Warning about the rand’s strength against the dollar
The South African rand has strengthened against the US dollar over the last year, but South Africans should not expect guaranteed future strength in the coming year.
The rand, like many currencies worldwide, has strengthened against the US dollar since the beginning of the year.
This primarily comes amid concerns over the US’s fiscal policy, lower interest rates in the US, and the new administration’s desire for a weaker dollar.
Developments in South Africa have, however, been relatively positive, with the country being removed from the grey list, receiving a ratings upgrade from S&P Global, and achieving some of the best market returns in the world.
This has seen the rand strengthen from R18.18/$ a year ago to R17.13/$ today, with the rand seeing some of its best performance in years.
Notably, several metrics indicate that the rand remains significantly undervalued compared to the US dollar.
For instance, the popular Big Mac Index, which compares the price of Big Macs worldwide, shows that the rand is significantly undervalued.
The latest comparison showed that a Big Mac costs R53.90 in South Africa and US$6.01 in the United States. The implied exchange rate is thus R8.97/$.
The difference between this and the actual exchange rate (at the time of the index) of R17.88 suggests the South African rand is 49.8% undervalued.
While the rand has been a strong performer over the last year, Morningstar Chief Investment Officer Dan Kemp warned that a quick correction is unlikely.
Speaking to BusinessTech, Kemp said that currencies can remain far from their fair value for years.
He added that currencies can take anywhere from a few months to around five years to adjust to their fair values.
While the rand may strengthen further against the US dollar, South Africans should not be overly optimistic about the rand reaching its Big Mac value of R8.97/$.
South Africa heading in the right direction
UK-based Kemp remains optimistic about South Africa’s potential, noting that the country is moving in the right direction.
From the start of the year to September, Morningstar said that South Africa has quietly been one of the best-performing markets in the world, seeing a 42% return in US dollars.
However, Kemp noted that this growth has been widespread and concentrated among single-commodity miners in the gold and platinum sectors.
Kemp added that South Africa has not benefited from foreign inflows over the last year, with the nation still making up only about 3% of the emerging market universe.
Given that other emerging markets, such as Brazil and Mexico, offer more attractive valuations, South Africa will remain a relatively small market for international investors.
For South African investors, however, Morningstar still sees value in several local companies, especially in the mining and banking sectors.
The company stated that diversified miners, such as BHP, Anglo American, and Glencore, offer more diversified trades, while gold and platinum miners appear fully priced.
South African financials also offer the most attractive upside for local rand-based investors, with the nation’s Big Five banks trading at reasonable valuations.
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