Like a rock tumbling down hill, oil prices have broken 40 dollars per barrel and sustained their downward momentum. Bearish reports ranging from the outcome of the OPEC meeting in Vienna over a week ago to supply outlooks from the International Energy Agency continue to weigh on the global crude market and have further dampening effects on global financial markets. Particularly equity markets look troubled with the notion of a diminishing global growth picture, and the prospects of a global recession come 2016. Not just limited to the aforementioned reasons, but markets remain on a jittery footing heading into the Fed meeting this week. It is remarkable how much can change in one short week as market participants exhibit signs of discontent with what’s in the pipe for the year ahead.
The greater probability though is not so much a fear for how North American markets will react to Fed actions next week, but instead what will result in the world’s emerging markets. South Africa reminded us this week that there are greater fears for emerging market (EM) investors than simply the price of the US dollar and commodity markets. Simply put, the commodity markets slump has put downward pressure on some of the world’s EM’s as returns are depleted and pressure mounts on government revenues. A strong US dollar also inflates the burden of US dollar denominated debt many of the countries and residing corporations have issued to finance themselves. But with the pressure of inflated interest payments and depleted revenues comes political risk.
With South Africa as the example, the Treasury and the Central Bank have long been viewed as stable and independent institutions. The benefit of an independent treasury is that it is an added pressure to government to restrain their finances and keep government debt in check. This all changed for the Republic of South Africa this week when the President Jacob Zuma fired his finance minister and replaced him with an unknown party insider. The Economist Magazine actually cited a spike in Google searches of the man’s name as people were unfamiliar with who would be taking the helm of the country’s finances. As the fear is this was a politically motivated decision, the rand, South Africa’s currency, in a swift reaction sold off 5 per cent against the US dollar despite sitting on multi year lows.
This is a critical time for emerging market economies. Also, given the demand from EM’s for precious metals, it has direct implications for the gold market. At the beginning of December Fitch Rating Agency downgraded South Africa’s debt to one notch above junk status. This is as Debt-to-GDP rose from 2009 until present time from under 30 per cent to just above 45 per cent. Political risks, whether from South Africa or any other nation, become more prevalent for investors and can change the dynamic of global markets.
This will likely reinforce a theme for the beginning of 2016 that the dollar, if not for investment opportunity in US markets, will be attractive for its safe haven and even more so liquidity status. It’s a challenge for commodity markets to counter trend a strong US dollar and as long as the outlook for EM’s is bleak, a strong dollar may persist. The global economy will be challenged in 2016, and objectively, remains one of the bearish factors weighing on the gold market.