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| South Africa Series |
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Table Mountain Standing on Table Mountain, bright sun, blue sky, 75 degrees Fahrenheit, a cooperative balmy breeze, setting eyes on the rocky headland of the Atlantic coast of South Africa known as the “Cape of Good Hope” one contemplates how far the world has come since Magellan’s voyage. A Portuguese maritime explorer, Ferdinand Magellan, did not give this place its name. Bartolomeu Dias called it the “Cape of Storms” in 1488. John II of Portugal later renamed it as the “Cape of Good Hope.” Budding daffodils in New Jersey, New York City traffic and JFK airport gave way to a snow storm in Zurich. Later than expected a de-iced plane traversed nearly all of the length of the African continent. A two hour flight from Johannesburg to Cape Town completed the journey. From this view, the warm and swimmable Indian Ocean on your left greets the darker, blue, cold waters of the South Atlantic. It is a unique, strategic and beautiful vista. The glistening city lights, the harbor and its urban and developed coastline are miles away from Wall Street. However, in Cape Town financial institutions and money management firms focus on world markets, a short fall in Mexican crude oil reserves, more adverse housing data and continuing credit market dysfunction which distract the residents from this beautiful setting. We are here for the Global Interdependence Center (GIC) conference on Friday morning where central bankers will discuss monetary policy. We will be briefed tomorrow on the South African economy, the impact of power shortages, commodity price pressures and governmental change. CNBC–Africa was kind enough to invite a guest hosting at 9 a.m. Cape Town time. The next two days are filled with meetings and discussions. For now, some reflection as the sun sets on this point on the southern hemisphere. The latitude corresponds with Sydney, Australia and Santiago, Chile. The perspective from this latitude is truly global. The concerns pondered by investors everywhere are affirmed here as well. South Africa is in the Emerging Markets Index and in several Exchange-Traded Funds (ETFs). We read about it, studied statistics and examined the composition of the ETFs. In the next two days we are going to take a personal look. Many investors think of the South Africa Stock Exchange as a proxy for the price of gold. They may want to re-examine that assumption. We will report more when time permits.
South Africa Trip Report, Part 1: Economics and Stock Markets One sees the cranes and building operations as South Africa lunges toward the 2010 World Cup to be played in a 68,000 seat new stadium in Cape Town. Project “No Shacks 2010” is the government’s attempt to replace all the shantytowns of the apartheid era with newer housing units. Both the stadium and the housing evolution are behind schedule if the private opinions we heard are correct. The country also has its problems with power outages, mining stoppages for lack of electricity, rolling blackouts and crime when power failures occur and security electronics cease functioning. These troubles are well known and have contributed to a slowdown in economic growth. The sole nuclear power plant in South Africa is undergoing modernization in a “hurry up” attempt to expand output. Meanwhile, there are impoverished and formerly segregated apartheid sections of the country’s cities where the unemployment rate among younger black males is nearly 50%. With the help of guides, some touring in these areas affirmed the worst of our fears. Gangs rule the night in some places. In addition there are about 5 million undocumented immigrants in South Africa. Many, perhaps most, are fleeing neighboring Zimbabwe. The proportion of undocumented persons to total population in South Africa is estimated at 3 times that of the United States. These undocumented visitors are frequently found concentrated in the more rural areas. Their actions there are characterized as criminal by the government. Others say there is a racial motivation of black retribution coming from the outrage of oppression when they were in formerly white dominated Rhodesia (now Zimbabwe). We did not personally venture into these rural areas near the border so we have no first hand knowledge. We did hear plenty of views on both sides of this issue. For investors, there are two fundamental questions. The longer term one focuses on whether or not sub-Saharan Africa can become the world’s next, high growth emerging market? When that question was asked of Asia 30 years ago, the answer was very tepid - maybe given the then political construction in most Asian countries. Look what has happened in Asia since. That Asian success naturally leads risk oriented globalists to ponder if Sub-Saharan Africa can repeat the Asian miracle over the next several decades. This is a natural issue when one considers this vast underdeveloped continent with its terrific resources and its huge, lower wage labor pool. In our view the longer term answer may be a resounding “yes.” Certainly we find that the potential is there. At our GIC conference (www.interdependence.org) in Cape Town we had this conversation with African central bankers, entrepreneurs, investors and institutional money mangers. We come away with a strong opinion that the longer term outlook is bullish if the racial divide can be surmounted. We also have confidence that the many of these countries’ central banks are keen to avoid the Zimbabwe disaster and are following policies to keep inflation relatively tame. This is not easy when the food component of consumer prices is as a high as 50% in some of these indices. As a side note, America’s ethanol subsidy and linked corn price inflation has made this more difficult for Africans whose diet is very maize oriented. How to approach these markets? South Africa is nearly 7% in the MSCI Emerging Market index. The country specific exchange-traded fund (ETF) is found under the symbol EZA. The heaviest weight in EZA is 14% for SASOL, a mining (not gold) and energy (coal) enterprise. At 10%, the second heaviest weight is MTN Group, a telecom company whose phone and data service were excellent when used by my Blackberry. There are gold and platinum companies in EZA; however, folks who buy this solely as a precious metal play are making a mistake. About 20% of EZA is in finance; we found little substantive exposure to the world’s credit and mortgage market dysfunction. Among other ways to get to South Africa one must include GAF, the Middle East and African ETF. Here the South Africa component is nearly a 60% weight. We do not own any GAF in Cumberland’s portfolios. Our present South Africa exposure is substantially underweight the benchmark. We own about a 2.6% South Africa exposure in our emerging market portfolios vs. a 6.8% benchmark weight. EZA is only one of the several ways we use to build that 2.5% position. For reference: EZA is down about 13% for the first quarter of 2008 vs. a decline of 10.5% for EEM, the emerging market ETF. We are maintaining our under weight position for the present as we watch events unfold in South Africa. We would consider raising that weight if and as we see concrete results from the country’s effort to rebuild its electricity function and as it deals with the unfolding and, we hope, successful removal of the former apartheid boundaries. We must thank our colleague, Cumberland’s Chief Global Economist Bill Witherell, for assistance in this South Africa Research effort. And we acknowledge the effort by the Global Interdependence Center to bring its dialogue worldwide. Cumberland Advisors continues to be a proud supporter of the GIC, www.interdependence.org. Any errors herein are mine alone. Lastly, we offer a personal note. Several times during the last two years I have debated the use of economic sanctions and divestment initiatives on CNBC. My debate counterparties have included notable governmental types including former CIA director James Woolsey. I have opposed their divestment and sanction initiatives and characterized them as counter-productive. During my trip I was able to confirm that view. In Johannesburg, the taxis are mostly made by Toyota. They used to be made by Chrysler. Chrysler was forced to depart when US anti-apartheid initiatives broadened from the Sullivan principles to outright sanctions. I asked folks about that. They universally critiqued the US response. They noted how American management had been replaced with less sensitive non-Americans. They illustrated how many locals made fortunes by acquiring the divested assets at distressed prices. I heard similar things about the US-forced IBM departure. No where could I find a single supporter of the sanctions that my CNBC debate opponents cite as evidence that US divestment initiatives caused the fall of apartheid. Having now visited Robben Island (Mandela jail cell) and Soweto (Johannesburg) I remain convinced that economic sanctions do not work. They did not bring down apartheid. They did injure the ordinary citizens and they did entrench the wealth and power of the thugs. This seems to have been true in South Africa and it appears to be the case elsewhere. This is the first in a three part series about our South Africa trip. Part 2 will discuss some observations about the racial divide.
South Africa Trip Report, Part 2: Racial Divide? Apartheid: “a political system in South Africa from 1948 to the early 1990s that separated the different peoples living there and gave privileges to those of European origin.” Melting pot: “society composed of many different cultures; a place where people of different ethnic groups are brought together and can assimilate, especially a country that takes immigrants from many different ethnic groups.” It started in the mid-17th century. The Dutch East India Company first established Kaapstadt (now Cape Town) on the western side of Table Mountain. The water source, Platte Klipp, was formed by the mist condensing on the mountain top. For merchant sailors, this became the important re-provisioning stop between Europe and the Far East. There were no shortened trips through the Suez or Panama Canals in those days. French Huguenots (Protestants) escaping religious persecution joined the Dutch in the Cape of Good Hope region just as their coreligionists did in New Amsterdam (now New York). Present day Franschhoek, one of South Africa’s wine regions, is the Dutch translation of the words “French Corner.” Other European Protestants followed and settled. The region flourished until the British Empire sought control. They succeeded in the Boer Wars which ended in 1902. Great Britain now ruled South Africa. In those conflicts, Britain separated the races. The black Africans were initially a paid labor force because the British didn’t view them as the enemy. The whites were interred in the world’s first version of a concentration camp. The British army used a “scorched earth” policy and cleansed entire areas of women and children in addition to the Boer’s male military force. It was the British who subsequently introduced the first racial laws in the region and it was the British who first displaced large populations of both whites and blacks. Post World War 2 political change swept the white racist Afrikaner National Party into power. Apartheid became law in South Africa. Black populations were segregated and moved. The evolution of Apartheid led to rigidities. Blacks needed special papers to move anywhere. They were confined to “townships.” If they were caught outside the specific place of permission, they were severely punished. Note that there were four categories of race under this regime. African Blacks were the most severely restricted. “Colored” were next and were people of mixed blood. The term “colored” has a much different connotation in South Africa than in the United States. Under the Apartheid regime “coloreds” were not required to live in townships. Indians were also targets of discrimination under Apartheid. The term applied to those who originated from the Indian sub-continent. White minority dominated South Africa became an oppressive state for non-whites. Apartheid was a modern version of slavery and exploitation. Only 14 years ago, did the regime change in South Africa. It is only 14 years since the Nelson Mandela led African National Congress prevailed in the first open election. Thus the legal structure of Apartheid came to an end. Note that the change occurred because South African President F.W. DeKlerk realized that the white dominated oppressive regime could not be sustained. 91% of the population was non-white. The white 9% could not maintain their dominance. That realization led DeKlerk to a policy change. That is why he negotiated the lifting of Apartheid with Mandela. But is a change of a law enough to change people? “Mandela was here” said our guide. He, too, had been an inmate in the Robben Island political prison with Mandela. We walked and he talked. This was not my first encounter with prisons. My mind drifted. I looked across the water at Table Mountain and thought about how prisoners in Alcatraz could see the Golden Gate Bridge. Did these Robben Island inmates have the same longing? We took a bus to the stone quarry. The metaphor was powerful. Here on Robben Island the prisoners used their time in the stone quarry to communicate with each other and to plan a political outcome. The prison guards were rotated so quickly that they didn’t catch on to this use of the quarry. My mind wandered to the political prison and stone quarry in Nazi designed Mauthausen (near Vienna). Comparing the two quarries, two prison populations and two outcomes offers a revelation. Both held political prisoners of powerful, harsh and oppressive regimes. Apartheid practitioners were brutal and intolerant. Like the Nazis, they permitted no dissent. Unlike the Nazis, they didn’t build crematoriums. They didn’t design a system to perform mass murder. Enslavement? Yes. Annihilation? No. Robben Island is not Auschwitz. Soweto was not the Warsaw Ghetto. We rode around Soweto (South Western Township). We passed the Winnie Mandela House and passed the Bishop Desmond Tutu House. There are an estimated 5 million folks packed into this area. Until apartheid was lifted, the blacks were confined here. They could leave only for authorized work and only at certain hours of the day. White owned business vended to them at exploitive prices. Soweto and the uprisings there grabbed the world’s attention. I stood in the museum and pondered the picture of Mbuyisa Makhubo carrying the body of Hector Pieterson. The photo galvanized world opinion. On that June 16, 1976 day South African security forces opened fire on unarmed students demonstrating in Soweto. For the anti-Apartheid movement it was as dramatic as the Kent State shooting was in the United States during the Viet Nam war era. In the aftermath of the June 16th event, Soweto blacks massacred every white they could find in the area. Racial retribution and risk and fear intensified. This is a fresh memory. It has been only 32 years. Since 1994, South African political leadership has tried to avoid retribution. “Let Bygones Be Bygones” was the opening phrase of Nelson Mandela’s inaugural speech. Political calls continue for reducing the barriers and removing the legacy of apartheid. That is why the violent activity is characterized as crime by the government. They do not want to call it racial war. “Is there a difference between stone quarries in Mauthausen and Robben Island?” I asked George. He was born in Soweto and lives there. He was the tour guide and is a well educated and worldly man. “Can Apartheid transition into a melting pot?” I asked. “We must” he said. “There is no other choice.” George described the plan: education, jobs, rising incomes, pursuit of opportunities, new housing. He pointed out the construction and the removal of the barriers. He was full of hope. He is a practical yet hopeful man. On the way to the airport we learned that 1 million whites have left South Africa in the last four years. We heard about a seminar being given in a nearby hotel where Australians were recruiting white South Africans to choose a new home. Police forces now ride on the commuter trains to add security for the riders and attempt to diminish the crime rate. Surveillance cameras are ubiquitous. AIDS is a serious epidemic in almost all of Africa. Average life expectancy at birth in South Africa today is 49 years. We can truthfully end this part of our series with the same question that we asked George: “Can Apartheid transition to a Melting Pot?” This is the second of our series about our trip to South Africa. More to come.
South Africa Series Part 3: Wives and Price Inflation During our South Africa trip we saw the disruptive results that a hyperinflation has on nearby countries. We did not go into Zimbabwe. But we did hear first hand about illegal immigrants in South Africa and Zambia who are fleeing the Zimbabwe regime. And we did hear about the destruction that 100,000% inflation has had on what is a resource rich country. We were told that China is one of the very few sources of foreign direct investment in Zimbabwe. The Chinese are looking very long term and do not seem to offer any advice or extend any influence on the local politics or the hyper-inflation. All of Africa worries about inflation. Every central bank is dealing with higher food prices. And food prices are a large part of the price index in these emerging economies. I had a private lunch meeting with one central banker and we discussed his monetary policy issue case study. We set out the following factual situation. We rounded the numbers for ease. Please note that this concept is accurate and it applies to a number of smaller sub-Saharan countries. His food component is half of the price index. It has maize (corn) as a major item. Energy is also a large piece and the remainder is the core items for that country. Core inflation is about 5% per year. Food and energy inflation are in double digits. The overall inflation rate is about 10%. The economy has a trend real growth rate of 5-6%. He asked: “What would you do with the policy setting interest rate of the central bank in this case study?” If you put the interest rate in the mid-teens so that you are attempting to fight the overall inflation rate, you are imposing a huge threshold on the non-food portion of your economy. It is very difficult for a 5% trend growth rate to continue when the interest rate threshold is something like 15%. If you put the policy rate slightly above the growth rate and slightly above the non-food inflation rate, you would set it in the high single digits, say 7%-8%. The public would see a single digit interest rate and a double digit headline inflation rate and wonder if the central bank is validating the inflation. Hence you would be fueling inflation expectations. So what is a central banker to do? Now let’s add something else to this mix. The food price inflation is largely driven by maize prices. These are a global food reference and are usually aligned with corn prices. High corn prices are the result of America’s ethanol policy where we are using massive subsidy to advance an otherwise non-economically viable ethanol industry. So, the central banker says to me: “I have to worry about food inflation in my country because of your (US) ethanol policy. Now, my friend, what would you do if you wore my shoes and had to set the interest rate in my country?” I have paraphrased the meeting in a simplified way and avoided the modeling that is used in these countries. The economists and bankers are skilled in the use of these tools. But they are dealing with an issue that is not easily resolved. Their food price inflation is sourced in a place beyond their control. And they also have this hyper-inflation infection in Zimbabwe festering like a tumor. The electoral outcome may have a great influence on sub-Saharan Africa’s potential to be the next regional emerging market. Now we have an anecdote about wife price inflation. In my game reserve visit I met a married couple who were working in the hospitality industry. They had developed English language skills and were gracious and accommodative as they served meals to a section of the dining room assigned to them. I asked them about their marriage and about their church. In that conversation I learned that he had paid 13 cows to his father-in-law for his bride. While many he knew had several wives, he said that he intended to be monogamous. He noted that others who were able to pay for multiple wives did so but he had been influenced by the church to do otherwise. He knew of one case where a man had many wives and had spent over 100 cows accumulating them. We had lots of discussion. I could write reams on my observations. I will just add this one now. I asked what happened when a man like him worked in a service job and did not have cows. He noted that money can be used and that the going rate is the price per cow at the time of the transaction. The price reference remains the cow and not the currency. I asked what the price range for a bride was ten years ago. He said between 5 and 10 cows. And now it is between 10 and 15 cows. If we consider the cow as the reference that would mean the inflation adjusted price of a wife is about 60%-70% higher than it was ten years ago. In an economy with a real growth rate of 5%-6% per year, and where the income gains were distributed reasonably proportionally, the price of a wife would be keeping up with the growth in incomes. So the real price of the wife would match the real growth in income and the inflation rate of the wife price would be about 6% or 7% per year. Inflation comes in strange ways. I did not delve into whether or not wives are in a core inflation index or a headline index. And I certainly did not venture into the realm of hedonic (quality) adjustments to wife price inflation. Sub-Saharan Africa is a fascinating place, even for an economist. South Africa Series Part 4: Themba For a website buffalo photo and animal details on this and others mentioned see: http://www.awf.org/content/wildlife/detail/buffalo then select the particular animal on the right side of the www.awf.org home page. During the game drives Themba usually sat in the lookout chair, a seemingly precarious perch in a seat extended frontward over the left headlight. Either his right or left hand always held the railing as we bounced along the dusty narrow road or lurched through off road terrain. Any abrupt stop or swerving of the vehicle and he could be seriously hurt. When we had to move at higher speed our ranger/driver/gun-bearer would first stop and Themba would climb into the vehicle before the faster ride commenced. That happened within seconds of spotting the water buffalo. Twenty bumpy minutes later we were on the hillside staring at three buffalos as they munched grass. The ranger explained that the animals are not threatened by the jeeps. That is why these three wild buffalos ignored us. Scientists speculate that a jeep appears like a large inert subject; one ranger suggested that we think of ourselves as a huge slowly moving rock. The animals disregard the engine noise, too. They are oblivious that the land rover had invaded their space. So here we were just twenty feet a way from these wild water buffalos, animals with a reputation of aggression. They kept right on eating their lunch. We watched, photographed and then moved on. Soon the tempo would change. “Do not stand up. Do not stick out your arm. Do not show any part of your human form. Stay in the jeep. Do not try to touch.” The ranger’s instructions were very sharp, precise and absolutely clear. Themba had found lions. During this remarkable adventure we encountered lions several times. There were mothers with cubs. We watched a pride sleeping or resting in midday. Lions own the turf. They go where they want and do what they want. Cheetah and Leopard will not hunt near lions because they know that the lions will then come and take the prey for themselves. One time we rounded a bend and stopped. Five lions (young males) were walking on the road in our direction. We were sitting in the open jeep. No covering; no roof. I was on the outside seat. One of the lions came by me at a distance of only a few feet. I believe that I could have reached out and touched it. I could see small details in its facial features. I measured the size of its mane with my eyes; the mane frames a male lion’s head. Larger manes serve as a warning to younger males that they should be wary about approaching the dominant male lion’s harem. I watched the ripple of its muscles as it took each step while sauntering by. There is no doubt about it: this 400 pound animal is not your ordinary house pet. “What would happen if I tried to reach out?” I asked the ranger. “You don’t want to do that” he reminded in a loud voice so that everyone could hear him.” As soon as they see something that looks like a human form, everything will change. It can be very dangerous. Elephants, a mama leopard with cubs, hyenas, cheetah, monkeys, impala, Kudu, waterbuck, giraffe, hippo, wild dogs, warthogs, marvelous bird species, extraordinary insects, crocodiles, lizards, and more. It seemed like an endless journey in one’s own private 20,000 acre zoo. And all of it was up close and personal. Themba has good eyes. He can tell if a leopard track is fresh from that morning or older from the night before. At night the camp is patrolled for the safety of the guests. You are escorted between the lodge dining area and your cabin. You are asked not to walk anywhere alone. In the wilds of Africa, a human, especially at night, is likely to become dinner. Over the years I have listened to those who took a game drive or safari rave about their trips. Never has anyone been disappointed. Now I know why. It appears that one can take this journey with great travel safety. The various tour organizers have gotten the African game reserve experience down to a science. The countries are welcoming and they want the tourists; the safaris are far away from the politics and the turmoil in some African governments. From the moment we landed until the moment of actual departure, I personally felt very safe and secure. Fortunately, so did the lions. Some end notes:
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