Investors have become conditioned to “buy the dip” in recent years. Every small set back in markets has been a buying opportunity, largely on the back of central bank support. Every time markets fall a central bank official, at the least, issues some soothing word store as sure nervous markets, and this week has been no different. The question is should we be buying this dip as well?

To answer the question we need to put the setback in context. Despite some of the dramatic headlines, valuation levels remain very elevated. Given that valuations are the main driver of future returns, the recent changes in price have by no means presented a mouth-watering buying opportunity.

Local market PE – stll expensive


World markets – no slam dunk


Even though we manage client portfolios on a bespoke basis, our investment goal is the same across portfolios. We aim to compound long-term wealth by providing above average returns at below average risk. We try and do this by patiently building a portfolio of companies that exhibit the following three simple characteristics:

  • Good business
  • Good price
  • Good management

Despite the sell-off, there are not enough companies that meet our criteria for “good price”. As a result we do not view this as a great buying opportunity, particularly in the domestic market. We do view it as an opportunity to continue to accumulate stakes in good businesses that were already trading at a discount, but where that discount has now widened (i.e. a good price has become a great price).

One such business is Imperial Holdings, a company which we own and have added to in the sell-off. Imperial is not a great business, but we are of the view that it is a good and improving business, has exceptional management and, most importantly, trades at a very good price. During the company results presentation this week, CEO Mark Lamberti made a very interesting point. He commented that “the 2nd and 3rd order effects of a response to slowing Chinese growth have yet to be fully understood”.

In my view this is a critical point and one that requires a great deal of thought. Thus far the market has only priced in the 1st order effects of slowing growth in China, largely through the pricing of commodities and emerging market assets and currencies. While our market has held up better than most because of the make-up of the index, other emerging markets have seen very sharp declines.


If the scale of some of these price changes in the most cyclical assets are to be believed, I find it difficult to imagine how the knock on effects for other industries and companies will be as muted as the market is implying. As a result we are very wary about paying up for anything at the moment. Buying at the right price is more important now than ever.

Concluding thoughts

A more uncertain market environment is certainly challenging, particularly given the easy ride investors have had in recent years. It is likely that at some stage the same complacent investors who have confidently been buying the dip for the past few years will lose their nerve. Portfolios that offer lower than average prospective returns at higher than average risk will start to be questioned. We welcome any decline in sentiment and are ready and waiting to continue to add to our stakes in companies that are already undervalued, regardless of the macro environment.

So to answer the original question – no, we do not think one should be blindly buying the dip, but rather continue to selectively accumulate, but to do so with caution!

Recent performance numbers by South African equity managers are being heavily influenced by exposure to the most cyclical part of the market, commodity or resource shares. Some managers have taken big bets on the sector and are suffering, whilst others continue to stay away. This note will explore how we see the risks and opportunities in this very volatile sector of the market.

The chart below was extracted from a global macro investment blog highlighting the head and shoulders formation of the global commodity index. Despite the very sharp fall the author expects significantly more downside, a scary thought for anyone invested in a commodity producer.


We are not guided by technical factors, but have spent a lot of time thinking about the sector. We have tried to remove ourselves from the noise of daily price movements and think deeply about the fundamental outlook for the next 3-5 years. With current commodity prices at their lowest levels of the last 10-15 years, most companies will require much higher prices to produce an adequate return for investors.

Given the low level of expectations in the sector it has natural appeal to anyone with a contrarian mindset. Despite the negative sentiment and very low expectations, we remain of the view that one needs to approach the sector in a circumspect manner. Recent experience will remind investors of a very strong rally in commodities post the financial crisis, but this was on the back of an extreme, credit driven binge in China, something that is unlikely to be repeated. The recent rout in commodities has been very widespread and it is difficult to find a single commodity that has held its ground.

Commodities – percentage drop from peak


Going forward we think the outlook will vary from commodity to commodity, in line with their individual supply and demand fundamentals. It is possible that some may have entered an environment of structurally lower prices, where as others will see a cyclical recovery in the years ahead. As an example, it is possible that the significant increase in supply of iron ore and oil could lead to lower prices for a long time. We do not know if this is true, but we do see it as a risk to an investment in the more popular commodity counters that make up a large part of the index, i.e. Sasol and Billiton.

Sugar is a commodity that is facing severe cyclical headwinds, but we believe that in time the cycle will turn and production will adjust to lower prices. It is also a commodity with a very smooth demand profile, particularly in growing regions like Africa, where Tongaat Hulett (Tongaat) is increasingly focusing its sales efforts.

Sugar – steady demand, currently oversupplied


Thankfully for Tongaat their property and starch and glucose divisions are very profitable, enabling the company to continue investing into a poor sugar cycle. The property assets in Kwazulu Natal may produce lumpy earnings, but they are a unique asset and will produce solid cash flows in the years ahead. While these cash flows are currently supporting a poor sugar cycle, at some stage we expect more of them to flow back to shareholders as debt and sugar capex peaks. When the sugar cycle does eventually turn (we have no foresight as to when that might be), current investments will result in greater production at a lower cost per unit of production, leading to improved profitability.

Tongaat Hullett – unique property assets with strong sales momentum



In Tongaat, our largest holding in the commodity sector, we are buying into a depressed commodity cycle, but we are doing so in a prudent manner. We are buying a commodity with a very smooth global demand profile (not just China), but the margin of safety is also supported by strong cash flows in other divisions that are not tied to the commodity cycle.

The wild card – the US dollar

Weak growth and excess supply has hurt commodity prices, but a resurgence in the US dollar has played a significant role as well. Speculators in particular are increasingly betting on this inverse relationship.


Further strength in the dollar is something that we view as a very real possibility, particularly as the Federal Reserve contemplates a “less easy” monetary stance. Should this happen it may well put further pressure on commodity prices, albeit these will be partly shielded by a weak rand. While we do not try and base investment decisions on currency movements, we do bear this potential outcome in mind, particularly when monitoring position sizes. We are also of the view that a significantly stronger dollar would possibly have a larger impact on the prices of some of the more popular areas of the market, even though they may not have a direct link to commodity prices.


The current downturn in the commodity sector is extreme and frightening. One only has to look at the muted job cuts in the sector to get a sense of the severity. Local resource shares are increasingly pricing in this very poor cycle, creating potential opportunities for investors who are willing to take a long-term view, as opposed to trying to time the bottom of the cycle. We are spending significant time and effort looking for ways to buy depressed assets in the sector, but will continue to do so very selectively and apply strict risk controls around our exposure to the most cyclical part of the market.