NFB Proficio Newsletter Issue 78

NFB FINANCIAL UPDATE Issue 78 January 2015

FROM THE CEO’s DESK

W

e wake to a new year full of interesting possibilities, a few great risks and not a lot of certainty on a few fronts. Looking after money and ensuring it stays and grows is certainly going to be tough in the next while, particularly on the local front. The most extraordinary correction in the oil price and its impact on the cost of fuel to beleaguered South African consumers has been welcomed, but this development has some other interesting implications. A further positive to the extra bucks we will have to pay off debt, save or spend will be a likely muting of inflationary pressure, making it easier for the Reserve Bank and MPC to keep rates where they are, perhaps even lowering them! This again alleviates pressure on those of us with mortgages, rentals or overdrafts, again resulting in greater discretionary spending capacity in households.

On the risk side, shares and businesses in general with exposure to mining, mining infrastructure, oil, fuel and the like will be vulnerable to these companies cutting

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Mike Estment CFP professional BA / CEO - NFB Financial Services Group

financial services group

spending, probably dividends and also employees. Take a quick look at the USA's recent rather promising recovery and you realize that the “fracking” industry has been a massive employer, giving the US economy and the Fed a welcome assist in getting itself out of the shtuck! Fracking has a much higher cost profile to traditional “OPEC” type oil. As the price of crude oil has plummeted many have already, or shortly will, become marginal.

This, some say, is the strategy of the Saudi's, capable of biting the bullet, still making money, although much less in the short term, but by allowing supply to exceed demand, scaring miners, entrepreneurs and financiers back into the closet! This might well result in the crude oil price recovering towards the end of the year. The other point worth mentioning is the shape of the bounce back after oil prices drop in any material fashion. Each time this has happened in the last few decades, the correction has been fast and very rewarding to those brave enough to take on the might of the market.

On the local front it is pleasing to see business luminaries expressing their disdain at the State of the Nation, our president and politics and civil service at large. The damage being done by poor planning, pathetic delivery and then the everpresent corruption button has gone to a point where many worry it could become irreversible. The Eskom saga is the most obvious and well recorded of these. Big business, already under severe supply constraints has warned government to go elsewhere to find capacity. Retail consumers and small business are the next natural prey.

We went out to dinner the other evening, rather unexpectedly I might add, as a result of a non-scheduled power outage. On my wife phoning, holding on for the customary twenty minutes, and eventually getting to enquire about the cause of the meltdown, a rather unpleasant official let us know it was not load shedding, but a fault in our suburb. So we packed the family into our car and went off to our local diner, where we were completely snookered as they were without power, and given the stoves were powered by electricity, which stupidly they had assumed could be relied upon, they

had to close. Sending waiters, cooks, cleaners, owners and customers off into the dark. Their fridges being off for the duration, currently not too long (four hours seems the norm) manage to keep the produce good for another day's business.

Small blessings! The guys next door must be ex-Zimbabwean. They had gaspowered stoves. Delighted (pun intended) we pounced on a table and enjoyed the beginnings of a great meal.

Unfortunately, at about midway, the lights went out. The building managers had omitted to fill the diesel generator's fuel tanks. This resulted in the restaurant closing, asking its patrons to acknowledge their debts (no power to run the credit card machines or internet), and to return in the morning to settle same! Living around the corner, this was no problem for us (or the restaurant). I'm not sure everybody acted with the same sense of community.

This is a small, but demonstrative example of what might lie ahead.

Escalate these blackouts to days on end and the ball game looks scary. This electricity supply mess, highly obvious to all and sundry now, has seemed to pop out of nowhere. I am worried about Medupi and Kusile's equivalent facilities or utilities in the area of water, hospitals, bridges, airports, harbours, rail infrastructure, to name a few. Each of these facilities are expected to be available for existing, never mind foreign businesses to elect to take the capital and other risks so desperately needed to get South Africa onto a growth trajectory it is well capable of and creating the jobs and tax revenues which allow the economy to grow as it should.

Sorry that I open the batting on such a somber note. On the subject of batting, congratulations to AB de Villiers on his superb record breaking innings at the Wanderers!

Oh! By the way, any guesses who the owners of the building are where the power failure happened and the diesel tanks were unfilled?

The Government Pension Fund (PIC)!

A final note: certain changes have been announced in the reporting and taxation of trusts. We would strongly suggest you consult with your tax advisors in this regard.

fortune favours the well advised

TurmOIL Black gold's black swan?

age credit: 123RF Stock Photo

The rapid decline in the oil price has been a topic of both market commentary and dining room conversation in recent months with the spot price shedding some 55% plus from a 2014 high of over $115 per barrel in June to under $50 per barrel at the time of writing. This extraordinary collapse undoubtedly will have an effect on various macroeconomic indicators, both globally and locally, and thus results in a number of knock-on effects for investors and consumers alike.

In order to understand the effects this anomaly is likely to have on the markets (and our pockets) it is important to take a step back and examine what the likely cause of the decline is.

Oil prices, much like fundamental economic theory teaches us, are predominantly based on the metrics of demand and supply. On the demand side of the equation we have seen a fall in the global demand for oil due to weak economic activity, a gradual shift from oil reliance to other fuels and increased US shale production, curbing their own need for imported oil. In terms of supply, historically this was largely controlled by members of OPEC (Organization of Petroleum Exporting Countries) through production quotas agreed every two years. However, as the US has gradually shifted from an importer to the 2nd largest oil exporter, there has been a weakening of the oligopolistic power of the OPEC nations.

The outcome of the latest OPEC production quota meeting in November was a refusal by Saudi Arabia and those in OPEC aligned to the Kingdom to cut the quotas, thus resulting in an oversupply of oil which subsequently led to a rapid fall in the price of crude. Reasons behind this decision have been attributed to the refusal to lose further market share in global oil exports and the fact that Saudi Arabia can continue to produce oil at much lower cost levels than that of their OPEC and non-OPEC oil producing counterparts, partly due to massive stockpiles of both crude and foreign currency reserves. Market speculation suggests that operating at these levels will result in large pressures on US shale drillers and force cutbacks, thus preserving market share for the oligarchs over the medium to long term.

Whilst oil prices affect a broad range of macroeconomic variables and/or policies we've restricted this analysis to the balance of payments and economic growth, inflation and interest rates, equities and taxes.

Balance of Payments and Economic Growth As an oil importing country South Africa benefits from a fall in the price of crude, so much so in fact that a study by UBS, published in December last year, has shown that we are at the upper end of countries with an inverse GDP growth correlation to the oil price, as seen on the graph below.

(A permanent $10 drop in the oil price is modelled to add +-0.3% to South Africa's GDP)

A declining oil price would allow for (providing no change in import volume occurs) a healthy reduction to the wide current account deficit, although this will be somewhat counteracted by the increased diesel imports needed by Eskom to “keep the lights on� and a potentially weak rand in the face of a strong US dollar and muted local growth.

Holding all else equal, we would expect to see local economic growth figures boosted to a degree by a falling oil price.

Inflation and Interest Rates One of the most tangible effects of inflation in our daily lives is the variation in the number at the bottom of the small white slip we glance at with bated breath at the petrol station.

Whilst the price of crude has fallen over 50% we do not enjoy this full saving. Currently only 48% of the petrol price consists of BFP (Basic Fuel Price), which itself consists of added external elements such as freighting fees, insurance and storage costs. The remainder of the price is attributable to levies, taxes, mark ups and internal logistics costs.

Furthermore, in its most directly influential form, petrol accounts for just 5.7% of the CPI basket. The knock on multiplier effect of other industries will no doubt have an additional effect on inflation as well, although this is more difficult to accurately measure. That being said, the consensus view is that we will see a fall in inflation to the mid-range of the SARB's (South African Reserve Bank) target of 3% - 6%.

This should allow Reserve Bank Governor, Lesetja Kganyago, to avoid short term interest rate hikes, which in turn should have a further positive effect on local GDP growth.

Equities From a bird's eye view, a lower oil price should result in a healthy boost to the economy by means of improving the terms of trade, allowing for reduced production/input costs and therefore higher profit margins, and increased demand through growth in consumer disposable income.

These factors all in turn should lead to greater corporate earnings and thus a strong local equity market.

However, considering that the JSE is trading at levels considered to be either fully priced, or in some circles overvalued, we would not expect the large scale gains one would ordinarily see in a fairly priced market.

We may, however, holding all else equal, see some strength coming from the unloved gold counters which are some of the most operationally exposed to oil price movements. This could be supported by a low Fed Funds Rate in the US and the probable initiation of quantitative easing in Europe, as global markets attempt to create

inflation by reinvigorating their respective economies.

Taxes In February, Finance Minister, Nhlanhla Nene, will deliver the budget speech for 2015. Much has been written about the need to increase taxes in order to balance the public coffers. Speculation has ranged from increases in the VAT rate to 15%, corporate taxes to 30% and the adjustment of the personal income tax marginal brackets and rates, or a combination of the above.

The solution, however, or a portion thereof, may well now also be tied to the price of oil: an increase in the fuel levy. As previously mentioned, at present the actual cost of crude accounts for less than 50% of the petrol price, with the second biggest contributor being the fuel tax at approximately 20%. Rather than reducing the price of petrol, the lower basic fuel price saving could be used to increase the fuel levy and thus offset the need for some of the more direct tax hikes.

Of course this would in turn neutralize some of the positive effects of a cheaper spot price, but may well prove a more palatable method of stabilizing the budget deficit.

Conclusion In conclusion, subdued oil prices should lead improved terms of trade, lower inflation, more muted interest rate hikes, economic growth stimulation and sectoral equity strength.

As with all macroeconomic factors, spot oil is just one cog in the complicated mechanics that control the financial markets and anyone who claims to have 100% accurate predictive powers is playing a fools game. The spot price and futures market of crystal balls is, fortunately, uncorrelated to the oil price.

Should you wish to re-look at your financial plan as we head into the new year, please don't hesitate to contact an NFB financial advisor at any one of the NFB offices in Johannesburg, East London, Port Elizabeth, Stellenbosch or Cape Town.

Article written by: Matthew Chapman B.Com (Hons) Financial Analysis & Portfolio Management B.Com PPE Representative under Supervision NFB Gauteng

Sasol One stock that has been under particular scrutiny during this period of oil price weakness has been one of the darlings of yesteryear, Sasol (SOL). As this five year graph illustrates, Sasol has a strong correlation to the ZAR oil price, which is a function of the USD/ZAR exchange rate (Yellow) and the US dollar oil price (Green.) The stock has a positive correlation to both the USD price of oil and the USD/ZAR exchange rate (strengthening dollar/weakening rand is positive for Sasol.) The ZAR weakness of recent years has assisted the stock in making large scale gains, although this has almost been completely undone by the quick fall in oil prices.

Capital Gains Tax What is capital gains tax (CGT)?

The simple definition is: capital gains tax is a tax paid on the profit made from the sale of an asset.

Capital gains tax arises when an asset is disposed of i.e. sold or deemed to be disposed of on or after 1 October 2001 for proceeds that exceed what the asset was bought for i.e. base cost.

Capital gains tax is not a tax on its own, but forms part of income tax and is therefore part of the Eighth Schedule to the Income Tax Act 58 of 1962.

Capital gains are taxed at the lower effective tax rate than ordinary income. Gains and losses made prior to 1 October 2001 are not taken into account. Also note that not all assets attract capital gains tax, and sometimes losses and gains made are disregarded.

Who does Capital Gains Tax apply to?

Capital gains tax applies to individuals, both residents and non-residents, trusts and companies.

A resident, as defined in the Income Tax Act 58 of 1962, is liable for CGT on assets located within and outside of South Africa.

Non-residents are taxed on the sale of immovable property located within the republic or on assets of a “permanent establishment” in South Africa. A withholding tax applies to non-resident sellers of immovable property (section 35A). The amount withheld by the buyer serves as an advance payment towards the seller's final income tax liability. Certain indirect interests in immovable property, such as shares in a property company, are deemed to be immovable property.

Retirement funds are fully exempt from CGT and public benefit organisations such as non-profit organisations may be fully or partially exempt.

Here are some exclusions that apply to capital gains: g R2 000 000 on a gain or loss on the disposal of a primary residence g Personal use assets e.g. car g Retirement Benefits e.g. retirement annuity, pension fund, preservation fund g Payments from original long-term insurance policies e.g. life insurance policy g Under current legislation an annual exclusion of R30 000 capital gain or loss is granted to individuals and special trusts and an exclusion on the year of death of R300 000 g Small business exclusion of capital gain for individuals of 55 years and older of R1 800 000 when the small business' market value does not exceed R10 000 000 at disposal.

The Second is: BASE COST – this one is a bit more complex as there are a number of ways to determine an asset's base cost.

What the asset was bought for – there is also “qualifying expenditure” which can be added to the base cost if they relate to the “direct cost of acquisition” of the said asset; 20% of proceeds; Cost of valuation date of 1 October 2001; TAB, otherwise known as Time Apportionment Basis The third and final component is: whether you made a Capital Gain/Loss Example: Mr John Doe, a South African resident, has shares in a local company to the market value of R1 500 000 in 2015; he bought the shares for R1 000 000 in 2012.

Mr John Doe decides to sell the share in 2015 at market value. What is the capital gain and income tax inclusion?

Mr John Doe dies in 2015. What is the capital gain incurred on the disposal of the shares and what is the income tax inclusion?

Proceeds – Base cost = Gain/Loss

R1 500 000 – R1 000 000 = R500 000 (Gain) (30 000) (Annual Exclusion) R470 000 Net Capital Gain *33.3% (inclusion rate) R470 000 * 33.3%

= R156 510 – Income Tax Inclusion

R1 500 000 – R1 000 000 = R500 000 (Gain) (300 000) (Death Exclusion) R200 000 Net Capital Gain *33.3% (inclusion rate) R200 000 * 33.3%

= R66 600 – Income Tax Inclusion

Should you require any further information on CGT, please don't hesitate to contact an NFB financial advisor at any one of the NFB offices in Johannesburg, East London, Port Elizabeth, Stellenbosch or Cape Town.

How the calculation works There are three components when it comes to calculating Capital Gains Tax. The first is: PROCCEDS – this is simply what the asset was sold for.

Article written by: Xolisa Funani B.Comm, PGDFP Trainee Financial Paraplanner NFB Port Elizabeth

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