Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG. The information in this document is provided as general information. It does not constitute financial, tax, legal or investment advice and the PSG Konsult Group of Companies does not guarantee its suitability or potential value. Since individual needs and risk profiles differ, we suggest you consult your qualified financial adviser, if needed. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

September 2017

QUARTERLY NEWSLETTER

W.C. Niemann

"Gold is the anti-complex asset, and therefore one asset that an investor should own in a complex world." - Jim Rickards -

Global equities posted solid gains in the third quarter of 2017 as the synchronised expansion in global activity provided steady support for asset markets. Against this positive backdrop, central banks have finally indicated that they want to gradually reduce the level of monetary policy stimulus in place.

In September, the US Federal Reserve announced that it would start reducing its $4.5 trillion balance sheet as of October. It also suggested that another rate hike is on the cards for December. The European Central Bank looks set to announce a further slowdown in the pace of their bond buying program in October and the Bank of England also indicated that it would normalise their base rates soon. This welcome shift from quantitative easing to quantitative tightening, signals a major step towards policy normalisation after the global financial crisis, a period during which the four major advanced-economy central banks’ balance sheets have more than quadrupled.

Source: Federal Reserve, Bank of England, European Central Bank, Bank of Japan, Haver Analytics, Fidelity Investments

Quantitative tightening, which has never been attempted before, is every bit as bearish for stocks as quantitative easing was bullish. We have written countless times about asset prices which are at nose-bleed levels. According to the chief economist of the Bank for International Settlements, Claudio Borio, even minimal rate rises are likely to cause a major fallout in financial assets. Deutsche Bank estimates that markets should have a better idea of quantitative tightening’s impact in about a year’s time when the current $2 trillion annual increase in central bank balance sheets fade to zero.

Source: Thomson Reuters Datastream, Fathom Consulting

Central Bank Balance Sheets

12 Month Change in Central Bank Assets (USDbn – at current FX rates)

Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

One major risk for financial assets lies in the possibility that corporate bond yields currently misjudge the extent to which reflation is dependent on inflating asset prices. High Yield Corporate Spreads in the United States are at historically low levels, which in turn led to higher debt, which is being used to push up asset values. According to Albert Edwards, one builds debt structures on false asset values when one pushes asset values beyond their fundamentals. This will only become obvious when the asset bubble bursts. If asset values were to collapse, corporate bond spreads will explode, especially considering US interest cover has declined to levels last seen during the depths of the previous recession.

Source: FRED, Thomson, Macquarie Research, SG Cross Asset Research

Economic growth is likely to struggle under quantitative tightening, as the bulk of economic consumption during the quantitative easing period was supported by artificially inflated asset prices. During this period savings approached all-time lows. Any deflation of financial assets could have a significant impact on consumption, which in turn accounts for two thirds of the US economy.

Source: BLS, Thomson, Macquarie Research

As for the world economy, Bank of America concluded that the volatility of the global economy has tumbled to all-time lows and this will reverse two dominant investment philosophies: global growth trade, which has been driven by foreign exchange, will now be driven by interest rates and crossover foreign demand, which has driven domestic bond markets, will be significantly slower. All of this may potentially lead to a collapse in volumes and a resulting “coiled spring” mean reversal, which will ultimately lead to a synchronised rise in bond yields driven by central bank expectations and rising term premia.

US High Yield Spread vs US Interest Cover

US Consumption supported by lower savings, but primarily supported by asset prices

Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

Source: BofA Merrill Lynch Global Research, OECD

Concerning bond yields, quantitative tightening is already having an effect on world treasury markets. The US Treasury market is currently experiencing its longest losing streak of 2017. Bond guru, Bill Gross, recently stated in a Bloomberg interview that the three-decade bull market in bonds may be coming to an end when the 10-year Treasury yield moves above 2.4%, which is only a few basis points away.

Source: Thomson Reuters Datastream, Fathom Consulting

As mentioned in last month’s newsletter, gold will be one of the main beneficiaries from the changing investment environment. Schroders plc argues that despite having a solid track record as a currency of last resort in uncertain times, the weighting of North American gold equities in the S&P 500 and the Toronto Stock Exchange has fallen to just 0.6% after reaching a peak of above 2% in 2012. The current positive investment cycle of this precious metal has potentially many years to run.

Variability in GDP growth across countries is at the lowest in 50 years

Breaking the Trend – Bill Gross eyes key 2.4% level for higher yields ahead

Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

Source: Bloomberg

Another case for gold comes from Marcia Christoff-Kurapova of the Mises Institute. She recently argued that hard assets could be used in an attempt to deal with an environment where the actual economy is doing poorly while the market is soaring. Gold, land, art and other precious and base metals are essential assets amid the aggressive debt levels and monetary printing that have so unbalanced the financial markets since the global financial crisis. In this context the Bank of Russia has been the world’s number one stacker of gold for the past 3 years and it is clear that countries buying up gold versus investors who do so (mostly value investors) are clearly from two different worlds. Aren’t momentum investors missing something here?

Source: Mises Institute

Weight of North American gold equities in the S&P 500 and Toronto Stock Exchange

Gold as % of Total Reserves

Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

Portfolio News

In May’s newsletter, we commented on Vodacom’s annual results. It was our opinion that the company’s acquisition of a 35% stake in Safaricom, a leading mobile network operator in Kenya, made strategic sense. Shareholders approved the deal and the share price benefitted substantially as it provided the South African telecommunications company with access to high margins in a high cash generating business in a lucrative market.

The share price started the quarter from price levels of R165. At the beginning of August we decided to sell our entire Vodacom stake at R183. The share was trading at a significant premium to its historical fair value and we felt that the current slowdown and increased competition in South Africa would negatively affect the group’s profitability.

Our decision proved to be correct as Vodacom’s UK parent company, Vodafone, sent a negative signal to the market when it sold 5.2% of its shareholding in September, at a discounted price of R165. The share price has also pulled back further, post this announcement, when Reuters indicated that the South African Competition Committee was investigating the group in respect of a contract covering 20 governmental contracts.

Source: Inet BFA

Argent Industrial Limited released its results for the year ended 31 March 2017, at the end of the second quarter. Revenue increased by 8% and headline earnings per share grew by 11%, but new struggles emerged that could continue to haunt the Industrial Holding company in the future.

Management stated that they are at present operating in a very difficult steel-trading environment and that its automotive plant had to be closed due to General Motors’ decision to exit their South African Operations. The group’s manufacturing division was also hit by the current economic downturn and recent rand strength.

Considering the existing difficult macroeconomic situation and the unpredictable domestic political environment, we are of the opinion that the group’s struggles will continue in the short- to medium-term. Since our initial stake in July 2013, the share price has basically traded in a downward-sloping band and we made the tough decision to sell our entire stake in the company after 4 years of continuous disappointment.

Vodacom Performance in the Third Quarter

Performance since May Newsletter

Performance since decision to sell

Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

Source: Inet BFA

Our local banks received a lot of support from the rand’s strength during the past quarter. FirstRand started to trade above its fair value, but we expect the strong momentum in the financial services provider’s operations to be maintained and to be transferred into new segments. We therefore decided to cut our clients’ holdings to between 4-5% only.

Currently trading at a forward price/earnings ratio of below 12 times - and 2.8 times its net asset value - we feel that the share is fairly valued. The share also offers a lucrative historic dividend yield of 4.7% and the group boasts an above industry Return on Equity ratio.

Source: Inet BFA

Argent Industrial Share Price Performance

FirstRand Performance During 2017

Bloemfontein Stockbrokers & Portfolio Managers | Preller Walk Centre, Genl Hertzog Drive, Dan Pienaar, Bloemfontein, 9301 | PO Box 12337, Brandhof, 9324 | Tel: +27 (87) 820 4844 | Fax: +27 (86) 545 4590 | hannes.barnard@psg.co.za | psg.co.za

The opinions expressed in this document are the opinions of the writer and not necessarily those of PSG and do not constitute advice. Although the utmost care has been taken in the research and preparation of this document, no responsibility can be taken for actions taken on information in this newsletter. PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider. FSP 728.

Conclusion

The long road from the global financial crisis to recovery has passed another milestone with the arrival of quantitative tightening. This policy tool has never been attempted before and it is expected that all the stock-bullish tailwinds from years of quantitative easing will reverse into fierce headwinds.

As a leading alternative investment that tends to move counter to stock markets, gold will be one of the main beneficiaries of the expected stock-market weakness. We have written about our investment cases on precious metals and commodities in various previous newsletters and feel that we are prepared for the imminent storm.

Bibliography:

Fidelity Investment Team, ‘Quarterly market update Q3 2017 key takeaways’ https://www.fidelity.com/viewpoints/market-and-economic-insights/quarterly-market-update Schroders Investment Team, ‘Quarterly Markets Review – Overview of markets in Q3 2017’ http://www.schroders.com/en/insights/economics/quarterly-markets-review---q3-2017/ Durden, Tyler, ‘it’s not just the markets: Economic volatility tumbles to 50 year lows’ http://www.zerohedge.com/news/2017-10-11/its-not-just-markets-economic-volatility-tumbles-50-year-lows Hamilton, Adam, ‘Fed QT Stocks, Gold Impact’ http://www.zealllc.com/2017/fedqtsgi.htm Edwards, Albert, ‘Global Strategy Weekly – Bank of England leads the way in monetary schizophrenia’ Edwards, Albert, ‘Global Strategy Weekly – I have seen the future and his name is Kevin’ Chappatta, Brian, ‘For Bill Gross, the Demise of the Bond Bull Market Is Just Basis Points Away’ https://www.bloomberg.com/news/articles/2017-10-08/for-bill-gross-bond-bull-market-s-demise-is-basis-points-away Durden, Tyler, ‘Macquarie: Investors are mentally exhausted because they understand there is nothing normal in this market’ http://www.zerohedge.com/news/2017-10-09/macquarie-investors-are-mentally-exhausted-because-they-understand-there-nothing-nor Durden, Tyler, ‘Hard Assets In An Age Of Negative Interest Rates’ http://www.zerohedge.com/news/2017-10-02/hard-assets-age-negative-interest-rates?page=1 Khumalo, Kabelo, ‘Shareholders back Vodacom deal’ https://www.iol.co.za/business-report/companies/shareholders-back-vodacom-deal-10360841 Reuters Staff, ‘Vodafone sells down shareholding in South Africa’s Vodacom’ https://www.reuters.com/article/vodafone-group-vodacom-grp/vodafone-sells-down-shareholding-in-south-africas-vodacom-idUSL8N1LN2I1 Allix, Mark, ‘Argent chides state for ArcelorMittal help’ https://www.businesslive.co.za/bd/companies/industrials/2017-06-29-argent-accuses-government-of-creating-an-inefficient-monopoly/