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Is it too late to sell resources stocks?

Cape Town - A question plaguing investors is what to do about the resources stocks in their portfolios, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

"Having dropped so far, has it become too late to sell resource stocks?"

"At the same time it might be tempting for under-weight portfolios to start buying resource stocks at these levels," OAM suggests.

"After all, the Resources 20 index has slumped -37.49% since the start of the year and is down -23.18% in the past month alone."

OAM says that in spite of the massive declines indicators are signalling more pain ahead.

"The main culprit is China’s economic slowdown and the shift in focus from investment spending towards consumer expenditure," according to OAM.

"Global investor concerns are likely to resurface amid further loss in China’s economic momentum and the strong likelihood of high profile insolvencies."

South Africa economic review

• GDP grew in the third quarter (Q3) by just 0.7% quarter-on-quarter annualized below the 1.0% consensus forecast. It was hoped there would be a stronger recovery following the unexpected -1.3% contraction in Q2.

The main culprits were agriculture which declined -12.6%, mining -9.8%, and the “electricity, gas and water” sector by -8%. Positive contributors were manufacturing which grew 6.2%, the “finance, real estate and business services” sector 2.8%, and the “wholesale, retail and motor trade, catering and accommodation” sector by 2.5%.

On a year-on-year basis the economy has grown by just 1.5% for the year-to-date, which is disappointing given the low base caused by last year’s strikes.

• The Reserve Bank composite coincident business cycle indicator, measuring current conditions, fell in August by -0.4% month-on-month and -0.1% year-on-year. The forward-looking composite leading business cycle indicator declined -0.3% on the month and -5.5% on the year.

Seven of the nine constituents making up the leading indicator showed negative contributions. These include job advertisements, average hours worked per manufacturing worker, volume of orders in manufacturing, real M1 money supply growth, number of new passenger vehicles sold, the prices of key export commodities, and the composite leading business cycle indicator of major trading partners.

The only two positive contributors were the number of building plans approved and the interest rate spread between 91-day Treasury bills and ten-year government bonds.

• The RMB/BER business confidence index declined from 38 in the third quarter (Q3) to 36 in Q4 well below the 39 consensus forecast increase and the key 50 level which demarcates expansion from contraction.

The business confidence index (BCI) has declined 15 points since the start of the year to its lowest level in five years. Of the five sectors which make up the BCI, new vehicle sales fell from 27 to 19, wholesalers from 50 to 47, and building contractors from 45 to 39, while manufacturing remained unchanged at 34.

Only retail confidence showed any improvement rising from 34 to 40 although still below the key 50 level.

• The trade deficit widened sharply from –R1.26bn in September to –R21.39bn in October. While October is a seasonally poor month as imports are front-loaded ahead of the festive season the trade deficit was far worse than the –R4.90bn consensus forecast.

Imports fell on a year-on-year basis by -2.3% helped by falling oil prices, which contributed to a -21.8% decline in imports of mineral products. Exports fell by -2.6% on the year with the depreciating rand unable to compensate for declines in commodity-related prices and weakening external demand for commodities.

Although October provided a shock to the trade balance the –R59.39bn cumulative deficit for the year-to-date is still well below the –R95.14bn deficit over the same period last year.

• Although foreign investors sold a net –R0.57bn worth of domestic equities in the past week foreign participation accounted for just 26.9% of total trading activity, which is well below the 37.6% year-to-date average.

Over the past week net foreign buying was noted in the property sector while net selling was focused in the financial sector followed by industrials and resources.

During the month of November foreign investors sold a net –R8.53bn worth of equities reducing total net purchases for the year-to-date to just R6.21bn.

Net foreign purchases of domestic bonds have been more resilient with a total of R25.80bn for the year-to-date although net selling of –R2.62bn occurred in November.

• SA Reserve Bank governor Lesetja Kganyago, while speaking to editors of Mining Weekly warned that the rand’s reaction to the anticipated Federal Reserve rate hike on 16th December could be “exaggerated”.

Kganyago believed that currency trading at that time of the year would be unusually thin and also that the Fed rate hike had not been fully priced-in: “When (the hike) takes place, we expect that there should be some return of flows to the US out of emerging markets. There is always a debate about how much of that move has been priced in, but I think that, while a significant part of it is priced in, it is not fully priced in.”

Kganyago confirmed that the Reserve Bank would not intervene to support the currency.

• Growth in private sector credit extension (PSCE) accelerated from 8.4% year-on-year in September to 8.9% in October beating the 8.5% consensus forecast, with improvements in credit extension to both companies and households.

Credit extended to households increased from 4.3% on the year to 4.5% and to companies from 11.2% to 12.9%. Annual growth in mortgage advances, which accounts for 40.3% of total credit, held steady at 6.0% on the year.

Growth in “other loans and advances”, which includes unsecured loans to households and companies and makes up 41.1% of total credit, increased sharply from 10.1% to 12% on the year.

Although stronger credit extension is encouraging the recent jump is unlikely to build momentum due to persistently weak business and consumer confidence, high levels of household indebtedness, and rising interest rates.

• Producer price inflation (PPI) accelerated from 3.6% year-on-year in September to 4.2% in October well above the 3.7% consensus forecast. The main culprit was the “food products, beverages and tobacco products” category, which increased 6.2% on the year and contributed 2.1 percentage points to the headline figure.

On a month-on-month basis PPI increased by 0.9%. The main risks to continued acceleration in PPI include a drought-induced spike in food prices, further steep electricity tariff increases, and the effect of rand depreciation. The PPI data will be closely watched by the SA Reserve Bank, which is likely to keep hiking the benchmark repo rate from the current 6.25% to 7.0% by mid-2016.  

The week ahead

• Sovereign credit rating updates from Fitch and Standard & Poor’s (S&P) rating agencies: Due Friday 4th December. Fitch has SA on negative watch and is expected to downgrade from BBB to BBB- in line with S&P and Moody’s rating agencies.

S&P is unlikely to downgrade SA’s rating as it does not yet have the country on negative watch which is normally a precursor to a downgrade. However, S&P may put SA on negative watch at the upcoming assessment, which would pave the way for downgrade at subsequent rating updates.

A negative watch announcement would have negative implications for foreign purchases of domestic bonds, and likely prompt further rand depreciation.

• Barclays purchasing managers’ index (PMI): The Barclays/BER Purchasing Managers’ Index (PMI) has declined further below 50 for the fourth consecutive month, dipping to its worst level since August 2009.

• Standard Bank purchasing managers’ index (PMI): Due Thursday 3rd December. Like the Barclays PMI the Standard Bank PMI is expected to reflect persistently weak activity in November. The PMI is likely to remain unchanged from October’s 47.5 level, below the 50 threshold which demarcates expansion from contraction.

• New vehicle sales: Due Tuesday 1st December. According to consensus forecast total vehicle sales are expected to show a decline in November of -8.60% year-on-year unchanged from October’s decline.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is no sign yet of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.

• 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 8.70% which if broken could open a new target of 9.5%.

• Although recently recovered the MSCI World Equity index broke downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. It is unlikely that the downward move is over as the correction was too small for a bull market of the magnitude and duration of the 2009-2015 bull market. The downside target for the MSCI World Equity index is 1 400.

• 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.

• Although recently recovered the S&P 500 index broke downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.

• 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 $5 000 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 $1 300, $1 250 and $1 100. Gold’s next target is $1 000 which is likely to be breached before the bear market ends.  

• Although recently recovered the All Share index broke below its bull market support level which has been intact since 2009. The downside target for the All Share index is 43 000.

Bottom line

• A question plaguing investors is what to do about the resources stocks in their portfolios. Having dropped so far, has it become too late to sell resource stocks? At the same time it might be tempting for under-weight portfolios to start buying resource stocks at these levels. After all, the Resources 20 index has slumped -37.49% since the start of the year and is down -23.18% in the past month alone. In spite of the massive declines indicators are signalling more pain ahead.

• The main culprit is China’s economic slowdown and the shift in focus from investment spending towards consumer expenditure. China is a significant determinant of base metals prices having directly accounted for over 40% of the growth in global investment over the past 15 years.

Investment spending’s contribution to China’s GDP has climbed sharply from 33% in 2000 to 48% currently. Over the same period residential real estate investment as a proportion of GDP increased from around 3% to 12%.

• Investment spending as a proportion of GDP needs to drop in order to restore China’s economy to a sustainable footing. This means demand growth for most base metals is set for a severe multi-year decline.

• Base metals prices tend to follow the global investment cycle. Unfortunately resource prices have not fully discounted the expected deceleration in China’s investment spending. While base metals prices are down around -50% since their peak in 2011 they are still higher in real terms than they were during the emerging market crisis from 1997-2000. Given that new supply is still coming on stream from projects that were initiated during the resources boom, resource prices are likely to fall below the last crisis lows.

• Concerns over China’s growth dominated the global equity market sell-off in August and September. Global investor concerns are likely to resurface amid further loss in China’s economic momentum and the strong likelihood of high profile insolvencies.

While China’s official GDP growth rate is 7% this is likely to be overstated by as much as 3.5 percentage points. As the full severity of the actual slowdown becomes apparent there are likely to be further steep declines in base metals prices and resource stocks. Resource stocks are likely to be the biggest casualties from any bad news from China.

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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