Investment Environment August 2010


Having reported at the end of May that the world lives in fear of a double dip largely driven by the crisis surrounding the Euro and with markets generally coming off an April high, there appears to be a wait and see approach. While investors wait the focus has shifted from the sovereign debt issues in the Euro zone to US macro economic data that seemed to be confirming a slow down of economic activity. However, it would appear that at least for now the prospect of a double dip has been averted with economic indicators improving towards the quarter end. More particularly solid rates of economic growth continue out of Asia and emerging markets. To some extent this is tied to the health of the Chinese economy.

This environment has led to a focus on commodities and especially precious metals with a bit of a “gold rush” as investors seek a safe haven against the prospect of the double dip scenario.

While most South African portfolios are naturally biased towards resources, which is appropriate in light of the above, the South African Government has created some uncertainties around resource stocks. This stems from the recent granting of prospecting rights by the Department of Mineral Resources (DMR) to Imperial Crown Trading over part of Sishen Mine which is owned by Kumba. This was shortly followed by the DMR ordering Lonmin to refrain from selling other metals associated with the output of platinum group metals.

Recently Commodity Reference Warrants (“CRW’s”) for various precious metals have been listed on the JSE which allows investors to participate in the performance of the underlying commodity, rather than be exposed to the operations of a resource company. There is however an opportunity cost as the CRW’s do not pay dividends which a successful resource company would. It might be appropriate to introduce an exposure to these commodities using CRW’s and we briefly comment on the precious metal environment below:

Platinum is our preferred precious metal based on the fact that the market is in supply deficit. This is notwithstanding the high exposure to the auto industry (catalytic converters) that has been subdued by the economic recession. However on any economic recovery auto sales will improve with strong demand emanating from Asia. Of the precious metals, platinum is the most likely to be used in further innovation into commercially viable products due to its catalytic properties, particularly in the “green energy” space.













Palladium has more recently outperformed its sister metal, Platinum, and has the following medium to long term positive attributes. Palladium’s main use has been in the production of auto catalysts and recently proved to be effective in diesel engines which makes it a substitute for platinum on a one for one basis and is less than 1/3 of the price. Recently there has been a surplus of palladium in the market, apparently because of Russian sales of accumulated inventories. However, these inventories are understood to be now depleted and the medium term demand is anticipated to outstrip the supply thereof, improving the pricing dynamics of the metal.

Gold is very much a safe haven investment for both investors and central banks. During economic crisis such as the recent European debt crisis, the gold price reacts positively. The recent all time high is US$1,265 and while the current pricing is not far from that, its purpose in a portfolio is to hedge against economic crisis. It also behaves as a quasi currency with a particular sensitivity and hedges the cross rates of the US$












Silver is very much a sister metal to gold but experiences growing surpluses as a by-product to industrial metals. These surpluses generally have to be absorbed by financial investors and while silver prices take their direction from gold, it is generally a more volatile market. We believe that gold is a more appropriate investment and hedge against economic downturn however our preference is very much the platinum group metals.

While investment markets generally lack direction and volatility remains high, we want to maintain the core of any portfolio in large capitalisation equities. We are currently investigating the CRW’s to ensure that we fully understand the structure, liquidity and counter party risk. Where appropriate, we intent introducing a CRW but this would be predominantly for growth investors due to the lack of income earned. It is important to understand that we would favour the platinum group metals as we believe that they have similar fundamentals to other precious metals but have the prospect of increasing commercial viability through innovation.

Finally, we place only a < 30% probability on a double dip scenario and therefore continue to use volatility to hopefully achieve some good long term buys.

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