We remain optimistic about equities generally, yet we do not expect JSE Resources to out- or under -perform the market generally.
JSE performance is often in the mix of resources vs other sectors
South African managers of balanced equity funds usually stand or fall by their judgments about the mix of resources, industrial or financial stocks in their portfolios. Resources can out or under perform by large orders of magnitudes as we show below.
JSE Resources Vs Industrials vs Financials (18 Sept 2008=100)
Source: I-Net Bridge and Investec Private Client Securities
Extreme relative moves were experienced in 2007-2008
Fifteen months ago, by mid 2008 when compared with a year before, the JSE Resource Index had outperformed the Financial Index of the JSE as much as 60% and had gained 40% on Industrials. Within a few short months, when the credit crisis was at its height and commodity prices collapsed, Resources had fallen more than twice as far as Industrials or Financials.
The JSE sectors have moved in line over the past twelve months
Over the past twelve months after the fall and with the strong recovery from March 2009 in commodity prices and emerging equity markets, all the major sub sectors of the JSE have performed more or less in line. The annual return on JSE Financials and Industrials have been about five per cent ahead of Resources and all sectors have moved into positive annual return territory.
Resources/Industrials and Resources/Financials (Sept 2008=100)
Source: I-Net Bridge and Investec Private Client Securities
What matters for relative and absolute JSE performance is not rand strength or weakness – but the causes of rand strength or weakness
The key to the out- or under-performance of the Resource sector is not simply, as many would be inclined to suggest, simply rand weakness or rand strength. Rand weakness will only be especially helpful to Resources and harmful to Financials and Industrials if the cause of rand weakness is South African specific. For example if some SA political development causes investors both locally and abroad to raise their risks of doing business in South Africa causing an outflow of funds and rand weakness, Resources will do better than Financials or Industrials. Vice versa if an improvement in sentiment causes the rand to strengthen, when the rand plays will outperform the rand hedges.
Mid 2006 to mid 2008 was an ideal time to be exposed to JSE resources
A combination of the kind of rand weakness experienced in 2006-08 coupled with stronger commodity markets represents ideal circumstances for JSE resource valuations. We show in the figure below how the rand weakened against the Aussie dollar (another commodity currency) in 2006-07 despite commodity price strength; and so Resources performed well absolutely and in a relative sense, outperforming handsomely the other JSE sectors. We also show how the rand recovered some of its losses and has held its own against the Aussie dollar over the past 15 months. Resource valuations came under particular pressure from the combination of weaker commodity prices and a relatively stable rand.
JSE Resources/Industrials, Commodity Price Index and the ZAR/AUD (Sept 2008=100)
Source: I-Net Bridge and Investec Private Client Securities
Rand strength for fundamental reasons is good for the JSE, but not especially good or bad for JSE Resources
When the source of rand strength or weakness is to be found outside South Africa, in the form of global economic strength which leads to stronger global commodity and emerging equity markets, there will be no reason to expect resources to out- or under-perform other sectors of the JSE. This has been the case recently. The rand has strengthened because of the recovery of the global economy led by emerging economies. The rand is stronger because of much firmer emerging equity and commodity markets.
The recent strength in commodity prices has been helpful for Resource company valuations on the JSE as well as those of the rand hedges (companies with a substantial part of their business outside South Africa). The strength in commodity and emerging equity markets has simultaneously boosted the rand and so the South African economy plays listed on the JSE have kept pace with the JSE generally.
The case for increasing exposure to the JSE equities at the expense of bonds must be based on a belief in rand strength for global reasons. What is good for the rand in the global economy will be good for the JSE, resources included. Rand weakness for global and SA specific reasons would be a reason for seeking less exposure to equities generally even though resources are likely to suffer less than average damage in such unhappy circumstances.
Our view is that the recovery in the global economy will continue to be helpful to JSE equities and the rand and so there are no SA specific reasons for strongly preferring resources over the other sectors or for reducing exposure to them. While continuing to overweight equities we would continue to recommend a broadly neutral mix of Resources, Industrials and Financials.