We’ve spoken about it a lot before. We’ve already taken one position accordingly, though now we’re getting much deeper. South Africa, that is.
Position for a truly devastating collapse of the South African economy. Executed via four trades:
- Long XAU/short ZAR: long gold and short ZAR
- Long HSBC/short FirstRand (FSR): shorting South African banks against world banks
- Long palladium via North American Palladium (PDL)
- Long Target Stores (TGT)/short Woolworths South Africa (WHLJ.J)
South Africa is moving ahead with plans to change the constitution of South Africa to allow the government to seize land without compensation.
In our opinion it is a “100% certainty” that there will be an economic collapse in South Africa. It is heading down the same path of Zimbabwe and Venezuela. Both these countries were economic success stories at one time, and now they are complete basket cases from which there appears no easy return. The intellectual capital has fled and the infrastructure has been decimated.
And if you think I am joking and you’re thinking, “how can South Africans let their country go the same way as Venezuela and Zimbabwe?” Well, don’t approach this situation with your western rationale or logic. Perhaps you will understand after listening to this video clip:
To the vast majority of the populace, economics, the very little they do understand of it, doesn’t matter much. Rather the populist rhetoric is:
- The white man is the source of all our problems. They owe us!
- There’s an opportunity to get something for nothing
- Take what is in front of you. Live for today, tomorrow is another day.
The fact that the land was settled in the 1600’s at a time when the indigenous tribes were mostly the Khoisan, a tribe that has been ostracised by the present government does not fit with the narrative and so is ignored.
The fact is a massive uneducated pool of people know nothing of their own history and are still tied to an incredibly barbaric tribal system. It’s silly that saying such things invokes the cry of “racism” and yet ask anyone who’s lived in any country in Sub-Saharan Africa, and you’ll find the same facts laid out.
Yes, another day in the Southern State of Africa.
I want to keep this alert “objective” and free from emotion, but it is worth mentioning that I grew up in South Africa, have many friends in the country and deep networks that provide me with real time solid information. Information, I may add, which goes largely unreported by the Western media.
I left South Africa some 20 years ago as I could see the writing on the wall way back then. I think this recent land expropriation law is the tipping point — the point from which there is no easy return. Venezuela 2.0 here we come.
So keeping emotions aside I want to discuss what is likely to happen to South Africa within the next 10 years and ways that we can position ourselves to prosper from South Africa’s inevitable slide to where Zimbabwe and Venezuela currently find themselves.
To understand where South Africa is heading, let’s take some time out to understand how Venezuela ended up so utterly and totally broken. A place where the populace can now be found eating sand, literally.
Everytime I think of Venezuela I think of Ms. Universe. As a young man I always wanted to go there and live for a few years just to try it out, though, if I’m to be honest with you, it wasn’t just the country I wanted to try out, but I digress. I was young, male, single, and normal. I promise you I’m much more civilized these days.
But today’s reality is something more like this:
Which is probably still ok if you are young and into a bit of “adventure”.
Some 30 years ago, Venezuela, with its resource wealth, had per-capita GDP on a par with Norway. However, now the country finds itself with more than 80% of its people living in abject poverty, with an annual inflation rate making the Weimar Republic hyperinflation look tame.
The current president is adamant that the economic implosion is due to a silent war being waged against it by the US and political opposition parties. Chavez would have probably argued the same if he was alive! It is, of course, complete bollocks.
The truth is that the collapse is due to socialist policies of former president Chavez which had land expropriation at its very heart.
Chavez amended the Constitution in 1999 declaring large “idle estates” contrary to the interests of society. In 2001 he introduced a Land Law which allowed for the expropriation of these idle estates.
The rationale for this constitutional amendment was that the poor owned only 6% of the land, while the top 5% owned 75% of it. According to Marxist Chavez, these stats made it imperative to expropriate idle land estates and allow peasants to gain ownership of the land in order to cultivate it.
This is a near exact echo of the ANC’s claim that black South Africans own less than 5% of agricultural land, while whites own about 70%… and that all this land must now be expropriated without compensation and then “shared among those who will work it.”
In Venezuela, targeted idle estates were initially defined as “high quality idle agricultural land over 100 hectares” or “lower quality idle agricultural land over 5,000 hectares.”
However, later the maximum amount of “idle” high quality land allowed was reduced from 100 hectares to 50. Lower quality “idle” land was capped at 3,000 hectares.
In reality, it was not only “idle” land that was taken. The government encouraged land invasions, which often reduced formerly productive land to unproductive “idle” land which then qualified for expropriation. It was simply a sleight of hand allowing for “legal” expropriation of land. Well, this is already now happening in South Africa. It is, however, just the beginning.
The Chavez “government” also introduced a “one-cow-per-hectare” rule, where farms with less than one cow per hectare were deemed unproductive and expropriated for that reason.
Farmers who increased cattle numbers (in order to stay above the one-cow-per-hectare rule), were then deemed to be abusing the land. These farmers were then expropriated too. In essence, every farm became a target.
Land was largely allocated according to political criteria thereby ensuring a self-perpetuating cycle. It was very simple. If you voted for Chavez, you got land. So you voted for Chavez. Of course, the more who voted for him the easier it was to expropriate land, which simply ensured an accelerating annihilation of the economy.
By 2010 some 25% of Venezuela’s total productive farmland had been “reallocated” to smaller farmers.
The bad news, as you can guess, is that the redistribution of land to small farmers did not result in an increase in food production. On the contrary, agricultural production collapsed between 2007 and 2011:
- maize by 40%,
- rice by 39%,
- sorghum by 83%,
- sugar cane by 37%,
- coffee by 47%,
- potatoes by 64%,
- tomatoes by 34%,
- and onions by 25%.
It seems like while “only” 25% of the land was expropriated, the uncertainty and unrest it caused had an overly large impact on land that wasn’t’ expropriated. This was as a result of the finance sector, which we’ll come to at the end of this report and how we’re executing on this trend.
Anyway, after 2014, when the oil price plummeted. Imports of all essentials, including food, became difficult for the government to afford. Shortages developed and food rationing was introduced. Price controls were tightened, and farmers and producers were forced to sell at prices below production costs,thus ensuring that the market economy had no chance of actually solving the supply demand issue.
By 2015, thousands of people were queuing for five to six hours a day in the hope of buying food and other much-needed items. Supermarket shelves were emptier than Chavez’s head:
In 2016 foot riots began, along with the hijacking of food trucks and the violent looting of stores. Desperate starving people will do desperate things to stay alive. The delivery of basic foods had to be conducted under the control of the military defence forces. As if they’d not done enough damage, the labour ministry then announced that all private and public employers must allow their workers to be reassigned to growing crops.
Although land was the first target of expropriations, it soon spread to other sectors. In 2007, for example, the government demanded majority control of projects managed by international oil companies. It also expropriated the assets of Exxon and Conoco who refused to cooperate.
And in 2008 the government, not content with their handiwork, nationalised the cement sector.
In 2009 Chavez closed many small banks for bogus reasons, but re-opened some as state-run firms. He also vowed to nationalise any bank that failed to meet the government’s lending guidelines further decimating the ability of capital to flow productively and supply meet demand.
Then in 2011 Chavez announced that he was nationalising the gold industry (obviously he needed the gold for forex purposes). Unsurprisingly that, too, ended in disaster:
Yes, this is the sort of stuff you imagine happening in the failed Soviet era state. But realise that this was just a few years ago, basically present day stuff. It is one reason why we’re fearful of the very powerful leftist socialist ideology that is sweeping the Western world, but I digress. That’s a topic for another day.
Between 2013 and 2017, Venezuela’s economy contracted by 39%. It is expected to plummet yet further, with a 50% contraction by 2019 at the current rate of collapse.
Although the government stopped providing official figures in 2016, monthly inflation reached 100% in February 2018, translating to annual rates of inflation of more than 1,000,000 per cent.
The most efficient metric we can use to understand the real numbers is the black market rate for the bolivar.
This rate is openly used by shopkeepers and sits at over 300,000:1.
Basic water and electricity infrastructure is near collapse. Local industry has been destroyed and virtually everything has to be imported, including food, but the government no longer has the funds to do so as FX reserves have been depleted and there’s nothing coming in to fill the coffers.
The percentage of the population living in poverty is now well over 80%. Extreme poverty has leapt from 24% of the population in 2014 to well over 61% just three years later. That’s stunning.
If Venezuela’s experience is anything to go by, expropriation of land — whether productive or “non-productive” — leads to widespread poverty. It is a grand delusion to think that it will lead to prosperity. South Africans are heading for a truly awful reality check.
And Zimbabwe? I didn’t want to waste any time discussing that basket case because it is rather obvious for all to see.
It is important to realize that Mugabe started grabbing land and essentially sponsoring the murder of white farmers from 1999 onwards… and it took about 10 to 15 years before a full and complete economic collapse occurred, just as it did with Venezuela. It doesn’t happen overnight but it will happen.
So here’s what did happen with both Zimbabwe and Venezuela as a result of the land expropriations. In no particular order:
- Currency markets blew out
- Industrial production collapsed
- Financial institutions went bust
- Inflation went off the Richter scale
The Death of South African Lending, Credit, and the Financial System
Any government that has ever messed with property ownership rights of its people has paid a hefty price.
Wide-scale land expropriation without compensation will lead to a massive banking crisis. If large swathes of land are expropriated without compensation, it will leave many South African banks (including the government owned Land Bank) with holes in their loan books so large you’ll be able to land a meteor in them.
Virtually every farm uses debt, be it for mortgages, equipment, seasonal crop or working capital finance.
Loan and bond agreements entered into with a bank do not typically take into account a scenario in which property seizure results in a forcible change of ownership. If a loan is defaulted upon as a result of expropriation, pray tell, what recourse a bank will have when title is lost to the government or some politically connected group of thugs?
And while this is about to hit we can see that farm debts are at record highs. It really is the perfect storm for the South African banking sector.
And guess who this debt is outstanding to.
Of the publicly traded banks, FirstRand and ABSA Group have the largest proportion of agricultural loans, being 3.6% and 3.4% of their total loan book respectively. Standard Bank’s is 2% and Nedbank’s sit at 1%.
What isn’t mentioned is agricultural cooperatives and agribusinesses who provide financial advances to agricultural producers to cover their input costs that are then repaid once the crop is harvested. And neither is there any discussion at all on commercial finance companies who provide finance for equipment and machinery.
Expropriation, which leads to a failure to recover agricultural loans, will result in widespread bankruptcy and an ensuing economic crisis.
How would banking and finance sectors be able to overcome large-scale loan losses from expropriation without financial compensation? To prevent a banking collapse, the government would have to step in to prop up the banks and other financial market role players. Fine, let’s play that game. Given that the state owned pension fund (the PIC) owns about 10% of South African banks, they might have to think seriously about not letting banks fail.
However, given the difficulties involved in pulling this off and South Africa’s perilous financial position, which promises to get much worse rather rapidly, this is unlikely to gain widespread acceptance.
Add to this fustercluck of a situation, South Africa has gone through a debilitating drought of the last few years which has resulted in very little investment in the agricultural sector. It would be difficult to see how there will be any further investment in the agricultural sector going forward when expropriation becomes a reality.
Even now there is no appetite to invest in or finance any new agricultural business as a result of the uncertainty created by this batshit crazy policy.
Now, when expropriation does occur, who, we ask, is going to finance these new “landowners”?
Rest assured that without finance you will go from this:
I’ve seen it firsthand. This is exactly what has happened in Zimbabwe. And while I’ve not seen it firsthand in Venezuela, the evidence is that the same situation exists.
But there is more to it than expropriation of real estate property. Expropriation of businesses in South Africa has actually been going on for at least 20 years. From small beginnings at first to the current blatant state sponsored robbery which is now law.
As the Economist pointed out earlier this year:
Many of the farms that have been handed over have since failed because the new owners do not have the skills needed to run large commercial farms. As much as 70% of the estimated 8m hectares of land transferred by the state since the end of apartheid is now fallow.
In South Africa now, as a business, you cannot survive unless you have a meaningful proportion of your directors, shareholders, and management being black or “previously disadvantaged”. This is called “affirmative action” or “black empowerment”, which are simply are “digestible” phrases used for racist economically destructive policies.
I don’t want to go into the details of “black empowerment” (too lengthy), but I will go through the new “mining charter” which will give you a good understanding as to what is happening in South African industry and business as a whole.
Here is the essence of the new mining charter. Brace yourself, you might just fall off your chair when you think of the long-term consequences of this:
- A new mining right must have 30% Black Persons’ shareholding, with the 30% shareholding to be apportioned between employees, communities and entrepreneurs in a specific manner
- An 8% shareholding is allocated to mine communities, to be held through a trust
- A 14% shareholding to black entrepreneurs
- Holder of a mining rights must pay 1% of its annual turnover to the 30% black persons’ shareholding prior to, and over and above any distributions made by a Holder to its shareholders
This 1% payment is always subject to the solvency and liquidity test as provided for in the Companies Act
- The Charter requires 70% procurement of mining goods and 80% procurement of services from BEE entities; it also requires that analysis of 100% of mineral samples be done by South African based companies
- At board level, a minimum of 50% black representation, 25% of which must female black representation
- At executive/top management level, a minimum of 50% black representation, 25% of which must be female black representation
- At senior management level, a minimum of 60% black representation, 30% of which must be female black representation
- At middle management level, a minimum of 75% black representation, 38% of which must be female black representation, and
- At junior management level, a minimum of 88% black representation, 44% of which must be female black representation.
Human Resource Development
- A holder must invest 5% of the leviable amount on essential skills development.
Why would any foreigner want to do business in or allocate capital to South Africa? These policies of the South African government are completely anti-capitalistic… and reflect instead policies more closely aligned with communism.
Even the average village idiot could tell you that the South African mining industry is going to follow a slow and painful decline with the “irony” that the very people that the mining charter is purportedly going to “empower” will be those worst affected, along with all the businesses surrounding this industry and, in turn, those businesses surrounding the mining service businesses. In short, the whole of South Africa.
Sadly in many respects I think South Africa is doing a more thorough job at fucking their economy up than Venezuela and Zimbabwe ever did.
And What Do White Farmers Have to Say?
I could go on writing at length about my view of the ultimate outcome of the land expropriation but I thought I’d give you some insight into what ordinary folks in South Africa are thinking.
A friend of mine who still lives in South Africa sent me the following. I think it rather eloquently lays out the thinking and chain of events surrounding expropriation of land in South Africa. This isn’t the theoretical crap you’ll find written by some economist or asset manager sitting in a plush building in Manhattan, sipping on his organic coffee, and who, when visiting South Africa, has been wheeled from one plush office to another, extolling the virtues of emerging market growth opportunities, high birth rates, and resource rich lands.
I know the gig. For a period of time I worked on the emerging markets desk of the then private British investment bank Robert Fleming & Co. That’s how it goes. No. This is the real deal written from a South African farmer. Maybe Facebook has a use after all!
WHAT WILL HAPPEN WHEN THE ANC TAKES MY FARM
I have no doubt that the ANC Govt has given a lot of thought to the topic of Expropriation Without Compensation (EWC) however I think they might not have fully comprehended the consequences of such a policy. As a farmer I thought it might be useful to enlighten them as to the course of action I would take once my farm is targeted for EWC. Before I continue I would like to emphasize that this is not a threat nor delivered with the mindset of a saboteur, it is merely a description of the sequence of events that would unfold in the event of such a policy being enforced.
• I would immediately identify all the moveable assets on my farm and start selling them or placing them in a suitable storage facility. I list these below simply to demonstrate to non-farmers what makes a farm functional and profitable. The first to go would be all the livestock followed by all the machinery including tractors, pumps, silos, centre pivots, electrical transformers, irrigation equipment, water troughs, implements and piping. I would strip the dairy and sell the bulk tanks, milking machines etc. I would take down all internal fencing on the farm and recoup what I could. All sheds would be disassembled and all houses and other buildings would be stripped of anything sellable, including their roofs.
• I would disconnect/cancel the 5 Eskom points on the farm and obtain refunds on the deposits I’ve paid on them.
• I would re-trench all my staff and pay them off in accordance with the Labour Act. I would then strip all the staff accommodation on the farm and sell what I could.
• With the sale of all my livestock and cessation of the farming operation I would immediately default on the R5.5m I owe FNB but I wouldn’t worry as the farm is the loan’s security and I don’t really own anything else.
• When the day came to leave the farm I would hand the ‘keys’ over to the new ‘owners’ but I’m not quite sure what they would do as there’d be no roof on the farm house and there would be nothing to ‘farm’ on the farm. It would just be a piece of land, but that’s ok because the ANC says owning land makes you wealthy.
When you take the sequence of events described above and multiply it on a national scale you see another sequence of events unfolding.
• The new ‘farmers’ arrive on the farm but there is no livestock, machinery or working capital to continue the operation.
• They go to the banks to borrow money (A good farming habit) but the banks are sitting on a R160 Billion defaulted debt book from the ‘old’ farmers and won’t lend a cent to agriculture. They’re fighting for their own survival now.
• The Govt doesn’t have the money, which would be far more than the R160 Billion mentioned above, to re-capitalise and finance all the farms so most of the farms either fall derelict or are farmed at a subsistence level.
• There is a massive but short-term surplus of Beef, Sheep and Poultry products due to the sell-off by the previous farmers. This brings prices down drastically in the short term but eventually the meat runs out and there is nothing to replace it. Meat prices skyrocket.
• Dairy products cease almost immediately after the livestock cull/sell-off and within weeks there is a critical shortage of all dairy products. Importing is impossible due to the Govt’s actions which have decimated the value of the Rand.
• Maize lasts quite a bit longer and with careful rationing will endure until the next season but there is no crop in the ground for next year due to the new ‘farmers’ lack of machinery, experience and access to credit.
• All agricultural Co-Ops and suppliers very quickly cease operation and/or go bankrupt and re-trench all their staff. They cannot survive by selling single bags of seed and fertilizer to subsistence farmers.
• All processors of agricultural products such as meat, dairy and maize cease operation due to lack of product and re-trench all their staff.
• Rural Municipalities start to feel the pinch as there are no longer any farmers paying rates and the agricultural businesses in the towns have also sold up and left.
• Smaller rural towns that depended on agriculture eventually collapse and rural communities are forced to travel long distances to major centres to find ever dwindling supplies.
• Ironically the EWC movement creates more Urbanisation as the rural folk flee the agricultural desert that has been created.
• All food dependent enterprises such as fast food chains and restaurants either disappear or are greatly reduced…along with all their staff.
• With all the unemployed farm workers, as well as those who have lost their jobs from other sectors, there is an unsustainable demand on the UIF system and it soon collapses.
• The Social Grant system teeters as the ripple effect from the agricultural collapse enters all sectors and the tax-base is shredded.
• Food riots become common and genuine hunger and poverty widespread.
• Unlike Zimbabwe the South African population has nowhere to run.
• With the White Farmer no longer an available target and the true ‘value’ of land revealed in all its fallacy the masses turn on the only target they have left. The ANC.
What I would say here is that this farmer and others like him are making a crucial and possibly deadly assumption. That assumption is that there is some due process afforded the confiscation procedure, which itself would provide sufficient time for farmers to asset strip their lands. That may happen a few times but would likely be rapidly changed to a situation where targeted farms are approached secretively and whereby the land owners would be simply escorted off the property ensuring that the above doesn’t take place.
In the end the result is the same. The new owners of the land will have neither the skills nor the business acumen required to run a commercial operation of this kind and within a short time production will decline sharply and many of these farms will finally be left fallow.
Indeed if Zimbabwe is anything to go by, the incoming thugs will begin asset stripping the moment they get onto the properties. That’s what happened in Zimbabwe as the “new owners” sold tractors, implements, you name it. Even smashing up the farmhouse to sell the windows, roof iron and so on. For a brief period of time they were “rich”, buying themselves luxury vehicles and the like though obviously never having read or learnt the story of killing the golden goose.
Another problem is almost certain. Those acquiring the newly minted farms will be politically connected which itself will cause a legion of hooting and panting thugs to look around and say to themselves, “hey, wait a minute… when is it my turn?”.
This, in turn, will lead to roaming bands of violent, militant thugs who, upset with the ruling party’s expropriation process and decisions made as to “who gets the spoils”, take matters into their own hands, and go take properties themselves. After all, it’s not like the police are going to get involved to stop this. The law, after all, says that expropriation of white owned assets is now legal.
All of this is to say that things are about to go from bad to worse and probably in ways we can’t yet imagine. Our task however is to manage capital and so we’ll do just that.
Applying the View
Let’s now discuss ways to apply this bearish view of South Africa. We have spent a lot of time on this and analysed literally dozens of various equities, bonds, you name it. The task, as always is twofold. Firstly, to reduce our risk as much as is possible and the second is to seek outsized returns. As such we love pair trades which you’ll notice in these positions mentioned. They are:
- Long XAU/ZAR (long gold and short ZAR)
- Short the South African banking system by going long HSBC and short FirstRand (FSR)
- Long palladium via going long North American Palladium (PDL)
- Short South African retailers: long Target Stores (TGT) and short Woolworths South Africa (WHLJ.J)
Let me now discuss them. I will try to keep it brief because this Alert has already turned into a War and Peace!
The rand is going to blow out — that, we think, is a given.
The challenge is figuring out which currency to short the rand against. One could go the “vanilla” option and just go long the dollar/rand. Or go long gold in rand terms. It is an easy trade and most platforms have this FX cross. The way we see it, there will be a hell of a lot more ZAR in circulation 5 years from now and very little more gold, particularly as South Africa’s gold decreasing production trend continues (which it will). Also we’re already long the Invesco DB US Dollar Index Bullish ETF (UUP) in the portfolio. By using XAU/ZAR in this fashion we capture the potential upward pressure on gold prices (only increased by the coming supply destruction in South Africa) and still hold our short rand position. In terms of overall portfolio construction we believe this to be intelligent.
To me being long the XAU/ZAR is a no brainer. The big debate is how aggressive to get (how much leverage to employ). I don’t want to be prescriptive here or get into trade specifics as everyone has a different tolerance towards risk.
Seems to me that it will go sideways for a few years then ramp up, then sideways, then ramp again… but rarely goes down on a 2-year view. If we’re right with our forecast, then the next major move will be an accelerating ramp up.
Sure, we could get into fundamentals, namely detail about the dwindling production capacity from the world’s gold mines and South Africa’s production continuing to slide but you are probably all well versed in that, and truthfully, if we’re right about the overall trend, then it’s a given that the mining sector gets a steel capped boot to the head.
To cut a long story short… it is going to be easy (and necessary) to dramatically increase the supply of ZARs over the coming years while it will be very difficult to increase world gold production!
As a “matter of interest”, when an emerging currency wants to move, what is an “oversold” situation goes on to become even more oversold. In other words, “oversold” has no rational boundaries when it comes to emerging market currencies. Below is what has just happened with the Turkish lira
Shorting South African Banks
There are essentially 4 big banks in South Africa. FirstRand(FSR) is the biggest and incidentally has the biggest exposure to farm debt (at 3.65% of their loan book).
We’re going to short FirstRand as it is a good proxy for the South African banking system and all the issues facing it over the next 5 years.
South Africa’s banking issues aside, I think it makes a huge amount of sense to short FirstRand from a valuation perspective.
Fortunately FirstRand is amongst the world’s most expensive banks. It sits on a P/Book valuation of 3x whereas the “average” price to book ratio for world banks is about 1x (Bank of America sits on 1.2x and HSBC sit on 1x as a matter of comparison).
Big deal, you may say. Well, how about this? FirstRand (in USDs) has about the same market cap as:
- France’s Societe Generale,
- UK’s Standard Chartered,
- State Street,
- and Suntrust.
That is bloody nuts.
I recall in 2015 when Aussie’s CBA was the 7th biggest bank in the world by market cap (about 30% smaller than Citibank). At the time we said this was nuts.
It seems to me that the market is pricing FirstRand for an “economic miracle” outcome in South Africa as in nothing will go, or can go, wrong. And yet, not only is this going to go wrong. It promises to go “holy mother of Mary” wrong.
Shorting FirstRand isn’t our biggest headache, rather it is which bank to short FSR against. Do we go long a Japanese, European, or US bank against FSR? If we are going to be wrong in this trade (on a 5-year view), it is because there was a better bank to short FSR against.
We have chosen HSBC because it is probably the best proxy for world banks due to its geographical exposure:
In terms of performance, this is how HSBC has performed relative to FSR over the last 10 years. Yes, dramatic underperformance but there are reasonable signs of a bottoming process.
I don’t want to go into the details of the mechanics of the trade too much as long short trades are for more experienced investors.
One of the issues I have with The Insider is we have subscribers from across the investing spectrum — from seasoned hedge fund managers to investors who only have a few years of experience. This isn’t a problem in itself, rather how do I present ideas so as not bore more experienced subscribers or go completely over the head of less experienced subscribers.
So rather than go through the intricacies of these long short trades, if there is enough interest, I will hold a separate webinar to go through the mechanics of the trade and issues to consider within the next few weeks.
What are South Africa’s commodity exports that have an impact from a global perspective?
Below is a graph with South Africa’s reserves as a percentage of world reserves. Granted it is 10 years old but I doubt it would have changed materially in 10 years. Also, it is of reserves, not production. But reserves vs. production isn’t materially different, at least not for the purposes of this discussion.
It is probably not a stupid idea to look for bullish opportunities in commodities where South Africa accounts for a significant portion of world production. The commodity we have in mind is palladium, specifically North American Palladium (PDL), which was the subject of a Trade Alert on May 14th. Nothing has changed to our view since that publication. In fact, PDL is nearly 15% cheaper today, so consider this a reiteration of a buy on PDL.
Short South African Retailers
We believe that one of the best ways to “short South Africa”, from an equity perspective, is via stocks that are directly affected by consumer spending in South Africa. That is retail stocks.
When chatting with a prominent hedgie friend of ours he said, “why not short the South African equity index ETF, the iShares MSCI South Africa ETF?”.Good question. The issue with the iShares MSCI South Africa ETF (EZA) is it has a huge weighting to Naspers, a global internet and entertainment group (not something we want to be shorting at this point and certainly not much to do with the South African economy).
Woolworths is essentially a grocery, clothing, and general household goods retailer in South Africa and also the owner of David Jones (department store) and Country Road (up market clothing) stores in Australia.
Woolworths bought Australian retailers David Jones and Country Road in 2014, paying way too much for two broken business models and at a time when consumers in Australia were getting to breakpoint with real estate and credit card debt (something which we have spoken about for sometime now).
Woolworths gives us the best of both worlds as we believe Australian retailers will come under increasing pressure as rates rise in Australia (not to mention South Africa).
Below is a breakdown of Woolworth’s revenue by business and geographic location.
Woolworths has been reporting “unprecedented” tough trading conditions in both South Africa and Australia over the last 12 months. We’re thinking that if trading conditions are tough now just wait a couple of years.
As with FirstRand, I don’t think the point of debate should be so much as to whether or not to short Woolworths but rather what to short it against.
We’ve have chosen to go long US discount retailer Target against Woolworths. Target’s business model isn’t broken, and I believe that its business won’t suffer as rates rise.
Furthermore, US consumers are in a much better financial condition than their South African and Australian counterparts and will remain so. South Africa is on the verge of an economic crisis brought on by the governments own stupidity, and Australian consumers are about to suffer with the impending real estate boom coming to an end.
I am “quite sure” that the outperformance of Target relative to Woolworths has only just begun and the chart below is a precursor to what HSBC relative to FirstRand will look like in a couple of years.
As to position sizing, as always, play it cool. Think it through and then place your trade.
Personally we NEVER take much more than a 5% position sizing but hey that’s just how we play it. It is not intended to be any sort of policy. We have friends, professionals, who take up to 20% position sizing in their portfolios or hedge funds they manage. Each to their own, but to me it makes sense to take multiple intelligent bets across the board, where those bets are well thought through, diligenced, and present us with asymmetry.
Not all will work out. That’s life but we don’t need a 100% hit rate. Indeed, much lower than that will still allow you to knock out double digit returns across a portfolio which is the envy of not only retail investors but the big boys managing hundreds of millions and billions of dollars of capital.
Founder & Editor In Chief, Capitalist Exploits Independent Investment Research
Founder & Managing Partner, Asymmetric Opportunities Fund
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