selling was concentrated in the property sector, while net buying was noted in the industrial sector followed by the financial sector. Selling and buying in the resource sector was evenly balanced. For the year-to-date foreign net buying of bonds and equities amounts to R16.01 billion and R34.92 billion respectively.

• Moody’s credit rating agency reiterated its Baa2 credit rating for SA’s sovereign debt and left its outlook unchanged at “stable”. Moody’s expects the debt/GDP ratio to stabilize as early as this fiscal year but warned that government’s efforts to make state-owned enterprises more financially self-reliant could take longer than expected. Moody’s listed specific potential developments which would lead to a downgrade of the credit rating. These include a faltering in government’s commitment to fiscal consolidation and debt stabilization, and further deterioration in the investment climate which would endanger the external funding of the current account deficit.

• Despite intensive load shedding manufacturing production increased in June by an unexpectedly strong 0.9% month-on-month above the 0.6% consensus forecast and in stark contrast to the contractions in May and April of -0.6% and -2.3%. However, in the second quarter (Q2) manufacturing contracted by -4.9% quarter-on-quarter annualized consistent with Q2 GDP growth of just 1.1%. Among the sectors which contributed to June’s strong manufacturing reading, basic iron and steel production increased 5.7% on the month, electrical machinery by 5.0%, furniture and related by 2.9%, and food and beverages by 1.8%.

South Africa political overview

• The government has established an inter-ministerial committee chaired by Cyril Ramaphosa to assess the “unintended consequences” of the new visa regulations. New visa regulations introduced by the Department of Home Affairs have caused a sharp decline in visitors especially from China where numbers have declined by -38% compared with last year. The requirement for visitors to provide biometric data means visitors must apply for visas in person which is difficult in vast countries like China with only two visa processing centres. It is hoped that there may be some softening in the biometric data requirement. Tourism is a vital component of the SA economy contributing around 10% of GDP in addition to providing substantial export revenue and employment opportunities.  

• Gold sector wage negotiations have broken down and been referred by the National Union of Mineworkers (NUM) to the Commission for Conciliation, Mediation and Arbitration (CCMA). The CCMA have thirty days to find a resolution between the gold producers represented by the Chamber of Mines and the NUM. Strike action is likely to follow if a resolution is not found which is likely given the wide disparity between union demands and current wage offers. The Association of Mineworkers and Construction Union (AMCU) which holds a 30% membership in the mining sector has not yet referred negotiations to the CCMA but is demanding a 150% wage increase which is significantly larger than that of the NUM. It therefore appears inevitable that strike activity will ensue. Meanwhile, wage negotiations in the coal sector are in stalemate with unions demanding a 15% wage increase compared with the mines’ offer of 5-6.5%.

The week ahead

• Consumer price inflation (CPI). Due Wednesday 19th August. According to consensus forecast CPI is expected to accelerate from 4.7% year-on-year in June to 5.0% in July and on a month-on-month basis from 0.4% to 1.1%. The rise in CPI is attributed to the drought-induced increase in maize prices and state administered increases in water and transportation tariffs. However, core CPI excluding food and energy is likely to hold steady on a year-on-year basis remaining unchanged at 5.5%, which is within the SA Reserve Bank’s 3-6% target range.

• Retail sales. Due Wednesday 19th August. Growth in retail sales is expected to rebound slightly after falling to a four-month low of 2.4% year-on-year in May. According to consensus forecast retail sales grew in June by 3.5% on the year although mainly due to the base effect of weak comparative data resulting from last year’s mining strike. On a month-on-month basis further contraction in retail sales is expected due to weak vehicle sales and the effect of rising inflation on household disposable income.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. A break above the key “Fibonacci” level of R/$12.45 signals further depreciation in the rand to the R/$13.00 level.

• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.

• Despite the recent uptick in bond yields the long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.

• The US 10-year Treasury yield has broken above key resistance levels of 2.0% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.

• The benchmark R186 SA Gilt yield is testing support at 8.15% and needs to break below resistance at 7.90% in order to resume its bull trend.

• The MSCI World Equity index is in the 5th and final wave of a rising-wedge formation. A rising-wedge formation is a typical trend-ending signal. European equities are set to outperform US markets. The Nikkei exhibits the most bullish pattern.  

• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• The S&P 500 is breaking down from a rising wedge pattern, which is traditionally a trend-changing pattern. A break below the previous low of 2067 will confirm a trend reversal. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, has already broken down from its rising wedge.

• Brent crude’s break below the key $50 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $5,500 support level suggesting further downside ahead.  

• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1300, $1250 and $1100. Gold’s next target is $1000 which is likely to be breached before the bear market ends.  

• The All Share index has lost most of its gains since the start of the year. The All Share Index is testing the key support line which has been in place since 2009. A break below 50,000 would signal a sharp move lower to the October low of 47,000.

Bottom line

• The yuan’s devaluation will be particularly harmful to the currencies of commodity exporting economies including the Aussie and Canadian dollars, and the rand. The yuan devaluation is bad news for the rand and for the mining resource sector and the problem is likely to get worse. As well as to reflate its economy the People’s Bank of China (PBOC) is expected to announce further “once-off” devaluations to stifle capital flight from China. In order to quell capital flight it may be necessary to devalue the yuan rapidly and to such an extent that expectations of further devaluation are removed.

• Last week the PBOC implemented two once-off currency devaluations first by 1.9% and the following day by a further 1.6%. The once-off currency devaluations are the first since the yuan was pegged to the US dollar in 1994 raising questions over the severity of China’s economic slowdown.

• China’s economy is showing signs of slowdown, its property market is correcting, and export growth, industrial output, retail spending, and investment are all slowing. Credit demand is waning in spite of substantial monetary stimulus. Producer price inflation has been negative for nearly four years. The currency devaluation will help reflate China’s economy but at the same time will export deflation to the rest of the world.

• The yuan devaluation will cause commodity prices, which have already suffered sharp declines since the start of the year, to fall even further. A weaker yuan will raise the yuan price of imported commodities and therefore weaken demand. China accounts for over half of the world’s demand for mining resources, so the impact on base metals prices could be significant.

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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