The current year has been a tumultuous one for markets filled with increasing levels of uncertainty stemming from geopolitical tensions and trade wars as the US grapples with its trade and fiscal deficits.
In an age of decentralised information, misinformation has fuelled these tensions — including but not limited to accusations of a genocide in SA.
However, looking at market returns in absolute terms you would not tell there is so much uncertainty, with SA, US, European and UK markets positive on a year-to-date basis and hitting record highs this year.
This is of course not the full picture — US, European and UK markets hit their record high levels in the first quarter of the year, with heavy drawdowns at the start of the second quarter and some recoveries during the remaining half of the year.
Turning to SA, though we have hit our record highs in recent weeks with double digit returns, there are some underlying risks that remain beneath the surface.
For starters, much of the returns have been driven by the resource sector — predominantly gold and platinum producers. There have also been some strong positive returns stemming from outside SA, while the local facing sectors have moved sideways.
The biggest driver of the resource rally has led to one of the most contested gold and dollar debates in recent history. The question remains whether there is a structural break in both the gold price and in how the dollar is viewed.
There are multiple stats that highlight why the dollar is without doubt the most dominant currency in the world. These range from the denomination of commodities, the percentage of global trade conducted in dollars, as well as the percentage of dollars held by most reserve banks across the globe.
However, reserve banks and asset managers have been questioning the dollar as a safe haven asset class, as much of the policy uncertainty has emanated from the US. While we do not expect reserve banks to dump US government bonds and the dollar, even if they do we expect that the US Federal Reserve would step in and buy them up. We do however expect to continue seeing some more moderate consequences for financial markets, including the dollar.
For starters, though they are not selling aggressively, reserve banks are also not reinvesting as much into US government bonds but rather letting them mature slowly. They are also not rushing in to buy more dollars, alongside asset managers. This has meant the dollar has been a lot more volatile than it was in the past. As a consequence, there is a lot more positive correlation between market drawdowns and the dollar.
In the past the dollar has provided a natural hedge against market drawdowns, where during periods of risk off sentiment markets would draw down but the dollar would strengthen — cushioning the blow from a domestic currency perspective, including the rand.
Currently, with the positive correlation the negative returns have been compounded by the currency movement. This implies that most investment managers are under-hedged against the dollar — if this trend continues.
On the other side, the largest beneficiary has been gold, which has supported our markets. Gold counters are now appearing stretched from a valuation perspective, and gold is known for its heavy volatility, large price swings and market corrections. This is making most market participants nervous about its sustained trajectory going forward.
The potential difference in the current rally is the prospect of continued dedollarisation and heightened geopolitical tensions, leading to more reserve banks and asset managers allocating to gold as the de facto storer of value.
Of course, things could resolve themselves as quickly as we got here, and we have seen signs of resolution looking at recent market rallies. But even with those market rallies the correlation with the dollar seems to be asymmetric — positive on the downside, and negative on the upside, implying participants remain concerned about the dollar even as they find some comfort in markets.
From a portfolio management perspective, we have delivered double-digit returns for our clients participating positively on gold prices through our holding in Sibanye, which has also benefited positively from the platinum rally, alongside our other holding in Northam.
We have also benefited from the positive stimulus in China through our Naspers and Prosus holdings, as well as our holding in Richemont, which has benefited from a recovery in luxury spending.
Furthermore, the stabilisation in the Nigerian economy has boded well for our MTN holding, among others. We also continue to find a lot of domestic-facing counters in the finance and retail sectors to be attractively valued and expect positive, above-inflation real returns over the next couple of years.
• Smith is chief investment officer at Absa Investments.
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