• Stonewood AM

A Miner's Quagmire

Mining has for decades now been on the decline in RSA. Factors such as (but not limited to), economic empowerment, a newly introduced carbon emissions tax and the excessive cost of unionized, inflexible labour have been detractors to growth in the industry. It seems we are doing whatever it takes in our power, to in fact kill one of the largest contributors to our economy and undoubtedly one of the largest employment industries we have.

To lose the employment opportunities alone would be devastating for our current unemployment backdrop. It is almost impossible to remember a time, not so long ago, that we were considered an absolute powerhouse in the global resource and mining game. We accounted for a very large percentage of global gold and platinum production. While we remain a massive producer of platinum, we have lost important ground on many other resource fronts. So, with that said, it would be obvious to think that any investment in mining over this volatile period would have been one of the major detractors from portfolio investment performance.

The logic should apply that if the environment for a sector of the economy is positive and on an upward trajectory then the investment in that industry/asset class would be rewarding for investors. The truth is, the economy and the market are related but at times only very distant cousins.

For example, in a theoretical world of people drinking a lot of beer, one would think that buying shares in a beer making company would be profitable, because increased beer consumption can only be good for the revenue and, therefore, profits and finally adding to share value. Unless, of course, the cost of making beer has gone up by more than the increase in beer sales, the price of the beer company shares had already priced in improved revenues, or perhaps a regulatory fine has been imposed onto the beer company. Many factors can be at play for any one company, let alone the whole beer market and industry to necessarily benefit from improved conditions or trade.

Returns over the 1-year, 3-year and 5-year periods have all been disappointing for investors in the local market. With that scene set, it would be highly likely that since our mining industry has been in a steady decline for most of the above-mentioned periods that mining should have been a major detractor from investor returns.

You would be correct on the primary assumption, because over the long run fundamentals tend to carry much more weight than short-term market movements. The below chart shows exactly that; the long run performance of the Resource subset of local equities has been mildly negative over the last 5 years to the end of February 2019. While the other major sub-sectors (Industrials and Financials) have been significantly positive over the same period in relative terms.

Source: Bloomberg

As soon as you look at a 3-year number or 1-year number for the very same subsector the returns look vastly different. Enough to completely confuse almost any investor. Adding to the confusion is that over the very same period Gold, Platinum and Oil all performed poorly in USD terms.

If we look at the relative performance of Resources, Financials and Industrials relative to the All Share Index (ALSI) over the last 12 months, it’s very clear that Resources have been a stellar performer. In fact, they are the only sub-sector (of the three majors that you would have wanted exposure to). Resources are up an eye watering 32.5% to be precise.

Source: Bloomberg

If one looks over prolonged periods of time, the market tends to be a very good pricing mechanism. However, over shorter periods, sentiment as well as a few variables can have a very profound effect on valuations and relative performance.

In conclusion, investors and fund managers are likely to be tempted into chasing the last 12 months of performance by piling into commodities and mining stocks. It is tempting, as 32.5% in any market is a great annual return. Many will also make the case that mining stocks are not RSA focused and many are globally diversified resource businesses like BHP Billiton. That too would be correct, however, the fundamentals of mining in RSA have not changed materially for the better and therefore proceed with caution.


Market Update

Source: Factset

February showed a continued positive start to 2019 for SA equity, with a rise of 3.4% for the month bringing year-to-date (YTD) returns to 6.3%. This was, again, on the back of a continued strength from resources which has led to an overall rise of 26.5% in the last 3 months. It seems that iron ore prices reaching a 2-year high due to a 14.9% increase, following the collapse of a major Brazilian Mine Dump in January was a significant contributing factor to this increase in resource stock prices.

After a strong month for Property in January, February saw a decline of -5.7% in the SA Property Listed Index, bringing it down to be the poorest performing asset class for the month. Property counters like NEPI Rockcastle delivered increased distributions to its investors in 2018, despite a more challenging year than expected. Property is however 3.0% up YTD.

Looking at the fixed income market locally, SA Bonds dropped -0.4% for the month with long-dated and inflation-linked bonds losing -0.8% and -0.5% respectively. Data showed that CPI fell to 4.0% in January from 4.5%, a reprieve for most consumers but not so much for investors in inflation-linked bonds. Short-dated bonds were up 0.4% for the month of February.

The SA economy showed growth of 0.8% for the year of 2018, however the disruptions from load shedding pose a great threat to the expansion of the economy. Further, the suggested Eskom bailouts and planned split mentioned in the SONA, coupled with negative reviews from ratings agencies, saw a sell-off in the Rand leading to a depreciation of our currency against major counterparts.

Tito Mboweni’s budget speech showed very realistic representative figures for debt, expenditure and GDP which came as no surprise to the market and it was therefore little moved, despite the somber budget outlook.

Abroad, global equity markets also saw a positive month for February in spite of mixed signals from the world’s largest economies. We saw a failed attempt at a National Emergency by President Trump, in search of funding for the building of the border wall. The United States and China did, however, have talks about a potential trade deal which could materialize soon.

China lowered its economic growth targets all the while announcing wide-ranging tax cuts and targeted monetary support for the economy. European growth has stalled, as discussed in the previous article, but news about Brexit potentially being postponed or a second referendum being held saw the British Pound trade stronger against the Euro.

Emerging Markets (EM) ended relatively flat despite the ongoing friction and economic troubles in countries such as Venezuela and Turkey. Net inflows to EM have turned positive in January and have continued into February which is indicative of greater interest in EM markets and perhaps a risk-on sentiment from investors.

Gold has naturally had a relatively flat month with more and more individuals being more risk-on. We hope that the flows continue into the year, so that the ‘new dawn’ truly materializes for all South Africans alike.

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