Rand weakness provides temporary relief for miners

But can’t be the only thing required to rebuild an ailing industry.

Fresh turmoil on the Chinese stock market has compounded the effects of the changing of Finance Ministers, sending the South African rand to all-time low of R17.99 to the US dollar.

After losing 25% of its value against the greenback in 2015, the local unit has fallen by further 6.5% since the start of year, prompting fears the country may be on the verge of an economic recession. However, the weak rand may give the country’s beleaguered mining sector the shot in the arm it so desperately needs.

A rout in commodities has seen the prices of gold, platinum group metals, iron ore and coal – all of which comprise key South African exports – fall in dollar terms, while the weak rand has pushed those prices up in rand terms. This means that every ounce (oz) or metric tonne (mt) of the commodities produced in South Africa will yield a higher rand value for miners, who measure input costs in rands and sell commodities in dollars.

“The weak rand has definitely bought South African miners time but it alone can’t save them as they’re operating in a very toxic environment,” Peter Major, a mining analyst at Cadiz Corporate Solutions said. According to him, the economic, legislative, political and labour and environment has already destroyed half of the country’s mining industry and will destroy the rest if it isn’t improved quickly. “Masses and masses of new and ever growing legislation, regulations and  policy changes,  coupled with unions who often don’t play by the rules – such as intimidation, not holding secret ballots and going on unprotected strikes – along with populist politicians constantly demonizing the industry, have made life very difficult for everyone in mining in South Africa. The weaker currency isn’t going to change any of that,” he said.

 Afena Capital portfolio manager, Shoaib Vayej cautioned that the benefits of the weak rand are likely to be temporary and “..may come back to bite us a year down the line, especially if it leads to rand inflation and higher wage costs”.  He added that the reasons for some of the recent weakness in the currency should lead to an increase in discount rates for all South African assets, which has already been seen in the sell-off of government bonds, which would be negative for valuations.

rand graph1

Although the weak rand may look like a game changer for ailing South African gold companies by allowing them to increase margins and profitability, it is only likely to provide temporary relief.

“The dollar price of gold is double its long term average of $550/oz. $1,100/oz is the third highest gold price this country has ever seen. We have 40% – 50% of the world’s gold and yet we’re closing down more gold mines than ever before. This definitely sends a message that something is terribly wrong in South Africa when international gold production has continued to rise almost every year for the past 15 years,” Major said.

Citing data from the Chamber of Mines, Vayej said the gold industry has been in decline since the 1970’s, with the latest annual production figures of around 160 tonnes 85% lower than peak production. “I don’t think there is anything that will be able to revive production as the gold industry’s problems are geological. We are past peak production and have exhausted the resource”, he said.

palladium graph

According to Vayej, platinum group metals (PGMs) are also unlikely to benefit. “Most of the supply curve is in South Africa, the weaker rand will result in the curve falling and getting flatter and the dollar price of platinum should fall to match it. For social and political reasons, we can’t cut supply to rebalance the market”, he said. Given the poorer shape of the platinum industry, after the financial crisis, Lonmin’s recent bailout by shareholders and the VW scandal, he expressed concern about PGMs trends. If demand keeps growing the PGMs market will rebalance over time, if not, he said it may follow into decline.

palladium graph 2

In terms of the bulk commodities, iron ore and coal, South Africa’s macroeconomic factors are “not all that bad”, Major said. “Our iron ore is of a very high grade, well known and developed, and our coal prices are holding up okay”, he said acknowledging significant declines in the iron ore price over the past two years.

According to Vayej the difference between iron ore grades between South Africa and BHP Billiiton’s Australian operation, where iron ore lump ratios are at 60% and 25% respectively, are being offset by the freight cost differentials between the two countries and China. “[We] expect increases in competition as Roy Hill and Vale’s S11D come online over the next two years and there is negative to no demand growth. Prices are set to remain weak and so the outlook for South African iron ore is quite weak given the work starting cost position” he said.

Vayej said coal is slightly more positive as local producers are at the lower end of the cost curve but noted that demand is very weak. “Indian import growth was supposed to offset weak demand from China but the state-owned Coal India has hit production targets for the first time which isn’t too good for the seaborne market,” he said.

“From a commodities perspective, the world is in recession. Commodities are in freefall due to negative demand. We’ll be watching demand very closely especially from China,” Vayej said. ““There’s absolutely nothing we can do about China and the US [tightening its monetary policy].  But we can look in the mirror a little more often…The weaker rand is an opportunity that should not be wasted. We wasted enormous opportunities from 2004 to 2014; let’s not waste this one now.”

According to Mike Keenan, a South Africa strategist at Barclay’s Africa, rand weakness will continue this year but the rate of depreciation is likely to slow. The bank forecasts an end of year spot price of R17 to the dollar, which is in line with JP Morgan’s expectations. Charles Robertson, global chief economist at Renaissance Capital is more bullish on the rand, “the rand is now extremely cheap and this will correct in time. Currencies rarely stay two standard deviations away from their long-term fair value – as the rand is today. On a six to 18 month view, we think the current account and foreign direct investment trends will shift so much, the rand will be [at] 15.00 or stronger”.

“Government and unions need to work with mining companies. They must draft and enforce better policies and legislation and all of South Africa must use the weak rand to rebuild its balance sheet and country. Government, companies and unions should capitalize on this perverse, ‘made in South Africa weak rand event’ and learn from mistakes and get things right. The mining industry has to be rebuilt so that it lasts a couple hundred more years,” Major said.

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