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Take a look at NEW RAND Con­sider dirt-cheap OFFS But be­ware the snake pit what? D HEDGES SHORE PROP­ERTY CUR­REN­CIES

Finweek English Edition - - Coveer -

THE SHARE PRICES of old-gen­er­a­tion rand hedges fared so badly over the past six months they in fact of­fered a neg­a­tive hedge to in­vestors who tried to pro­tect them­selves against South Africa’s sharply fall­ing cur­rency. The 35% fall in the price of NewRand, the Absa ex­change-traded fund (ETF) spe­cially cre­ated as a hedge against a weaker rand, over the past few months un­der­lines the in­abil­ity of so-called rand hedges to do what they’re sup­posed to.

Luck­ily, a new gen­er­a­tion of rand hedges is com­ing to the fore. The in­ward list­ing of Bri­tish Amer­i­can To­bacco from Richemont and Rem­gro is a wel­come ad­di­tion to the cur­rent short list of new-gen­er­a­tion rand hedges. Un­for­tu­nately, due to SA’s outdated ex­change con­trol and other mea­sures, the share isn’t freely avail­able to in­sti­tu­tional in­vestors. Other new-gen­er­a­tion hedges – such as SABMiller, MTN, Naspers, Richemont and Lib­erty In­ter­na­tional, to men­tion just a few of the big ones – of­fer any in­vestor enough to be ex­cited about.

The need for as­sets to pro­tect the in­vestor against the end­less fall in the rand’s value started in the Sev­en­ties. The for­mer Bret­ton Woods agree­ment, which reg­u­lated the sys­tem of fixed ex­change rates world­wide, had col­lapsed and was re­placed by a new con­cept of float­ing ex­change rates. Sud­denly, ex­change rates were per­mit­ted to find their own value, and weak­nesses in over­val­ued cur­ren­cies soon be­came ap­par­ent. The rand was one of those.

Rather than open­ing the ex­change rate mar­ket and abol­ish­ing ex­change con­trol, which was only about a decade old at the time, the SA Re­serve Bank and Gov­ern­ment in­creas­ingly tried to ap­ply a pol­icy of in­ter­ven­tion and in­creas­ing reg­u­la­tion.

Their mis­placed be­lief that this would en­sure a sta­ble ex­change rate for the rand had the op­po­site re­sult. SA’s econ­omy was shocked from time to time by large overnight de­val­u­a­tions, which had to be an­nounced ev­ery time by a very em­bar­rassed Min­is­ter of Fi­nance. Those de­val­u­a­tions, along with our strict ex­change con­trol reg­u­la­tions – which en­tirely pro­hib­ited any in­vest­ment over­seas – led to a de­mand for prod­ucts to pro­tect the in­vestor, mainly or­di­nary listed shares. The old ex­ist­ing shares were repack­aged and a new cat­e­gory called rand hedges – which in­volved sev­eral spe­cialised ad­vis­ers – was formed.

The first sim­ple qual­i­fi­ca­tion for a rand hedge was an in­dus­try that earned its in­come in a strong cur­rency while its op­er­at­ing costs were in a weak cur­rency. Gold shares at the time were a clas­sic ex­am­ple. Their in­come was in US dol­lars and there was the fur­ther ben­e­fit that the gold price tended to rise ev­ery time the dol­lar weak­ened. Gold was the per­fect strong cur­rency in which in­come was earned.

On the other hand, the mines’ costs were largely in the weaker rand. The com­bi­na­tion of sales in a strong cur­rency and pur­chases (op­er­at­ing costs) in a weak one the­o­ret­i­cally of­fered the ideal hedge against a weak rand. Ex­change con­trol didn’t bother in­vestors, be­cause they could in­vest in gold shares.

How­ever, over many decades the ex­pe­ri­ence proved very un­sat­is­fac­tory. The gold mines had a nearly un­con­trol­lable abil­ity to squan­der the ben­e­fit of a higher gold price, even in US dol­lars, which was fur­ther in­creased by the fall­ing rand. Pro­duc­tion costs in the weaker rand usu­ally rose sharply and the spo­radic ben­e­fits

of of­fi­cial de­val­u­a­tions were quickly wiped out. The mines were also only too ready to al­low the value of the ore mined to fall, while cap­i­tal in­vest­ments speed­ily eroded the higher cash flow.

One of the short­com­ings of Absa’s NewRand port­fo­lio is pre­cisely that it still re­lies too much on this outdated hedg­ing model.

Un­til a few months ago there was no need for SA in­vestors to be at all con­cerned about hedg­ing against a weaker rand. The first prob­lem was a rand which in any case had been able to stand on its own legs for nearly five years and which had strength­ened against the US dol­lar and even more against the then so-called hard cur­ren­cies, such as the euro. Along with that, ex­change con­trol was eased sig­nif­i­cantly and es­pe­cially in­di­vid­u­als – who can now in­vest R2m over­seas – had less and less need of rand hedges. The in­sti­tu­tional in­vestors also de­vel­oped sev­eral prod­ucts that specif­i­cally met the need of rand hedg­ing.

How­ever, the share prices of platinum mines in SA, which took over a few years ago from the gold mines as the lead­ing earn­ers of hard money, have over the past few months very painfully pointed out the weak­nesses of the old gen­er­a­tion of rand hedges. In fact, it was the more than 50% fall in the platinum price, in strong and weak cur­ren­cies, that con­trib­uted to the rand’s cur­rent fall.

Sud­denly, platinum shares – the pri­mary hedge against ev­ery­thing bad in SA and in favour of ev­ery­thing good in the de­vel­oped world – had feet of clay. Not only did platinum share prices fall by up to 60% but the cur­rent low fol­low­ing the pros­per­ity of the past five years shows the cus­tom­ary in­ef­fi­cient cost con­trol that the gold mines had prob­lems with has now also spread to this sec­tor. The sparkle of platinum shares has dimmed faster over the past three months than even the sparkle of gold did.

At cur­rent prices, platinum shares may be a good in­vest­ment. Not be­cause they’re a hedge against a weaker rand but rather be­cause the in­ter­na­tional platinum price, whether in US dol­lars, eu­ros or yen, will rise again.

The same goes for the two re­sources giants – An­glo Amer­i­can and BHP Bil­li­ton. Un­til a few months ago both were con­sid­ered ex­cel­lent hedges against the weak rand and SA’s po­lit­i­cal un­cer­tainty. And they were also hedges, so many peo­ple thought, against the US sub-prime credit cri­sis, which has now be­come a world­wide worry. But then the tide turned. The prices of com­modi­ties fell so sharply the fall in the share prices of both re­sources giants even ex­ceeded the fall in the prices of bank shares on Wall Street. What a hedge!

There’s no doubt BHP Bil­li­ton and An­glo are two ex­cel­lent com­pa­nies with ex­cel­lent as­sets world­wide. They’re fan­tas­tic shares for any in­vestor who wants to ben­e­fit from the fu­ture boom in re­sources and any­thing to do with min­ing. How­ever, in their own right both are no longer hedges against a weaker rand.

Pre­vi­ously, Fin­week chose Sa­sol as the ideal hedge share for SA in­vestors. Af­ter all, over the past 30 years, since its list­ing in 1979, Sa­sol’s share price has risen from R3 to more than R500 not too long ago. Now its share price has halved – just when SA in­vestors needed a hedge.

Sa­sol is an ex­cel­lent com­pany. It can in the fu­ture con­vert lots of gas into liq­uid

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