Gold investors keeping a close eye on unfolding events in South

Having sat in numerous South African cricket grounds (nearby if not actually next to blacks) for the privilege of watching the West Indies Geriatric XI, the Sri Lankan third XI or the English Getting XI one can fully understand the potential for a white backlash towards change in the Republic. The South African cricket authorities have taken every possible measure to ensure the game is multi-racial but what was the point in making all those changes if the only reward was to be punished by being asked to watch fourth rate international cricket? Cricket may seem a trivial pursuit to North Americans, but in the civilized world it is a very serious matter. The rest of the world’s response to the changes which have occurred in South Africa cricket typify the attitude to any change in the country which falls short of complete capitulation by the whites to a black Marxist/Leninist regime.

Why is it that of the world’s leaders only Mrs. Thatcher can grasp the reality of the situation? Most South Africans probably concede that change is now unavoidable but they desperately need some encouragement or reward for bringing about that change.

“Buy on the rumor, sell on the news” has long been a reliable way to make money in the stock market and recent events in South Africa once again bear out the wisdom of this homily. We have argued before that instead of conducting post mortems into why markets fall it is often better to query why they went so high in the first place.

A couple of us from the London office of Yorkton Continental Securities spent much of December and January in South Africa (just in case it was the last white Christmas) and returned with the impression that there was a surfeit of euphoria in the country and that such sky high expectations indicated a market that was heading for a fall.

What did the bulls expect Mandela to say or do when he was released from prison that persuaded them to bid the market up to such dizzy heights?

Mandela presents an impressive, statesman-like image but, alas, it sounds as though he was incarcerated 27 years ago in the middle of a speech and, on release, has simply carried on from where he left off without taking cognizance of how the world has changed in the past quarter century.

This may not be entirely his own fault, but trotting out socialist dogma to placate his comrades in the African National Congress has frightened the South African business community and world financiers.

South Africa is undoubtedly one of the most socialist countries in the world in terms of government interference with the market place: there are price control boards for everything from maize to monkey nuts, and so paternalistic is the government that the gold mines are not even allowed to sell their own production.

However, despite this interference, profit has never been a dirty word in South Africa, just something the government taxes very highly. Furthermore, so great is the concentration of corporate power that to nationalise around 90% of the South African economy all that is required is to take over the two major life insurers, plus Anglo American, General Mining, Barlow Rand and Rembrandt.

Nowhere in the world has the demise of Marxist/Leninist/Socialism left such a huge political/ideological vacuum as it has in Africa north of the Limpopo. The leaders of countries such as Tanzania, Zambia and Zimbabwe took as their role model Romania and its late unlamented leader Nicolae Ceausescu.

The South African economy is in far from good shape, and perhaps the most telling statistic is that in every year since 1972, South Africa experienced double digit inflation. Thus far, hyperinflation has been avoided but eight years of 10% plus inflation is indicative of the tight rope being walked.

South Africa’s other major economic problem is that it is a developing country with a Third World reproduction rate but better than average health care, so the population is expanding at a terrifying rate and more than 55% of the population is under the age of 16. To achieve economic growth sufficient to employ the huge bulge in population requires a substantial inflow of capital to South Africa.

Sanctions on goods have had a minimal effect on South Africa but the ban on foreign investment has resulted in the country becoming an exporter of capital. It has had to repay foreign debt at a time when it desperately needs a capital inflow to create jobs for the burgeoning black population.

Mandela’s dogged adherence to a policy of nationalization — even if it is only political rhetoric — has probably done more damage than five years of sanctions because bankers, despite their apparent desire to lose money, do not lend to countries which threaten nationalization.

Releasing Mandela may have been morally correct but it was also an enormous risk and it is extremely difficult to be sanguine about the economic future of South Africa. The dramatic selloff of South Africa gold shares reflects the uncertain mood, but as yet fears about loss or disruption of future gold production from the Republic have not been reflected in the gold bullion price.

Gold bullion’s performance in recent weeks has either been very disappointing or most encouraging depending on your point of view. Russia, the world’s second largest gold producer, is in the midst of political and economic chaos and South Africa, which still accounts for 40% of global production, is teetering on the brink.

Surely such threats to the future supply of newly mined gold should be bullish for the yellow metal? On the other hand, the dramatic rise in global interest rates over the past couple of months should have had a depressing effect on gold prices, so perhaps the metal is showing encouraging resilience.

A major factor apparently inhibiting gold from breaking about $420 is forward selling by producers. We hold the perhaps contentious view that gold mining companies are there to dig the metal out of the ground and not to speculate on the price of the metal.

That is not to say that forward sales have no role to play in gold producing companies. We believe it is extremely prudent for producers to sell forward and hence lock in cash flow to cover known capital expenditures and debt repayments, but beyond that they are speculating with shareholders’ production.

Why do people buy North American gold shares? As most of the companies treat their shareholders with utter contempt and pay only the most nominal of dividends (if they pay any at all) investors (?) buy such shares not for a rate of return but as a leveraged proxy for gold bullion.

However, if the companies sell their gold forward the leverage is largely denied. Investors do not place say 5% of their assets in a gold share mutual fund as an insurance position for the fund manager to be 50% invested in cash. So, why should gold mining companies sell their shareholders’ gold forward? London-based Ian Lamont writes for Yorkton Continental Securities. This article appeared in a recent Yorkton newsletter.