For years, South Africa was going strong and couldn’t be stopped. However, today we see a beaten-up South Africa with just about everything fundamentally wrong with it that one can think of.
This is pushing up the U.S. dollar against a falling South African rand.
Let me go over the grocery list of why it’s falling and will continue to fall even in the face of rising South African interest rates.
What? A currency falling even though rates are high and may go higher? How could this be? Well, South Africa may have higher inflation that needs to be combated by interest rate hikes, but it has a drastically slowing economy, among other major problems.
The problem is, investors won’t seek yield at any cost. No, there has to be economic stability as well. Otherwise the risk isn’t worth taking.
Thus the problem with the rand. Remember, in currencies, traders buy a fundamentally stronger currency and sell the weaker currency at the same time, in order to profit from the difference.
Believe it or not, even as flawed as the U.S. economy is right now, it looks like a bed of roses compared to South Africa. So, let’s look at why the dollar (USD) is rising against the rand (ZAR) and, more importantly, why I think it will continue to do so.
One of the biggest shockers recently to currency traders was the release of South Africa's economic growth (GDP) numbers. The report showed that the country slowed to 2.1 percent growth in the first quarter after posting 5.3 percent growth in the fourth. Whoa!
Man, talk about putting on the brakes. Not only did the GDP dive, but so did the currency upon the news. It should have fallen off the map. That pace of growth was the slowest in more than six years.
So what do we have here? Slowing growth plus inflation equals stagflation, right? Currencies don’t fare well in that type of an environment because a currency needs growth along with inflationary pressures in order to grow.
So, if you pull the growth story out of the equation, investors aren’t encouraged to dive into the currency when they can go other places where not only is inflation growing but growth is healthy too.
Money has choices and it doesn’t have to stay locked up in one area. No, it’s free to roam around as it pleases and it can sprout legs fast if things get shaky, as they are in South Africa now.
So why is GDP slowing down? Isn’t this something that can be fixed pretty quickly? Heck no.
It’s slowing down for a number of reasons, but let’s start with one biggie. South Africa’s president decided not to follow advice given to him years ago and chose not to expand the power grids in the country.
Roll the hands of time forward a few years and now there are power shortages all over the place. Way to go Mr. President! Thabo Mbeki even makes George Bush look good right now.
The power shortages and outages have slowed output in mining, which is a huge industry in South Africa. After all, they’ve held the title as the world’s largest gold miner for quite some time now, although they may even end up being dethroned from that, too.
Back to this mining problem. Mining output has fallen an annualized 22.1 percent, the biggest drop since 1967. That's huge.
Overall manufacturing, which accounts for 16 percent of their economy, fell 1 percent after expanding 8.2 percent in the fourth quarter. So we’re talking about a huge slowdown in the near term, and it’s not going to end any time soon.
In fact, one of the reasons that makes buying the USD/ZAR such a good long term play is that it’s going to take about seven years — an eternity in currency trading — to fix the power problems. Once again, thank you Mr. President! It’s been a long time since someone’s had a screw-up last that long. I think Mbeki just broke the record.
So South Africa will be shelling out around 343 billion rand over the next seven years to fix this enormous problem. Ouch!
Okay, so that’s one side of the economy. But what about the consumer? Won’t they come in and save the economy? No, once again.
Why? Because interest rates are already at 11.5 percent, and there’s a huge probability that the South African central bank will hike rates at both of the next two meetings.
This is going to drive up the borrowing cost for consumers and for businesses.
Consider this: Higher rates means even more mortgage problems with a slowing economy, businesses slowing further, and that sure won’t help their unemployment rate of 23 percent. Can you imagine almost one out of every four people unemployed?
Well, that’s what it is at right now, and it’s only going to get worse with higher borrowing costs for businesses and slowing expansion. The government wanted to get the unemployment rate down to 14 percent by 2014, but this energy shortage really threw a wrench in those plans.
In fact, the finance and real estate industry, which accounts for 20 percent of their economy, grew at just 4.9 percent — way down from the 8.5 percent formerly.
Just when you think South Africa can’t have worse luck, they have platinum and diamond mines that flood, which puts further delays on top of the power outages.
Now, remember that $135 oil we saw recently? South Africa is a huge oil importer. So their current account deficit has grown to its highest level in 36 years.
These problems are big, and they’re not going to be solved tomorrow. That’s why I love selling the rand right now against most anything, but especially the dollar, which is the most common way the rand is traded.
So with a current account deficit that has swelled to 7.3 percent of its GDP, I’m seeing major red flags thrown up here.
Just to add insult to injury, there’s been a recent outbreak of riots that has claimed at least 42 lives since May 17. The violence spread to several cities and the president had to send troops to get the riots under control.
This violence led to more than 16,000 people being displaced and 400 people arrested.
Wow, what a mess huh? When news like this hits in a massively slowing economy, you’ve got all the excuse in the world to sell the rand and take your money elsewhere.
That’s causing the rand to plummet and, I believe, it will continue to bleed for quite some time.
Oh yeah, and don’t forget they have elections next year, which just brings on more uncertainty, which a currency never loves.
South Africa might even lose its beloved spot as the No. 1 miner of gold. Yes, that’s correct.
In fact, China just announced that it has discovered four very sizable mines. While it didn’t disclose everything known about it (which is typical), it did note that the country mined 276 tons last year.
South Africa only mined 254 tons last year. Ouch!
If that keeps up and these mines are as big as China makes them out to be, then one of their few bright spots that South Africa has had going for it gets taken away by China.
Remember that seven-year power grid build out is going to slow the mining in South Africa for years to come. This gives China an added advantage.
China’s president, in a recent speech, noted that their country may mine as much as 300 tons of gold this year. Wow! These guys aren’t playing around.
So take your pick as to which calamity matters the most to you. But I stack them all together and I see a horrid picture for South Africa for the next several years while many other economies that have power blow right by them.
I expect this currency to suffer for quite some time. Even the dollar looks like Prince Charming alongside the rand. That’s going to cause the buck to gain against the ZAR in the near term and in the long term until many of these issues are worked through, and that will literally take years.
That's why the uptrend for the USD/ZAR pair, which started back in 2005, has years to run.
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