The 2020 Copper-Kwacha Divergence Continues

By: Munyumba Mutwale

‘Short Term Volatility is the Stronggest at Turning Points and Diminishes as Trends Establish’ George Soros

A strange phenomenon seems to have taken hold of the Zambian Economy since March 2020. The usually positive correlation between the Zambia Kwacha and the Global Copper price seems to have not just disengaged but turned negative. It appears that for the last 5 months the Currency and the Commodity seem to be moving in opposite directions, temporarily breaking with the view that rising copper prices give support to the appreciation of the Kwacha. This now brings into question, where does that put our hopes of a copper based economic recovery and with that hope seeming to switch on us what is our best option now?

At the End of July 2020, Award-winning economics research firm, Capital Economics had increased its official price target for copper from $5,500 to $6,800 for the year 2020. As unpredictable as 2020 has been, in the early hours of 1st September 2020, the copper price breached $6,800, in fact, getting as high as $6,830, but now it’s off those highs and trading at $6,700. This puts the copper price up 10% for the year so far.

Ironically it is the coronavirus that has given a lot of steam to the Copper price rally, specifically the rise in case numbers and severity of the outbreak in South America in the last few months. Rising case numbers in Chile, Peru and Panama had caused such bottlenecks and slowdowns in copper production, that it was announced last week that copper stockpiles in LME-approved warehouses hit their lowest since August 2007, at 103,475 tonnes.

Already trading at a 26-month high, copper is expected to rally throughout the year and into the following year, due to a combination of fiscal stimulus led by Chinese government infrastructure spending, monetary stimulus led by a variety of PBOC interventions, and a startling recovery of the Chinese Manufacturing and services industry, seen in PMI numbers that have sustained 50+ scores over a series of months now.. The Chinese services sector has also shown much stronger signs of recovery, leading to growing support for the hypothesis that China is now transforming into a service economy as it may have maxed out its industrial growth levels.

Added to this there is the expectation of a 2020-H2 Mining output decline of at least 4%, leading to further supply constraints. The extent of supply constraints has not found agreement amongst the global analyst community with Refinativ stating that they expect that in Q2 we have seen the worst of the supply constraints and they are expecting ‘a relatively sizeable global market surplus in 2020’, thus maintaining a price target of $5500.

Analyst Jonathan Barnes, of Roskill, said in a recent report, ‘the copper price will likely rise further towards the end of 2020, and that the current environment has strong parallels to the rebound in the copper price after the global financial crisis of 2008 thanks to massive stimulus efforts by Beijing.’

Finally, analyst He Tianyu, of C R U Group, has stated that he thinks prices still have the potential to increase, but in the short-term, they will be floating around the $6,800 mark. He also stated that there is the expectation of a price rally from mid-September at the earliest when the traditionally strong copper season kicks in.

All this should be good news for the Zambian economy and the Zambian Kwacha, especially with the fact that Brent crude is also down 30% for the year. Historically, the free float Zambian Kwacha has been fundamentally determined by the difference between the growth rates in oil and copper prices, however this year we have seen a break from that trend. The data has shown that since March 2020, the Kwacha and the Copper Price have been officially moving on a divergent path. This disconnection has been due to the effect of the new and more significant big forex market demand factor, External Dollarized Public Debt. Due to the dominance of External debt on the budget and on the forex market, it is now evident that the Zambian Kwacha, similar to a highly geared publicly traded entity, is now deriving its value from economic growth confidence and not trade flows and other fundamentals such as interest rates and inflation differentials.

In an interview with Bloomberg Television, then CEO of Credit Suisse, Tidjiane Thiam, stated,

‘In currency markets, there are only economies that are well managed and economies that are less well managed, that is the key difference. Well managed economies are economies that have a current account surplus, have their public finances in order, don’t run an unsustainable fiscal deficit and have significant forex reserves

Economies that come under pressure usually suffer from more fundamental economic problems…’

In line with this statement, one cannot peg the problems of the Kwacha on some global economic ‘contagion’ factor, but more due to fundamental problems in our economy and more so, the fact that economic growth in Zambia has been weak to nonexistent in the past 5 years. The decline of the Zambian Kwacha, alongside a slow to now negative economic growth rate, poses a serious risk to the Zambian economy, because it is slowly increasing the debt burden of the nation while sustaining declining or even negative growth in government revenues and collections. The risk is the debt pressure will increase unless Zambia sees a significant cash infusion through the capital markets, or the economy experiences a rapid turn around in its economic growth prospects.

It does appear though, that the current strategy seems to be one of resilience and hope. To wait out the Coronavirus recession, in hopes that we shall find a more friendly, or really a more liquid, global capital market awaiting us on the other side, that will be willing to inject capital into our domestic debt markets and refinance our various sovereign debt instruments. This is probably based on the fact that the IMF and other global institutions have concluded that 2020 is going to be a year of economic decline with the expectation of a strong economic recovery in 2021.

However, one must advise caution against that specific strategy, as there are some key factors that need to be taken into consideration that may affect the validity of said strategy:

1. 1. THE RISING UNPOPULARITY OF GLOBALISATION: The last era of globalisation has been marred with widening inequality gaps. The last 20 years of Chinese led globalisation has been blamed for the hollowing out of middle classes around the world, and thus there has been a rise in nationalist leaders and populist movements more hostile towards unfettered global trade, such as the Brexit Movement and The Election of President Donald Trump. The coronavirus has now made the case for anti-globalisation leaders who seek to repatriate manufacturing from China and reduce the influence of global trade lines. So we are potentially looking at a different Global economic order and system on the other side of this Coronavirus recession, and in fact, the coronavirus recession itself has provided the perfect opportunity for such a Global economic reset.
   2. CHINA MAY NO LONGER BE THE EMERGING MARKETS LEADER AND ITS CHIEF FINANCIER: Throughout the last 40 years, China has moved from an emerging markets economy to a 1st world developed nation, by simply becoming the world’s leading manufacturer. However, as china reopens its factories, it seems they may not be returning back to the dominance that they are used to. Over the past 30 years, China, which gained its main economic competitive advantage from cheap but highly productive labour for manufacturing, has seen that slowly disappear as the average Chinese factory workers annual pay has moved from approximately $150 in 1990 to approximately $13,500 in 2020. This is potentially giving rise to new manufacturing powerhouses such as Mexico, Thailand and Vietnam, who can provide much cheaper but highly productive labour to Global Manufacturing Brands such as Nike. However, this transition is not going to happen overnight, similar to the transition from Russia to China as the new global competitor in the 80s and 90s. So there is going to be a phase of economic limbo with no leading manufacturer who is incentivised to invest in developing nations like Zambia, because of the need for vertical integration of supply chains, as China had been doing from about 2001 to around 2015. For the next, probably 10 years, these rising nations are going to have to build up contracts, capacity and capital, and during that build-up phase, we are probably going to see a more constrained flow of funds to emerging and frontier markets, such as Zambia, for development assistance, thus putting a wait and hope strategy into question. Simultaneously and happening even faster, for the first time we are starting to see China do the ultimate transformation of becoming a 1st world service sector driven economy. Therefore the incentive for China to invest in developing nations as part of its vertical integration strategy for its manufacturing firms has reduced. This transition will also affect the level of Growth in China, which will no longer be above the 7% line it got used to. In this transformation, we are going to see China start to grow at the 1st world levels of 2% to 4% peak growth, further hindering its incentive and means to conduct unfettered lending and support to nations like Zambia. This reduction in Chinese economic growth, also makes it difficult for Zambia to continue its 20-year economic strategy of chaining the Zambian Economy to the back of the Chinese Economy in hopes of riding the Chinese economic growth wave. https://www.youtube.com/watch?v=h6GqEpmn_Fk
   3. THE INCREASING LIKELIHOOD OF A TRUMP RE-ELECTION PUTS THE EASY FLOWING GLOBAL ECONOMY AT RISK: The recent conventions have seen President Trump rise in the polls, however, added to this, there has been a fundamental flaw in the polling method that has been used to assess the Trump v Biden match up and it’s the same flaw that was applied in Clinton v Trump and Obama v Romney. That is the use of favourability instead of voter enthusiasm. Favourability shows Vice president Biden to be ahead, 49 to 45, but when you look at enthusiasm levels, which simply means, how much do the voters who support you, find you favourable because they actually like you and not just because they hate your opponent, you find that 70% of president Trump’s supporters are enthusiastic about him while only 38% of Vice President Biden’s supporters are enthusiastic about him. This means that vice president Biden runs the risk of apathetic voters who may choose to remain absent due to lack of enthusiasm, as Hilary Clinton and Mitt Romney discovered in their respective electoral losses. With a Trump reelection on the cards, and his eyes set on renegotiating, dismantling and reassembling global relationships and institutions, to be more advantageous to the United States, the ease of global trade and the easy flow of global capital, faces a significant challenge. Thus, Zambia’s resilience strategy may face an even further challenge.
   4. G-20 FISCAL ECONOMIC RECONSTRUCTION: The coronavirus has driven all the G-20 Nations into abnormal and record levels of debt and deficit, just to sustain their economies. So there is going to be a period where Global Capital is going to be constrained as many nations have to reconstruct their economies, and one should expect this to be a period of 5 to 10 years, similar to the post World War 2 economic reconstruction/recovery. As all the major G-20 nations are running record deficits, all of their domestic capital will need to be aimed at lending to their respective governments and corporations, just to keep their credit markets loose and afloat. So this takes lending to nations like Zambia, off of the priorities list during this economic reconstruction period.
   5. THERE IS CURRENTLY EXCESS CAPITAL ON THE MARKET: Right now there is more than $15 trillion of global debt sitting in negative interest rates, which is more than half of the worlds global debt stock, and portfolio managers claim to be desperately in search of any positive yields in the global debt markets. However, even in these circumstances, Zambian debt auctions are still being met with under subscriptions. This is due to the fact that, in line with the earlier quote from Mr Thiam, Zambia’s problems are fundamental and pre-existed the coronavirus recession. Therefore this tells us that even if capital returns to the Global Market, Zambian debt will still not be well accepted for the cash infusion we need.

 

Putting into perspective a declining currency that seems to have decoupled from the commodity markets fundamentals, specifically the copper and oil price differential, and a potentially hostile post coronavirus global capital market that seems to have already red-flagged the Zambian economy long before the coronavirus, Zambia’s only option is to grow its way out of this. Once again, to quote Mr Thiam in yet another Bloomberg interview,

‘Most companies and countries alike usually find that the number one cure to their biggest problems is consistent growth. Growth generally cures the ills that entities tend to face. It must be good growth. Growth based on a Secular trend, not economic cycles…’

At this point, the only option for Zambia is to commence a transformation from an FDI, Aid and Government spending driven economy to a local entrepreneur-driven economy. This can only be done by democratizing the financial services sector and drastically scaling back all regulations so that the average Zambian is capable of starting any enterprise, in any industry, at any scale. The key to sustainable growth is through the dismantling of regulations and reassembling of regulations and requirements to fit the capacity of the average Zambian.

In a survey of 100 businesses, it was found that the average entrepreneur started their business with K5,000 or less. True liberalization of the economy would mean that we ensure that every single industry in the country should cost no more than K5,000 to enter, and this includes, registration, regulatory compliance, legal compliance, basic operational requirements, starting inventory and some working capital. This would also mean that, with such tight cash flows available to entrepreneurs, the process from registration to operationalization of a business, should not take more than 14 working days in any industry. This means that all registration and regulatory compliance processes need to be sped up to ensure that they do not strangle new entrepreneurs’ cash flows with cumbersome, tedious and bureaucratic processes. If the time and financial costs of entry and operationalisation of any industry exceed the parameters mentioned, then we must systematically repeal and replace any acts, statutes, decrees, codes, regulatory requirements and rules that are the source of such encumbrances. Zambia should even consider removing industrial entry costs for a period such as the first 2 years of business, similar to how global cloud-based services, like Netflix, give you a zero-cost free trial for a period of time, and that feature of ‘trial-ability’ has actually been one of the major contributing factors behind the rapid growth of the global cloud base economy as it has greatly outpaced the brick and mortar economy. The aim of such interventions is to flood the market with entrepreneurs and derive economic growth, from the growth of these startups and small businesses and then grow the economy out of the situation it is in. Right now, as it stands, waiting for a copper-based recovery or a more accommodative global capital market may no longer be a feasible option, so to quote a 2016 candidate Trump, what do we have to lose?

The Author is a Financial Economist with over ten years of experience in the Zambian Financial and Capital Markets in and with companies and institutions such as the Lusaka Securities Exchange, Securities and Exchange Commission, Aon Zambia and many other participants. He is also a freelance economic journalist from Lusaka who writes about currency, commodities, macroeconomic policy and markets from the Global and Domestic Perspectives. He can be found on Twitter at @MutwaleM.