by Chantal Marx & Peet Serfontein
The gold price recently reached another all-time high, prompting investors to reassess their current exposure. Is it time to take profit for those who have held positions in gold or is it better to just hold on? And if an investor does not hold any gold - is there still a case to be made to initiate a position now?
The impact of political events on markets
Political developments, from elections and legislative changes to geopolitical tensions and policy reforms, can introduce a high degree of volatility into financial markets. This is because investors and market participants react to the uncertainties and potential shifts in economic policies that such events could herald, assessing how these changes might impact economic conditions, regulatory landscapes, and, ultimately, corporate profitability and growth prospects.
Mechanisms of impact
The effects of political events on financial markets can manifest rapidly, leading to immediate swings in asset prices, or they can unfold gradually over time as the implications of policy changes and political stability are fully digested by the market.
Theoretical frameworks
Economic theories like the Efficient Market Hypothesis (EMH) and Behavioural Finance provide insights into how political events impact financial markets.
The EMH posits that financial markets efficiently incorporate all available information, including political news, into security prices. According to this hypothesis, markets adjust to new information so quickly that attempting to outperform the market by reacting to political events is largely ineffective. EMH suggests that prices at any moment reflect all known information, making it challenging to achieve higher returns through market timing or equity picking based on news events. The hypothesis recognises the market's rapid response to information, which can lead to significant short-term price volatility as political developments unfold.
In contrast, Behavioural Finance suggests that markets are influenced by investors' psychological biases and emotions, leading to overreactions or underreactions to political events. This field acknowledges that investors are not always rational, and their decisions are often swayed by factors like fear, overconfidence, and herd behaviour. These psychological elements can cause market prices to deviate from fundamental values, especially in response to unexpected political news or in the lead up to known political risk events like elections.
While EMH emphasises the role of information efficiency in market pricing, Behavioural Finance highlights the impact of human psychology. These theories stand in contrast to one another but together, they offer a comprehensive view of how political events can affect financial markets, acknowledging both the market's capacity for rapid information processing and the influence of investor behaviour on market dynamics.
Historical perspectives
One of the earliest examples of political events impacting financial markets can be traced back to the Napoleonic Wars, where the Rothschild family reportedly used their network of couriers to gain advance information about the outcome of the Battle of Waterloo, leveraging this knowledge to make strategic investments. While apocryphal, the story underscores the long-standing recognition of the influence of political events on financial markets.
More recent historical examples include the 2016 Brexit referendum. The unexpected decision by the UK to leave the European Union led to sharp declines in global equity markets, a plummet in the value of the pound to its lowest level in over 30 years, and increased uncertainty about the future of the UK's and the European Union's economies. This event also illustrated the challenges of predicting market reactions to political events, as many investors were caught off-guard by both the outcome of the referendum and the market's response.
There are other reasons to be cautious as well. Cost-of-living pressures could dampen jewellery demand and indeed retail investor demand for gold ETFs globally. There may also be some tactical changes coming through from asset managers in response to record high gold prices and perhaps more compelling opportunities elsewhere.
We have also had two major geopolitical events unfold in the last few years - notably the invasion of Ukraine by Russia in 2022 and the Israel-Hamas conflict that began late in 2023. The uncertainty surrounding these events filtered through in agricultural commodity prices, metal prices and oil prices and the long-term impact on supply chains, inflation, interest rates, and currencies are still not fully understood.
Finally, elections also tend to have a marked impact on financial market outcomes. From a global markets perspective, US presidential elections have historically been a major source of market volatility as investors speculate on the economic policies of the incoming administration. For instance, the 2016 election of Donald Trump led to initial market declines due to uncertainty about his policies, followed by a significant rally, dubbed the 'Trump bump,' as investors anticipated deregulation, tax cuts, and infrastructure spending. Conversely, the 2020 election saw markets fluctuate due to concerns about trade policies, the Covid-19 pandemic response, and potential changes in tax policies under Joe Biden.
Taking opportunities around political events
Event-driven volatility in financial markets often provides opportunities to invest. While the risks must be considered, it is important not to panic and to keep a cool head. Investors often give way too much weight to 'tail risk events' or, in plain terms, low likelihood but highly negative possible outcomes. In elections, for example, populist rhetoric often dominates news headlines that make the individuals or groups purporting this rhetoric seem more influential or likely to receive substantial support than they in fact are.
Asset mispricing around political events will allow investors to gain access to certain highly coveted instruments at discounted prices. While traders can benefit from short-term mispricing, long-term investors have an opportunity to buy quality instruments at better prices that will enhance their portfolio returns over time.
Of course, should the market-negative case scenario materialise, having a well-diversified portfolio across asset classes, geographies, sectors, and specific instruments remains imperative in guarding against permanent capital loss.
Asset prices and the upcoming South African elections
South Africans will take to the polls at the end of this month, and this has (as expected) prompted additional volatility in the local currency and local asset prices. Historically, while there are other external factors to consider, local assets and the rand have underperformed going into elections and then rebounded in the weeks and months thereafter.
We think that given the current depressed valuations of local assets; we could see a meaningful improvement post-elections as political rhetoric subsides and foreign and local investors alike reconsider investing in SA assets. There are of course, a variety of reasons to remain sceptical - but valuations more than adequately reflect the structural constraints currently embedded in SA. In the equity space, specifically, valuations don't give credence to strong financial and cash flow metrics, cyclical opportunities, nor the ability of some of these companies to innovate and grow even in the toughest conditions. It is indeed in the quality SA Inc space where we see the most opportunity.
