Giving you more of an insight into financial jargon
17 October 2016
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On mobile, on digital, on demand, this is Old Mutual Live, Money Coach. Hello and welcome, my name is Chris Gibbons. A couple of weeks ago I had a conversation with someone that I call a ‘jargon buster.’ That’s someone that takes all of the complicated words and descriptions that we find in the world of money and economics and translates them into everyday language.
We covered concepts like the inflation rate, the markets, government bonds, stocks versus shares and GDP. I thought it time to check in once again with him before the sea of jargon closes over our heads. He is of course, Dawie Roodt, Chief Economist at the Efficient Group. Dawie, welcome once again to Old Mutual Live Money Coach, thank you for joining us.
Dawie Roodt: Thank you very much for calling me.
The bulls and the bears
CG: Let’s start, if we may, with one we hear all the time when referring to stock markets. The bulls and the bears, what does that mean?
DR: The bulls and the bears, those are just two names that we give to people that are positive or that are negative. Typically, what will happen, if you are bullish on something, then you would like to own a specific asset. Because you believe that the price of that asset will keep on going up. You would buy some of these assets, whether it’s shares or bonds or property or whatever. I’m bullish on the price of apples as an example; I will buy apples because I believe the price of apples will go up.
Being a bear is exactly the opposite. That is, I believe the price of something is going to go down. It is possible in a financial market to sell something that you do not have, provided you buy it back in future at some time. If I’m bearish on the price of apples, as an example; I will sell apples. Believing that the price of apples will fall.
Then tomorrow I will buy them back at a profit, at the cheaper price and a profit for me. Essentially people that are bullish are, let’s call them positive people. People that are bearish are people that are usually negative, expecting prices are going to fall.
What is a Rand hedge?
CG: Dawie, let’s stay with shares, what is a Rand hedge? I have this vision of a row of green Rand notes, all planted neatly and sprouting, what’s a Rand hedge?
DR: Well, it’s pretty much the same as your vision. The Rand is a currency that is very volatile. That means that the currency to Rand keeps on going up and down and it’s all over the place. We can see that the Rand the last couple of weeks has been exceptionally volatile against the US dollars as an example.
Of course, if you an importer, you want to import something, whatever you want to import is priced in American Dollars. Then you will find one day that if you want to import this in a months’ time, you’re going to pay a lot of Rands for that. The next day because the Rand strengthened, you’re going to pay less for that. Business people don’t like this, they don’t like this volatility in the currency.
What they quite often do, they somehow try to hedge or protect themselves from a very volatile currency. There are all sorts of techniques that you can use. You can, for example; buy in the futures markets Rands or Dollars or whatever the case may be. Making sure that whatever you’re going to pay for your imports in a month or six months’ time, will be at a certain price.
A Rand hedge stock is a stock or is a share that is hedged against the volatility of a currency. A very good example is our mining companies. A mining company sells whatever they mine, usually in US Dollars. It doesn’t really matter where the currency is, because they will still get X amount of Dollars for how many pounds or how many kilograms of whatever they sell on the international market.
If you are scared and you don’t want your investment to go up and down as the Rand goes up and down, you buy a stock that is pretty much protected against the volatility of the currency. Typically mining shares are like this.
What are ‘futures’?
CG: Dawie, you’ve just mentioned the next one on my list, you used the word ‘futures’ as in futures market, the people who are in the futures market, are they astrologers or what?
DR: No, let me give you a very good example, a simple example. Say I want to buy your car and you and I, we agree that I will buy your car in one years’ time at a certain amount. That is a contract between you and me. In the meantime, I can sell this contract to somebody else.
I sell it to my neighbour and now you have to sell this car at the agreed price to my neighbour instead of selling it to me. That specific contract becomes a negotiable instrument and that essentially is what a future is. It’s an agreement between two or more people, on a certain product that will be sold or bought in some future time at a specific price. We’re trading in the futures.
CG: Very timely right now, ratings agencies, what is a ratings agency and why are they important?
What is a ratings agency?
DR: They are analysts. They tell people or they tell the customers whether it’s a good idea to buy something or not. A rating agency, if you have a stockbroker, he is actually a rating agency in a way. If you call your stockbroker and you ask him is it a good idea to buy South African Breweries, as an example. He will tell you if it’s a good idea or not. Because he’s an expert on shares, he’s an expert on many shares.
The rating agencies do exactly the same. People pay them to give them advice on whether to invest in a specific country or on a specific instrument or not. There are a couple of rating agencies, the most important one is Standard & Poor’s, it’s an international rating agency. They quite often advise their clients on whether it’s a good idea to invest.
Like for example, in South African government debt instruments and at the moment Standard & Poor’s has got us as an investment rating. That means that they advise their clients that it’s a good idea to buy South African government debt, as an example. But we are just in investment rating according to Standard & Poor’s.
If they decide to downgrade us, we will become a so-called speculative rating. Another word for that is junk bonds. In which case many of those customers that Standard & Poor’s advise, will likely sell the investment in South Africa. That will lead to an outflow of capital out of South Africa and probably a much weaker currency.
CG: All right, a number of organisations, Dawie, put out indices, or indexes, if you prefer. About this or about that, but perhaps the most important, the business confidence index. What does that mean, how does it work?
What is an index?
DR: What is an index? An index is usually, it’s a lot of numbers over time. Say for example I track the price of bread every day and I write it down. The price of bread was 10 years ago R2. Five years ago it was R5 for a loaf. Today it’s R10 or R12 or whatever. They put all those numbers, they string them together. We call that an index.
An index consists of just about anything. It can be the price of bread as an example or it can be the percentage change in the price of bread or it can be a combination of things. They put a lot of things into a basket and they measure the price of that. We call that basket, quite often, the consumer price index.
That is where inflation is calculated from. There are many other indices as well, like for example different confidence indices and what they do in those baskets, they ask people, are you positive about the future? They look at what the exchange rate of the currency is doing, they look at inflation.
They look at all sorts of numbers in the SA economy, put that into a basket, measure it over time. Call it an index and Walla – there you have it! We call it, in this instance, the business confidence index. There’s a certain number to the business confidence index and there are many, many other indices in well. In fact, you can put whatever you want together and you call it an index and you can give it whatever name.
CG: Final one for you on this session Dawie, capital flight. Again, I have a vision of Rand notes with little wings attached.
What is capital flight?
DR: The reality is that we live in a global economy and South Africa is a small, open economy. An open economy means that we are very much integrated with the rest of the world. Capital flows into South Africa and capital will leave SA as well.
It’s very easy to do that if you have the necessary accounts, use them to transfer money via the banking system in and out of South Africa. You can buy things in South Africa and you can sell things on the financial markets in SA.
Quite often what happens is that especially foreign investors, they get concerned about things. Like for example state capture or like, for example, some comment made by a politician. They would decide, listen, I don’t want to invest in this country. I’m going to sell my stuff and take their money out of SA. Effectively what is happening is the capital is fleeing South Africa. That’s capital flight.
CG: And there we’ll leave it. This has been another edition of Old Mutual Live Money Coach, my name is Chris Gibbons. With me has been our ace jargon buster, Dawie Roodt, Chief Economist of the Efficient Group. Remember, please feel free to get in touch any time if you have any questions for me, or topics you’d like covered on Old Mutual Live Money Coach. Just send them direct to me at email@example.com. I’d be delighted to hear from. Until the next time, thank you for listening. Old Mutual Live, on mobile, on digital, on demand.