Explaining Rand strength 7 months later

Back in November ‘09 we showed the powerful effects money printing can have on all asset classes of the world except on the currencies being printed. 

It sends all correlations to 1, and if you’re not prepared for it, your assumptions may be horribly wrong, and investment outcomes may underperform benchmarks significantly if you’re a markowitz or model based portfolio manager and uprepared for another great reflation.

It is time for an update.

On all charts that follow, the ZAR is plotted as the red broken line on an inverted left y-axis (higher line = stronger ZAR).  The USD-ZAR exchange rate is plotted.

The first chart compares the USD-ZAR with the price of brent crude oil. 

The second chart compares the USD-ZAR with the JSE All Share Index.

Third up is USD-ZAR compared with the price of Gold in US dollars (XAU).

Last up is USD-ZAR compared with the S&P 500.

Like we said in November, “What do all these asset classes have in common you may ask? Simply, they are not being printed or increased at the same break-neck speed as are industrialised countries’ currencies in order to support failing financial institutions and bankrupt governments. You might be thinking how money printing will create jobs and see to prosperous, wealth creating economic growth worldwide; and if you’re thinking it won’t, you’re right on the money.”

To those who are watching the downside support trendline the USD-ZAR has bounced higher off over the past 3 or so years (you know who you are), thinking it will hold going into 2011, we refer you back to what we said about QE2 and its implications for the Rand. 

“A major structural issue that will further support the Rand – and something we have expected for some time now – is the resumption of QE by G7 central banks in Q2 but possibly Q3 2010 – the most likely candidates being the Bank of England, the Federal Reserve and the European Central Bank (more or less in that order).”

Okay so we got the order backwards, after Greece was taken down before a fragile US state and the ECB announced it would print a quick $1 trillion to solve the problem, but the point remains the US will be forced down the same path of increased QE.  No government can afford running the risk of having a sell-off in equities and real estate which will defnitely bring on a double-dip recession and imply an undoing of all the gains made over the past year.

This is bullish for the ZAR, and South Africa’s exposure to precious metals means we’re well placed to take advantage of what lies ahead in terms of the debasement of G4 currencies. 

Back in Feb we also noted that there is every possibility that the USD-ZAR suffers a bout of weakness before making the move lower. In fact, we’ll end today’s post with the same conclusion of Feb 26. 

“As a result of these poilcies, we expect the Rand will appreciate strongly against the GBP, USD, EUR, and JPY once QE (debt monetisation) is resumed (begins in earnest). We expect this move lower could take place as soon as Q2 or Q3 2010. If uncertainty surrounding QE2 rears its head in March 2010 [make it May], we expect there will be a sell-off in so-called ‘risk’ assets which would drag the Rand lower in the short-term, but this would only further increase the probability for QE2. Either way, we expect the Rand will hold its ground against the likes of the GBP despite weakness against the USD. Toward the end of 2010 the trend for the Rand remains stronger against these majors. While our target for an average USD/ZAR of 6.40 in 2010 might look a bit far-fetched at the present time, wait until you see the market’s reaction to the realisation that QE2 will be supporting government spending, not asset markets. We think it will be significant and lead to a significant re-pricing of EM currencies.”