One thing that most working South Africans look forward to is a holiday. Preferred holiday destinations for most are outside of the country. It is highly likely that when travelling abroad you will require foreign currency. Foreign currency is often purchased at banks at predetermined exchange rates - making one a price taker. The same is true for businesses - they cannot control exchange-rate fluctuations.
Our local currency has been making headlines again. The rand has strengthened significantly to 6.55 rand against the US dollar. There are a number of factors that have contributed to the strength of the rand, such as a weaker US dollar and higher local interest rates. Since the rand is free-floating - in that it is allowed to vary against other currencies and it is determined by market forces of demand and supply - the factors above have been in favour of the rand.
The US dollar has been weaker for a number of reasons, among them being sluggish economic growth and loose monetary policy. When you compare the US dollar with other currencies, it has depreciated overall, making these currencies a better hold.
Even though the SA Reserve Bank (SARB) has cut interest rates significantly, they remain high according to international standards. As a result, there have been huge inflows into SA as currency investors have been chasing a better yield. Buying a currency with higher interest rates and selling one with lower interest rates is called a currency carry trade.
It is essential that investors understand the effect that a stronger currency has on business. Generally, SA is a major exporter of primary goods and an importer of finished products. To simplify, we generally export natural resources and import oil and medicines, among other things.
A stronger rand has a negative effect on commodity shares and the recent volatility on the JSE can also be attributed to this. Mining companies such as Anglo, BHP Billiton, Harmony Gold and Impala Platinum export mineral resources and receive payment in US dollars, which is the standard currency for commodities. However, their cost base, including salaries and electricity costs, is in rands.
The stronger rand hurts their profits because they are receiving less in revenues overall. For illustration purposes, we omit the underlying commodity prices and focus on the rand movement. For example, when the rand was at nine rand, the miners received nine rand for every US dollar they had. Two years later, for the same US dollar they are receiving 6.55 rand. The net effect is clear: at 6.55 the miners are earning less.
On the other side of the coin, there are sectors that cheer for a stronger rand. Most drug manufacturers, shipping companies and clothing retailers import their products and pay for the imported products in US dollars. Such companies include Adcock Ingram, Grindrod and Mr Price. These companies are paying less in rand terms than a year ago.
Companies exposed to currency fluctuations tend to hedge themselves by either selling their products forward at a predetermined price for future delivery or swapping their foreign currency. The final impact of currency appreciation or depreciation is on a company's earnings.
A shrewd investor contains the effect of currency fluctuations by diversifying his portfolio. Let's watch closely as the reporting season gets underway and adjust our portfolios accordingly.
Velele Nkosi is a dealer at Barnard Jacobs Mellet Client Services-Member of the Johannesburg Stock Exchange. |
