Currency Spotlight: Rand (ZAR) Hedging

This past weekend my nephew overheard some of the adults participating in the all too familiar South African groan-and-moan session. While I was pointing out the rapid rand depreciation we witnessed over the past few weeks, with the rand hitting a fresh All-Time High (ATH) of 19.50 to the US dollar, my 8-year-old nephew interrupted me and asked whether it is because people do not like the new notes and coins issued by the SARB. I tried conjuring up a smart BCom-bro reply but after running out of precious suspense time, I ended up just nodding and replied with “Pretty much…”

Long story short, the major contributor to the rand’s depreciation is that international investors simply do not want to hold the rand, rand-denominated assets and rand-denominated debt such as our local bonds. The rand is but a small fish swimming in the polluted fiat currency pond along with all the other sovereign national currencies. Before we continue, it is worth pointing out that money and fiat currency should not be confused with each other. The term Fiat in Latin simply means “let it be done.” The reason fiat currencies have value is because the government declares the notes issued by the respective country’s central bank to have value. The value tied to these currencies is derived from governments letting it be done. It is an invention by a centralised entity, a nation’s central bank, with legislative authority.

A quick history lesson of why the world runs on US dollar bills, often referred to as greenbacks, in this invested fiat currency pond before we circle back to the rand’s spot in the pond. At the Bretton Woods Conference in 1944, the US dollar was tied to gold at 35 dollars per ounce, and all other currencies were tied to the US dollar at fixed exchange rates (one ounce of gold will today cost roughly $2000, that has roughly a 5 600% appreciation in the price of gold). That made the dollar the “world reserve currency,” which means it was the only currency accepted worldwide for the settlement of international trade accounts. This makes the dollar the big fish (even though the dollar was decoupled from gold in 1971), and the value of all the other fiat currencies is measured against the dollar.

The dollar is controlled by the Federal Reserve (the Fed). This makes the Fed the most important central bank in the world. The disturbing fact surrounding the dollar’s reserve currency status is that it enables the Fed to print new currency to buy the US government’s debt without devaluing the dollar, which allows the US to export most of their inflation. The Fed has increased the money supply at an unprecedented rate over the past 3-years which has caused inflation to become a global phenomenon. It is worth noting that inflation is not only caused by the price of goods and services rising. Also, rising prices can merely be a consequence of the currency losing value (purchasing power) with the creation of every additional unit of the currency. We are now in a situation where central banks around the world are trying to reel in the money supply, with the hope of easing inflation, by raising interest rates.

As a South African earning rand, you are faced with two threats concerning your purchasing power. Firstly, the rand is losing value versus major currencies and secondly, major currencies are losing purchasing power due to rising inflation, which depreciates our rand’s purchasing power even more. For reassurance purposes, fiat currencies are losing purchasing power, even the biggest fish in the pond.

The two main determinants which influence the flow of foreign funds into and out of South Africa (SA) carry trade- differences in interest rates between SA and major economies, and SA’s trade balance. Let us start with the carry trade. Carry trade refers to the return an investor can obtain when they borrow currency denominated in one currency at a given interest rate and then purchase bonds or debt denominated in another currency. The difference between the return the investor obtains from lending currency and the price they paid to borrow currency is the carry trade. For example, an investor can borrow currency in a low-interest environment like Europe, only pay around 4% interest on the borrowed funds, and invest those funds in SA government bonds (which are as they say “low risk” since the government or sovereign is financed by the country’s taxpayers) and earn around 10%. The 6% difference is the low-risk return the investor will pocket. The higher difference between the SARB’s repo rate and the major Central banks supports the rand by enticing international investors to invest their foreign currency in South Africa. Thus, the first and most prominent impact the recent rand depreciation will have on you as a consumer is higher interest rates as the SARB will be forced to raise rates to stem the rand’s depreciation.

The second major determinant of the rand’s value is SA’s trade balance. Terms of trade refer to the difference between South Africa’s exports and imports. When export earnings are greater than the value of imports, it is rand positive as more currency is flowing into our country than out and vice versa. At this point, I must highlight that the rand behaves like a commodity currency. This means that the rand is highly correlated with the price of our exported products. Those products are precious metals, particularly platinum since SA platinum exports contribute roughly 25% of the global platinum exports. So, when the price of these metals rises, do SA’s export earnings, which boost SA’s terms of trade, which is rand positive. SA’s trade balance has been mostly positive since June 2020. This was largely due to price rises of SA’s export products which allowed the rand to pull the USD/ZAR pair to a low of 13.35 in 2021. The strong trade balance has however been petering out and we can see the effect that has had on the currency. Let us get back to how this will impact you. Imports will get more expensive. There may be a lagged effect regarding the price of imported goods, but you will feel the full wrath of higher import prices at the petrol pump since crude oil and distillates are imported using dollars.

What can you do as a consumer earning a small fish currency (the rand) in a world where the purchasing power of fiat currency is depreciating worldwide? The most important hedge a South African must have in terms of protecting their wealth, savings and purchasing power is hedging against currency depreciation. This is where financial advisors throw up terms like off-shore versus on-shore investments. The rand has depreciated almost 250% against the dollar from 2005 to date so exchanging your rands for other currencies (moving money off-shore) has been a good hedge against the rand’s depreciation. However, you cannot park all your savings and wealth offshore. Retirement and local unit trust investors can only allocate up to 45% of their portfolios anywhere outside SA, up from the previous offshore limits that allowed 30%. But now even the major currencies such as the dollar are showing signs of fiat currency fragility, so what are the alternatives? My alternative to fiat investments is the holding of Bullion. The reason is that this form of money has an intrinsic value and cannot be manipulated easily by debt-hungry governments which manipulate their currencies with the help of their central banks.

The Krugerrand is the only legal tender bullion coin with its face value denominated in ounces of pure gold, therefore it is guaranteed that the SARB will purchase any tendered Krugerrand at the ruling price of gold on the day. Gold is often referred to as God’s money and silver is gentleman’s money, and I support holding either of these metals. Silver is a cheaper alternative to gold, which makes it more accessible for the average South African. In the 1990’s Krugerrands comprised more than 85% of the bullion in private circulation so rest assured that globally, everyone can speak the language of former President Paul Kruger. When looking at gold and silver priced in rand terms, it is easy to see why these assets provide sound protection against currency devaluation.

Over the past 20 years, from January 2003 to January 2023, the price of gold in rand terms appreciated by just under 1 000%, from R3,100 per ounce to R33,000. Similarly, silver appreciated just over 900%, from R40 per ounce to R410 per ounce. Just for perspective, the JSE returned investors roughly 750% over the same period.

Sources: Zerohedge