Friday, May 20, 2011

South Africa: Township of the Damned

You might get the impression from some of TMM’s comments about emerging markets that we love them all, from the BRICs to the frontier markets of Indonesia, Mongolia and Vietnam. Au contraire, TMM are very price sensitive and in a few cases we just “don’t get it” when it comes to certain markets which we see as stories of structural and perhaps quite violent decline. It is in that category that we place South Africa.

Much of the touting of South Africa by MENA analysts out there sounds like Vicky Pollard:
Q: Seriously, what percentage of people are HIV positive?
A: “Yeah but – no but – itsgotayoungpopulationlotsoflaborandisntJapandyingfaster, innit?”

TMM are not convinced, and not because of the obvious headline grabbing stuff like, say, having a ridiculously high rate of HIV and political leaders who apparently still don’t know how to avoid getting it (though, according to the NY Post, the IMF is no better). Or, for that matter, out of control crime rates and poor levels of educational attainment. Don’t get us wrong, that’s all awful, but it has been the case for quite some time and since the early 2000s the carry on the currency and South African equities have done quite well. FX carry below has hardly been all that bad:

Similarly, equities in USD terms are no Japan:

So, for a country which has been known to have weak leadership, a health crisis and security issues it hasn’t done halfway bad. To TMM the problems with South Africa are more prosaic – high tide for terms of trade, poor fiscal management and incredibly dysfunctional labor markets.

As with most big commodity exporters it is worth looking at what drives the trade balance as per below:

As for merchandise exports and gold, TMM lumped them together as the “stuff” category and went to the DMR website to work out just what the breakout was of shiny stuff (gold and platinum) vs lumpy stuff (coal and iron ore). As can be seen below, of those merchandise exports about 10% is platinum, 9% is gold and coal and iron ore are about 5% a piece.

TMM don’t rep to Citi’s terms of trade indices, but they do seem to capture the fact that ZAR should be partying as hard as AUD and BRL and likely running a big trade surplus too:

Au contraire... Much like the other two South Africa runs a current account deficit but it seems to be getting worse over time rather than better, despite terms of trade being utterly off the chart.

Now this could just be due to a strong currency causing manufacturing to decline, but then you would also think that South Africa would have low unemployment since wages for driving trucks would be approaching those of radiologists like in Australia. That does not seem to be the case – SA unemployment is high and has stayed high. Despite high unemployment and the fact that most mining jobs are unskilled or semi-skilled, comparing wages for mine workers to domestic wage inflation YoY makes it pretty clear that something is up with the mining sector.

Then looking at CPI components it’s clear that the big divergences are driven by communications on the downside (like everywhere else), but a ridiculous ramp in utilities.

Then if you look at actual numbers for a lot of commodities South Africa produces, the increase in output is pretty weak, especially for gold and platinum. So to summarize, you have a labor market with excess supply and pockets of rapid wage inflation and your most profitable and export-friendly sector cannot seem to increase production to capture that increased demand as much as they should. What’s up?


TMM are far from a bunch of union-busting robber barons, but there is a point at which the interests of a union become utterly conflicted with those of the population at large, a rubicon that South Africa crossed some time ago. It doesn’t help a country’s ability to encourage investment when major trade union groups are vocal advocates of nationalization of mineral resources and your nearby neighbor, Zimbabwe, recently went a long way towards that. Not to mention when your unions go past basic striking to outright vandalism as was recently the case for Eastern Platinum. With unions so firmly entrenched in the ruling ANC party TMM find it hard to see them learning to behave or think of the bigger picture any time soon.

As a result of this, TMM do not see SA’s exports picking up that much in volume terms, especially if further indigenization or nationalization occurs – just ask Venezuelans how their oil exports have performed post nationalization. In addition when a lot of your exports are Platinum, something that has limited use in an age of electric cars, and Gold, something that is sitting an awfully long way above cash costs, you have to start looking at what the financial account line items are that are balancing out flows in the FX market and providing financing to the government’s deficits, projected to be 5.3% of GDP in 2010. The financial inflows are awfully portfolio flow heavy ...and the FDI is mostly mining.

There is an awful lot of pontificating about who is vulnerable in a terms of trade shock. To TMM the Rand looks as bad as it gets, given likely political catalysts (nationalization/indigenization, more mining labor problems), a structurally poor picture for the economy and labor force, and the likely slow grind down in merchandise exports as car engines get smaller or go electric. As for gold, TMM are not convinced - and when it comes down to it, the South African mines are some of the oldest and highest-cost around. If prices drop, SA won't only lose out on price, volumes will be cut quickly too... Add to that an external balance that requires portfolio flows into, well, mining companies amongst others and government debt that is approaching 40% of GDP by end of 2011, in an unequivocally good period for the country. All of a sudden the longer-term prospects for the country look very precarious.

As to the long term, if South Africa's poltics really do converge with Zimbabwe why not have a currency union? With recent performance of the Zimbabwe dollar and what TMM thinks the country has in store for the Rand, the Southern African Whoonga (SAW) might not be a bad name for the new unit of account (we look forward to seeing the Argentine cross appearing on our screens). In the interim TMM are wondering how to be short ZAR/ZIM without having to visit Harare with suitcases.


Mark Thyme said...

South Africans are nowhere near as industrious as Zimbabweans. In fact there is a lot of tension between South Africans and recent Zimbabwean immigrants because employers prefer the latter, or so I hear.

I don't quite see the signficance of this though. Does it mean SA won't be nearly as energetic about taking the road Zimbabwe's gone down? Or that when SA implodes, it'll be even more hopless than Zim?

I give it a max of 10 years before SA discovers it too has "war veterans". Less if commodities fall apart.

Though it'll be interesting if the Chinese have started buying SA assets in the meanwhile.

Anonymous said...

short zar vs long turkish lira?

Leftback said...

Nice post. Even more than EWA and AUD (if that's possible), EZA and ZAR are All About the Mining.

The Chinese will buy SA assets when they are cheap. Wait for the next commodity crash.

Long EWJ:Short EZA reflects one over-valued market against another that seems under-valued.

In other news, Spanish-German spreads are rising as Spanish bonds are under pressure again, how that IED hasn't actually exploded yet I have no idea.

Leftback said...

Spain looking up at the key 5.5% yield on the 10y again. If it breaks north of that level, things will get quite interesting:

Spanish 10y

Anonymous said...

Great post. Can you explain the financial statement issues around the balance of payments as they intersect with portfolio investment and fx flows? Thanks.

Nemo Incognito said...

733 Anon: What happens on the current account has to be balanced on the financial account + change in reserves - ie, if you're a big importer of capital you're probably a big exporter of stuff (like China) and vice versa.

So, if you're a stuff importer how do you want to be funded? long duration of course - just like a company. FDI like investment in factories and the like is sticky and tends trend - look at Vietnam which despite being a disaster zone in macro management has seen the FDI keep up. Portfolio flows are fickle and a dangerous thing for a country to hang its hat on which, given South Africa's politics and the ability of their politics to do stuff that might cause investors to lose faith makes it a non-trivial gap risk candidate in FX should the politics definitively change.