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Want to revisit South Africa?

Let’s look at the South African rand, and then let’s look at what’s set to impact South Africa — shall we?

South African bonds returned 26 percent in dollar terms last year, according to index data from JPMorgan Chase & Co., as near-zero interest rates in developed markets encouraged investors to place their money in higher-yield markets. (Bloomberg Businessweek)

This is one such sign that investors aren’t seeing much risk in this environment and have been happy funneling money into emerging markets. Bloomberg has also said today the South African rand is the worst performing emerging market currency of the day. But we know there are two sides to every coin. For the same reasons that the South African rand has leapt to a roughly 3-year high versus the US dollar, it will be beaten down hard when the fire goes out.

What fire? For starters, the one from red-hot commodities (all puns intended).

Gold, platinum, oil, gas, iron, copper, bauxite and uranium are among the natural resources found and shipped out of the African continent, and much of that list can be unearthed in South Africa too. Naturally, watching crude oil, gold and copper prices soar became too much for investors looking for emerging market opportunities.

Crude oil, Copper, South African Rand:

Gold and South African Rand:

One must wonder whether commodities have not overshot fundamentals and are due for some form of pullback. And of course there is still the risk of bursting bubbles and Chinese growth slacking up, as we have highlighted many times – that would represent a more lasting weight on commodity prices and emerging markets.

Of course China is important for South Africa in more direct ways too. They are responsible for much of the investment capital and projects that are putting South Africa on the economic map. Inviting them to join the BRIC countries helps achieve that too.

We got a look at US diplomatic insight on China’s regional impact in Africa recently thanks to Wikileaks (the gang the establishment loves to hate):

The United States does not consider China a military, security or intelligence threat. China is a very aggressive and pernicious economic competitor with no morals. China is not in Africa for altruistic reasons. China is in Africa for China primarily. A secondary reason for China’s presence is to secure votes in the United Nations from African countries. A third reason is to prove that Taiwan is not an issue. There are trip wires for the United States when it comes to China. Is China developing a blue water navy? Have they signed military base agreements? Are they training armies? Have they developed intelligence operations? Once these areas start developing then the United States will start worrying. The United States will continue to push democracy and capitalism while Chinese authoritarian capitalism is politically challenging. The Chinese are dealing with the Mugabe’s and Bashir’s of the world, which is a contrarian political model, A/S Carson stated.

There’s been much speculation over whether adopting South Africa as a fellow BRIC is good, bad, or even makes sense. The thinking points are as follows:

1) South Africa is a frontier country, ripe for BOTH agricultural and technological development.
2) China’s opportunism and ruthless MO is already shining through; many farmers and small private sector businesses are growing disgruntled with the Chinese.
3) There are other emerging economies that already boast much larger economies (e.g. Mexico and Turkey) than South Africa.

Point number three is rather moot – this is about finding valuable investment opportunities for China (among other things). A larger emerging market would be a poor investment (time, money, and influence) for the BRIC countries if the growth potential has slowed or soured. Which leaves the former two points – a debate over whether the potential locked up in the African continent can be harnessed despite Africa’s own political and socioeconomic hurdles as well as the Chinese domestic presence. It’s hard not to include this Financial Times quote regarding the Democratic Republic of Congo, where the risks are similar (albeit perhaps more extreme) to South Africa:

For now, the government lacks the means to enforce these rules, caught as it is in a bind familiar to other failing states. Without an effective army, police force or public administration, decriminalising the economy is a daunting task. Like so many termites, ragtag militias, the national army, politicians drawn to rent-seeking and civil servants living off the population eat away at the resources of the state.

There is little doubt that leaders among the BRIC countries and Jacob Zuma have hit it off. The question is whether Zuma can carefully control Chinese influence whilst preventing dissension among African workers … because it certainly is not a pretty picture right now. From The New York Times:

For over a decade, the jobless rate has been among the highest in the world, fueling crime, inequality and social unrest in the continent’s richest nation. The global economic downturn has made the problem much worse, wiping out more than a million jobs. Over a third of South Africa’s workforce is now idle. And 16 years after Nelson Mandela led the country to black majority rule, more than half of blacks ages 15 to 34 are without work — triple the level for whites.

This little tidbit from Mail and Guardian makes one think Zuma will have a tough time balancing his allegiances:

The influential ANC Youth League goes even further than the ANC party itself and dispatch representatives to Stalinist North Korea. The young South African political officials called North Korea’s dictator Kim Jong Il the "great guardian" for peace, according to Business Day.

Reading deeper than the obvious delusions on Mr. Kim, there is likely a hankering for centrally planned economies inside the ANC … if not in Mr. Zuma too. The Chinese have succeeded so far with such a model; that’s rather appealing, no?

In the mind numbing world in which we live, where the major global media outlets bow down to the god of political correctness and multiculturalism, they ignore the horrible crime and corruption that takes place in South Africa. Why? Because to the liberal ruling elites’, safe and secure in their private jets, Mercedes, and walled compounds—when not jetting off to Davos (a place Mr. Zuma loves to hobnob with the Nomenclatura) to “save” the world—perpetuate the myth of South Africa as the model for “diversity.” It is pure perversity instead.

These comments have nothing to do with the defense of Apartheid. They have everything to do with the real consequences since it ended. From an investment standpoint, we should do our best to see the world as it really is, not as we want it to be.

We believe once this commodities cycle breaks, the South African economy will breakdown into a new Zimbabwe. We have said this before, but underestimated just how far the commodities rally could paper over holes in an economy. But given our views on China, the South African debacle isn’t a question of if, but when, as far as we are concerned.

Unfortunately this space doesn’t give us the opportunity to expand on all the linkages that will impact South Africa and crush its currency. But it is one of the key major risk events we see in the world that will sadly be very bad for the good people of South Africa—the decent people that wake up every day having to struggle with crime, government corruption, and lack of job opportunities while the rest of the world effectively tells them how lucky they are now.

We are in the midst of preparing a major special report on our key Global Macro Themes for 2011: Major Risks and Opportunities. South Africa will be part of it. We expect to release that report, along with a webinar for our Members on Tuesday, January 18th.

For now…we watch this currency to our amazement continue to rally on and on…patiently waiting to pounce: