The strength of a countries currency can be viewed as a proxy for the price of the country. Just like with any investment you must differentiate between price and value. Price is what you pay and value if what you get. When there is a great demand and / or excitement the price of the investment or commodity can be significantly higher than the underling value and conversely when demand is low and / or pessimism rules the price can be a lot lower than the underlying value.
Value investors focus on opportunities when the price is lower than their assessment of the underling intrinsic value, which is known as the margin of safety i.e. paying a price lower than the value should avoid the risk of incurring a permanent loss, that is assuming your assessment of value is correct and this is where the rub lies, particularly when it comes to establishing the value of a currency.
Valuing currencies is extremely difficult given the vast number of factors influencing the value. Economic text books will talk about PPP or purchasing power parity, which is an economic model for determining and comparing the value of competing currencies based on the price of goods and inflation differentials.
However, value is always a long-term assessment based on fundamentals, but prices are driven by daily noise and can fluctuate widely over the short-term completely disregarding the underlying value. This is particularly true for currencies, which is why I consider currency trading a form of gambling, but that’s topic for another day.
The question I would like to address is whether than current price of the Rand / Dollar @ R12 is cheap or expensive, which is of course like staring into a crystal ball given the before mentioned, but that’s not stopping me from having a view with the caveat that there is only a 50% probability that I may be right. How’s that for a clever disclaimer.
I believe there are three current tailwinds for the Rand. Starting with our new President Cyril. The anticipation of change has seen the Rand strengthen materially since his election as money has poured into the country.
The 2nd tailwind and possibly more important than Cyril is China, which has continued to grow strongly supporting commodity prices and therefore commodity producing currencies like ourselves.
The 3rd tailwind and probably the most important is the United States and their current interest rate cycle, which is on the way up and with it the likely strengthening of the dollar on the reversal of the carry-trade, which has been so beneficial for emerging market currencies.
If my crystal-ball is right then all three tailwinds are likely to turn becoming headwinds in the next 12-24 months, which will see the Rand weaken from current levels. This is based on a view that “Ramphoria” is likely to dissipate as the reality of the structural issues we are facing take the shine off the current euphoria, which I believe is more of a relief rally than a fundamental change to the assessment of our currency’s value. This will be compounded by slower Chinese growth and falling commodity prices exacerbated by a stronger dollar and outflows from emerging markets.
Some Rand weakness from current levels will support the economy and should not be viewed in a negative light with the current Rand strength actually hurting exporters and driving down foreign earnings, which now makes up 2/3rds of the overall JSE’s earnings.
What is most important for business is a stable currency, which for a small open economy like ours is a bit like wishing for rain. Good time to travel, good time to invest offshore???
Mcomm, CFP®, HdipTax
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