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Tuesday, 18 June 2013
Hedging the Rand
Rand-hedge shares are shares that will generally benefit from a weakening in the Rand exchange rate, mostly the R/$. We saw the Rand continuing to weaken this year. Looking at a three year chart the Rand strengthened against the Dollar to R6.60 by mid 2011. After a sharp weakening to R8.25 in the second half of 2011 following the Greek crises, the trend continued in 2012 and reached new 4 year highs in 2013 of R9.20.
Although the Rand is currently weaker than its Purchasing Power Parity of about R8.60, it is my view that the Rand can weaken further. The main reasons are:
Political instability, especially towards businesses and foreign investment.
Labour unrest and policy uncertainty, especially in the mining industry.
Fixed Direct Foreign Investment already showed a decline of 40% by the middle of last year.
Our twin deficits are a problem for foreign investors:
The budget deficit is still more than 5% of GDP after running surpluses before the 2008 financial crises.
The deficit on the Current Account of the Balance of payments (which includes the Trade Deficit) is unacceptably high at more than 6% of GDP. This deficit must be financed by foreign capital inflows, mostly into our Bond and Equity markets as portfolio inflows. These inflows are starting to show signs weakness. Without capital inflows the Rand must take the full blow as our Reserves are too small to support the currency. Previous attempts to support the currency with our paltry Reserves in 1998 lead to a loss of R130bn and the currency never recovered.
Foreigners already own between 30% and 40% of our Bonds and listed equities on the JSE. At some point they may not want to own too big a share. Without continued positive capital inflows to finance the current account deficit the Rand will fall.
Government is making South Africa a very unfriendly place for foreign investors at a time we are sitting on a bomb ready to explode in the form of our huge Current Account Deficit. Foreign investors are already showing losses on their investments here because of the weakening Rand. At some stage they will decide to cut their losses and run.
In this environment it may be prudent to structure a portfolio of shares with a big Rand-hedge component. There are two types of Rand-hedge shares:
Companies listed on the JSE but with most of their income and earnings derived from operations overseas. Richemont is an example of a company that derives almost all their profits outside South Africa.
All our major exporters will benefit from a weakening Rand. The prices of commodities are fixed in Dollars. Thus, any weakening of the Rand will lead to an immediate increase in the Rand price of the commodity, thereby increasing earnings and the share price.
Did you know that SASOL (JSE:SOL) gains R861 million in operating profit for every 10 cents the Rand weakens against the US Dollar. For every $1 increase in the price of a barrel of oil, Sasol gains R621 million profit. Since SASOL gets paid in Dollars so it benefits when the Rand weakens and oil prices rise.
A recent research study showed the following companies as the biggest benefactors of a declining Rand.
A 10% depreciation in the Rand against the Dollar will lead to an increase of more than 50% in the full year earnings of Anglo Platinum, Lonmin, Harmony, Aquarius, Royal Bafokeng and Northam Platinum.
Sappi and African Rainbow Minerals will receive a 30% boost to full year earnings and
Impala Plats, Assore, Sasol and Gold Fields will see full year earnings increase by more than 20%.
Companies importing goods will obviously be hurt by a depreciating Rand. Local retail shares that stand to lose the most are Imperial, Barlow World, Clicks and Foschini. These shares enjoyed big share price gains last year and look expensive in any case. In times like I stock up on as much SASOL shares as i possibly can buy.