The South African economy realized economic growth of 3.2% during the 2nd quarter driven largely on the back of a recovery in mining output and some acceleration in agricultural output. If the primary sector was excluded, the rest of the economy growth rate slowed during this period. Manufacturing was under pressure due to slowing domestic demand and weak global economies, particularly Europe. Inventory levels to GDP is still at low levels in relation to history at around 12.5% to GDP and manufacturing utilization levels are unlikely to recover strongly in the short term. However, South Africa remains well positioned relative to the developed markets due to a strong balance sheet and its exposure to growth on the African continent. The mining sector has faced significant challenges this year and more so in the 3rd quarter. Lower commodity prices together with the impact of lower production due to strikes will impact its contribution to economic growth during this year. If this industrial action goes on for a prolonged period, the impact on economic growth will be significant. Pressure on exports due to the mining & manufacturing sectors and continued increase in imports is having an impact with our current account deficit widening during the past quarter to -6.4%. Our terms of trade continue to weaken and should trend downwards during the 2nd half. Despite the worsening of the current account deficit and negative news around the mining sector, the South African currency has remained fairly resilient which can be attributed to the net flows of close to R90bn into South African bonds by foreigners year to date. Should these flows turn negative, the currency could weaken substantially from the current levels. Inflationary pressures are expected to rise on the back of the increase in liquid and soft commodity prices and together with slower credit extension consumer spend growth is expected to moderate.

Against the backdrop of global stimulatory monetary policy, South African yields will remain lower for longer but there is still a risk of Rand weakness impacting on inflation and there could be upside surprises. Our Income portfolios are well positioned to take advantage of opportunities while remaining focused on the quality of the instruments and the cash flows of the underlying issuers.

The South African economy remains resilient but economic growth expectations are being lowered for the current year. The services sector and domestic SA was positive but growth in retail starting to slow as noted in recent months. Credit extension contracted in April, largest decline since 2008, with bank impairments also rising. This could point to slowing consumer spending for the remainder of this year. The mining sector has been mixed with production under pressure in precious metals while remaining robust in iron ore, coal and manganese. Commodity prices remain below their peak levels with significant declines noted in oil and thermal coal in recent weeks. At current Rand spot commodity prices, the mining sector should deliver decent earnings but at lower levels than 2011. The manufacturing sector realized positive growth during the first quarter but the weak global environment has seen softening starting to come through. South Africa's terms of trade has started to fall from its recent peak in 2011 as weakness in mining has impacted. Any substantial decline to terms of trade in the coming months will weaken the Rand further and impact economic growth. The fall in both liquid (oil, etc) and soft commodities (maize, etc) has eased inflation concerns with inflation anticipated to peak at a lower level this year. A Rand blowout will however drive inflation risks to the upside. Employment remains weak with some net job losses reported in recent months. Public sector remains the major driver of new employment as the likes of Eskom and Transnet spending continue to rise. Our inflexible labour regulations are unlikely to encourage the private sector to invest and hire new employees for future growth with corporate cash balances continuing to rise.

Following the recent moderation in South African inflation, the SARB has indicated that there is no reason for tighter monetary policy until the global economy and the EU in particular shows signs of a sustainable recovery. Although it appears that yields will remain lower for longer there is still a risk of recent Rand weakness not being fully reflected in the current inflation and there could be upside surprises if the Rand weakens further. Our Income portfolios are well positioned to take advantage of opportunities while remaining focused on the quality of the instruments and the cash flows of the underlying issuers.

South Africa has evolved over the past 20 years with the economy becoming more diversified and being less reliant on historically major sectors such as mining. Importantly major service related sectors such as financial services, real estate and tourism have developed and become meaningful contributors to the economy. Financial services and tourism should continue to realize decent growth over the long term with South Africa's positioning as a financial hub to Africa becoming increasingly more relevant. Shortage of skilled labour in these areas could however hamper our pace of growth in the services sector over the next decade. Effective execution on transport infrastructure projects could help to unlock meaningful economic contributions from both the mining and manufacturing sectors. In the short term, weak demand from our developed world trading partners will impact our economy. Any significant slowdown in China (not anticipated at this stage) will also impact our mining sector and overall exports. The engine of South African economic growth over the past decade, household consumption expenditure, is expected to face some pressure in the short term due to declining real disposable income, high debt levels and high unemployment. Some reprieve will come through increased capital investment from government and public enterprises. South Africa's relatively stable financial situation could allow for more flexibility, both fiscally and through monetary policy should the need arise.

Over the past quarter, inflation breached the 6% upper limit of the target range of the South African Reserve Bank due to higher food, energy and administered prices. South African food prices and consumer goods do not yet reflect the Rand weakness of the past 6 months as manufacturers and retailers purchase their raw materials and goods 6 to 9 months in advance and therefore we do expect inflation to continue rising during the first half of 2012 to above 7% as the impact of the weaker Rand works through the system. Despite inflation moving above 6% we have only seen a marginal increase in money market yields and 5 to 7yr bond yields have actually moved lower over the past year. However, for the first time in the past 10 years we have seen the spread between the 30 yr and 10 yr SA Bond normalising due to the increase in 30yr bond yields to the current spread of 0.8%. Although the higher level of inflation has increased the probability of an interest rate increase during 2012, this remains dependent on the extent of the slowdown in the global economy and the South African Reserve Bank continues to indicate that if there is a severe global economic slowdown they would still consider supporting the South African economy with lower interest rates. Foreign purchases of South African bonds have been volatile over the past quarter and are expected to remain volatile depending on the risk appetite of foreign investors. Our portfolios remain well positioned to take advantage of opportunities and we remain focused on the quality of the instruments and the cash flows of the underlying issuers.

South Africa is relatively well placed when compared to its major developed economy peers, with our debt levels and budget deficits looking much healthier. This does provide the government with some financial flexibility as noted with the infrastructure expenditure announced in the budget. While government debt levels will rise, they are not anticipated to go above 40% of GDP over the next 2-3 years. The tough global economic environment will however, constrain economic growth in the short term with our export related sectors anticipated to bear the brunt of this. The mining sector is mixed with production growth in commodities such as iron ore, manganese & coal expected to deliver some volume growth while precious metals appear to be facing production pressures. However, recent weakness in the Chinese economy could put pressure on commodity prices, impacting the mining sectors contribution to GDP negatively. Weakness in the Rand may assist in reducing the impact. The South African consumer appears financially stable with debt levels having declined slightly during the last quarter while debt services costs are close to historical lows and unlikely to increase significantly in the short term. Taking the above factors into account, economic growth for 2012 is therefore anticipated to be lower than last year at around 2.7%.

Although it appears that South African food inflation has peaked, we do expect overall inflation to continue increasing during the remainder of 2012 due to increases in administered prices and the high oil price. Despite inflation moving above the 6% target range of the SARB we have only seen a marginal increase in yields as the SARB is expected to remain reluctant to tighten monetary policy until the global economy and the EU in particular shows signs of a sustainable recovery. There could be upside surprises on South African inflation if the Rand weakens and our Income portfolios are well positioned to take advantage of opportunities while remaining focused on the quality of the instruments and the cash flows of the underlying issuers.

The South African economy grew faster than expected during the first quarter of 2011, growing at an annualised rate of around 4.8%. This was largely attributed to the rise in manufacturing output, the increase in non-gold mining contribution from rising prices and increased consumer spending on durable and non-durable goods. While the growth was better than expected, the South African economy does face several challenges in the year ahead. Excluding the motor vehicles and the chemicals segments of the manufacturing sector, the broad part of the manufacturing sector remains under pressure. The continued strength of the Rand and muted global demand does make export related growth challenging while increasing imports have placed pressure on domestic profitability. The mining sector has benefitted significantly from the meteoric rise in China with high commodity prices and rising volumes driving non-gold mining growth over the past year. In the short term, with China aggressively raising interest rates to combat inflation, there is a risk that commodity prices could decline from current levels in the year ahead. After declining significantly over the past 2 years, real fixed capital formation grew this year as public corporations in particular increased capital investment. Consumers spending remained robust with the increase in real disposable income experienced during the past year having been the major driver. High debt levels, particularly among the higher LSM groups, together with increased inflation, will however constain the level of consumption expenditure in the short to medium term.

In the last quarter of 2010, foreigners were net sellers of South African bonds to the value of R24.4 billion while in 2011 year to date, this has reversed with foreigners being net buyers of South African bonds to the value of R33.7 billion. South African bond yields continue to offer significant value relative to developed market yields with the difference in yield between the 10 year South African bond and the 10 year US bond being 5.1%. The other reason for the change of heart can also be explained by the weakening sentiment in the global economic recovery due to the lingering sovereign issues in Europe and the tragic earthquake in Japan which has had a negative impact on global industrial production. The additional attraction to South African bonds can also be explained by the real yield that an investor can obtain relative to developed market real yields. Agricultural commodities continue to rise, oil has remained above the $100/barrel level and the US Dollar remains weak which together maintains the upward pressure in inflation. Currently the increases in food prices and fuel are being negated by the strength of the Rand to the US Dollar but the graph below indicates that the currency advantage is beginning to be eroded as food and petrol have been the drivers in the increase in inflation for the past 3 months. The risk of capital loss for the SA bond asset class remains high due to the inflation pressure. Relative to December 2010 the South African yield curve has moved up on the longer end of the curve and the Oasis Bond Fund has been well positioned. As indicated above there is a risk of South African yields moving higher due to inflation pressure which will create opportunities. In line with our philosophy we remain focused on the quality of the instruments and the cash flows of the underlying issuers and our Income Funds are invested in high quality instruments.