Some questions answered
December 19, 2003
Thanks for all the feedback following
my last two columns. Even though I can’t reply to each individual
comment, I do read all the emails I receive. Given the amount of feedback
I got, and the overlap in the comments and questions, I decided to use
this week’s column to respond to some of them. Here we go…
Question: Why do you dislike South African gold stocks
I have nothing against South African mining companies in
principle. In fact, Harmony Gold is one of the finest gold mining companies
in the world. What I don’t like about investing in South African
gold stocks, at this juncture, is the juxtaposition of the risks and the
In addition to the usual risks associated with running a
business anywhere in the world, South Africa has some unique issues that
its mining industry has to deal with. One of these issues is the reshuffling
of assets to compensate for apartheid era injustices. The blue print for
this reshuffling has been spelled out in the new Mining Charter and proposed
Royalty Bill. While almost all the South African mining companies have
been making changes in accordance with the new Mining Charter, it has
yet to become law. The Royalty Bill, that will impose a tax on South African
mining companies, still has to make it into the law books too. Will either
change, requiring further changes in the mining industry? I don’t
know, but that’s a risk you have to contemplate if you own South
African gold stocks.
South Africa has undergone incredible change during the
past decade. The change from a minority-rule, apartheid regime to a democracy
was, in my opinion as a South African, a vital one. I am not alone in
being both impressed and relieved at how smoothly the transition went
but I am perhaps less optimistic about the rate of social and economic
recovery than some. This is the crux behind the political risk in the
Officially the unemployment rate in South Africa is about
25%. But that excludes “discouraged job seekers”: people who
are unemployed but are no longer actively seeking employment. If you include
them, the unemployment figure increases to somewhat over 40%. In the United
States we have an unemployment rate of about 6%. I don’t think many
people who have not lived in a third-world country can fathom what 40%
unemployment is like.
Unemployment leads to crime. Crime destabilizes the entire
society, leading to unrest, which in turn leads to a public outcry for
the government to “do something”. But if the government is
essentially bankrupt, what can it do other than levy more taxes on companies
and those who are employed?
There were around 48,000 murders in South Africa from January
2000 to March 2002, but only 4,760 convictions. There were 21,108 murders
in 2001 alone. For perspective, there were 16,110 murders in the United
States that same year. Keep in mind that South Africa’s population
is only one sixth that of the United States.
Do you think that the social and political risks in South
Africa are negligible given the magnitude of its crime statistics? If
social distress leads to political action, do you think that the South
African government is done with the mining sector, or could the Mining
Charter and Royalty Bill, neither of which is necessarily in its final
version, be used to squeeze even more out of the mining sector?
Take another look at the performance of the rand against
the dollar in last week’s column and ask yourself whether it’s
a good bet to invest in South African gold stocks when you have to face
not only social and political risk, but also the risk that the US dollar
will continue to weaken against foreign currencies, including the rand.
Many people commented that the rand is not going to be strong
forever and that the gold price is likely to increase in rands (and in
fact in almost all currencies), even if the dollar does continue to weaken.
I agree. Even so, you still have to consider that capital (your savings)
is scarce and it is usually prudent to invest your savings where you can
get the best return for the least risk. So even if we assume that the
gold price is going to increase in all currencies, shouldn’t you
seek out the most leverage?
One could argue that the relative valuations of South African
gold mining companies already discount the currency, the political and
the social risks. That may be so, and I am not advocating that you purge
your portfolio of South African gold stocks. Nor am I claiming that you
could not make money by investing in South Africa. What I am saying is
that South African gold stocks are not going to give North American investors
the kind of returns they did in the seventies. Then the rand was fixed
against the dollar and the full impact of the higher gold price in dollars
was felt in South Africa. Now that the rand is floating against the dollar,
the increase in the dollar gold price will not necessarily be the same
as the increase in the rand gold price. This time the leverage is in US
I will invest in South African gold stocks again when, for
whatever reason, I perceive the upside to compensate for the risks, which
will probably remain the same.
Question: Won’t we see competitive currency devaluations
that will ultimately lead to an increase in the price of gold across all
I am sure that many countries are considering competitive
devaluations to sustain the attractiveness of their export products to
US consumers. But I sincerely don’t believe that governments can
always get what they want. The US dollar did not strengthen throughout
the nineties because either Bill Clinton or Alan Greenspan wanted it to.
The US dollar strengthened as capital flight from the currency
crises of the nineties (starting with Brazil in 1992, then Mexico, Japan,
South East Asia, Russia, Argentina, Europe, Turkey and Brazil, again)
created demand for the US dollar.
The dollar strengthened, on average (GDP-weighted average),
by 120% from 1990 to 2002 against the rest of the world’s currencies.
This increase in the dollar caused a trade imbalance because imports became
very inexpensive and US exports became uncompetitive. Now that trade balance
has to be corrected.
As far as I know, every reversal of a large trade imbalance
in history has lead to a recession, the magnitude of which was proportional
to the size of the trade deficit. Because the US trade deficit is still
at a historically high level, I am convinced that the recession in the
US economy is not behind us, it is still unfolding.
The reversal of the trade deficit is also what is going
to drive the US dollar lower against foreign currencies regardless of
how much some of those countries wish, and try, to competitively devalue
their currencies. It just won’t work because the US cannot sustain
the current trade deficit any more than you can jump up in the air and
Given the magnitude of the correction in the dollar’s
exchange rate, the gold price in dollars will increase more than what
it will increase, on average, in other currencies. So while the gold price
certainly could rise in other currencies, we will get maximum leverage
from this devaluation by investing in companies that have US based operations.
Question: Won’t mining stocks appreciate against
the dollar even if those same stocks only maintain parity against their
Yes, they might, depending on what the relative exchange
rates actually do. But let’s consider the purpose of investing,
which is to maximize our returns for the least amount of risk. If we know
that the US dollar is busy depreciating against foreign currencies, and
we know that that process will continue for as long as the trade deficit
remains out of control, then we also know that the best leverage to gold
is going to come from US based projects. How smart is it to strive to
If your goal is to mitigate risk by diversification, which
is a perfectly rational and intelligent approach, then owning gold stocks
with exposure to North and South America, South Africa, West Africa and
Australia makes a lot of sense. In such a portfolio some upside is sacrificed
for the mitigation of geopolitical risk by diversification. If that is
your approach, don’t be offended when I say that it will give you
average results, at best.
I am not trying to earn an average return on my investments
because, unlike people with real jobs, I invest for a living. Therefore
I have both the time and the inclination to try and figure out how to
gain the maximum leverage without significantly increasing my risk.
What I write about in these columns are some of the ideas
that have shaped my own investment paradigm. That doesn’t mean I’m
right, or that I will indeed be able to outperform the market, but it
does make writing these columns a lot more fun. What I am writing about
is the real thing: my money is on the table.
I can explain my ideas about markets and investing here,
but this is not the forum for discussing specific stocks. I am not in
the business of stock promotions. If you want to know what I am actually
doing with my own money, you can subscribe to my newsletter (www.paulvaneeden.com).
Be forewarned though, implementing theoretical ideas is
much harder than coming up with the ideas. I am looking for exposure to
good US based projects, but it’s easier said than done. The result
is that I am investing outside the US as well. Another thing to keep in
mind is that because I do this on a full-time basis, I tend to invest
in companies that would, for most people, represent too much risk. I try
to mitigate this risk by staying in close contact with the companies and
making a sincere attempt to understand, in much more detail than most
investors, what it is they are doing. Most of my money right now is invested
in mineral exploration companies, which are, as a group, highly speculative.
But just like there is a good reason why I am investing in the gold sector,
there is a good reason why I am currently focused on the exploration industry.
That, though, is a topic for the future.
I am taking a two-week break and will have the next column
for you on January 9th.
Wishing you a Merry Christmas, or Happy Hanukkah, and a
very, very prosperous New Year,
Paul van Eeden
Paul van Eeden works primarily to find investments for his
own portfolio and shares his investment ideas with subscribers to his weekly
investment publication. For more information please visit his website (www.paulvaneeden.com)
or contact his publisher at (800) 528-0559 or (602) 252-4477.
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