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Investment Indicators from Peter George Issue No. 68

Is South Africa a 'buy?'
(Part 1 of a 2-Part Series)

Peter George
April 6, 2005

"Forget the former things;
Do not dwell on the past.
See, I am doing a new thing!
Now it springs up; do you
not perceive it?
I am making a way in the desert
And streams in the wasteland."
Isaiah chapter 43, verses 18 & 19

In the opinion of overseas investors watching gold - including the writer's friends - prospects for South African gold stocks are generally considered less than attractive and in many cases the shares are shunned on principle. Several reasons are cited. These range from the economic to the political. We discuss them in detail and pull no punches. We explain why, far from being in doubt, South Africa's future is poised for take-off. The negative aspects most often raised are quoted below:

1. A strengthening rand is squeezing profits - forcing marginal mines to close. The local operations of Durban Deep (DRD Gold) provide a good example. They recently applied to place their North West operations into liquidation. 5,600 jobs are on the line. We address these fears and others, but from a different perspective.

2. Black Empowerment legislation in the mining industry increases the cost of capital. The additional burden of having to pay royalties on revenue could render the tax unbearable. Barring a significant change in circumstances, fresh investment in the sector has become unattractive. We discuss Black Empowerment as a necessary short term expedient.

3. The nation's President appears to have a distorted view on AIDS which threatens to blind him to the immensity of an impending devastation. In certain areas of the country up to 60% of the black population is HIV positive. In ten years time the demographic landscape could resemble the Nevada desert yet, in their latest budget, the ANC only appeared to allocate R1,5 billion to AIDS out of total government spending of R417 billion. This was less than half a percent. We will put forward reasons as to why we believe they are moving so slowly. We will in no way excuse their behaviour but will discuss alternative strategies which we believe will overtake them.

4. The western world has been looking to South Africa to encourage democracy, good governance and an end to wars in Africa. Unfortunately the governing ANC gives the impression of having developed a blind spot when it comes to the antics and abuses of its northern neighbour - led by aging nutcase Robert Mugabe. Some predict his disastrous land expropriation policies could spread down south, with equally damaging consequences to race relations and agricultural output. We explain why the ANC fears a change of government in Zimbabwe. We conclude it is going to happen anyway - in South Africa as well - if the ANC acts as apologist for ZANU- PF persecution of political opponents, particularly the unions.

5. Corruption in high places has become endemic. There is an ongoing fraud case involving a business associate of the country's Vice President. The prospects of Vice President Zuma succeeding Mbeki, do not bode well for those seeking an example of financial integrity at senior levels of government. Ex President Mandela had no illusions about the manipulative methods of would-be businessman, Schabir Shaik. South Africa is capable of electing people who are committed to rooting out corruption. If the ANC refuse to act, down the line others intervene. We explain why we believe this will happen.

6. The concerted push for 'Black Empowerment' is blighting long term job prospects for the country's young whites. Many of the better-educated ones have emigrated or are contemplating doing so. They leave for what they hope will be a better future in the UK, the US, New Zealand or Australia. Despite mixed feelings, parents are happy to see them go. In time - and if it continues - the process could severely deplete the nation's pool of professionals. This would make it ever more difficult to absorb the 30% plus of the population of so-called 'working age' which is presently unskilled and unemployed. We explain why we believe our white youth are, on balance, ill-advised to leave.

7. Finally there is the issue of crime. Policing in many areas has become either half-hearted or inadequate. Prosecution and imprisonment of minors is difficult in terms of current law. They are arrested and charged, then released to re-start their nonsense again. Armed robbery is given full license when punishment fails to fit the crime. Times were when a convicted armed robber automatically faced the death penalty - whether or not the victim died. Today - as in the UK with farm breakins - the rights of the guilty carry more sway than the actions taken by intended victims seeking to protect lives and property. We explain why a change of trend is likely.

The purpose of this article is not to turn a blind eye to the above negatives but to place them in perspective. It will take into account economic and political changes of great magnitude which can flow from global developments in the currency and commodity markets over the balance of the decade - and after. Their economic impact alone will be substantial. It could be further enhanced by social and political developments which are on the horizon but by no means in the public domain. The net effect of these changes could be to transform current negative sentiments in light of a long term future which is far more sanguine.

By the end of our article readers may begin to appreciate why the rand has been so strong. It is the country's 'share price' which rightfully discounts an expected flow of future benefits. These range from the economic to the political but may well contain something more besides. The nation's very spirit could be on brink of undergoing a metamorphosis, spreading up through the rest of Africa. The 'dark' continent could yet surprise a skeptical world as it begins to glow white hot. This article focuses on three areas in particular.

1. The effect on South Africa's Gross Domestic Product of a massive rise in gold and commodity prices over the balance of the decade.

1. Launch of the Pebble Bed Nuclear Reactor by 2010 - a leading-edge global solution in the field of energy. It is perfectly timed to solve the twin problems of 'PEAK OIL' and 'Global Warming.' It could catapult South African exports into by billions of dollars. Time period - 20 yrs.

2. We address current negative attitudes to South Africa. We explain at length why we anticipate positive change. We conclude that investment in South African gold shares will prove highly profitable over the balance of the decade.

A hatred of gold is not confined to western banks scurrying to extend the life of an embattled FIAT money system, as rising metal prices cause savers to spurn paper. Early Afrikaner politicians of the mid nineteenth century hated it even more. It threatened their very existence as a nation.

The discovery of gold-bearing rocks on the 'Reef' - underlying what came to be known as 'Johannesburg' - promised to attract an influx of thousands of foreigners or 'uitlanders,' in search of fame and fortune. Having fled the Cape to escape British control, the last thing 'Boer' farmers wanted was to be drowned by a flood of immigrant 'Brits,' pouring into the Afrikaners' independent 'republic' of Transvaal. Once the enormity of South Africa's gold reserves became known, the influx of 'fortune-seekers' would become a deluge. In similar manner, once the scale of the bankers' FIAT monetary fraud gains wider acceptance, the dumping of paper in exchange for gold will become a deluge of a different type. There the parallel ends.

In 1852, a Welshman, John Davis, discovered gold near Krugersdorp - 30 kilometres from what is today 'Johannesburg.' When Davis showed the results of his crushing and panning to the President of the Transvaal Republic, Andries Pretorius, he was ordered out the country. A little later, fellow Afrikaner Pieter Marais had marginally more success but the big stick lurked in the background. Having returned from 'trying his luck' in California and Australia - why would anyone go there? - he discovered traces of alluvial gold in the Jukskei River, which flows through Johannesburg. The President reluctantly allowed him to continue his search but threatened him with death should he reveal his findings. He survived because his find ran dry.

In 1873 a Scotsman discovered gold along a river in the Eastern Transvaal. Many of the early diggers were of the same ilk so President Burgers is said to have named the camp 'Mac-Mac' and the area 'New Caledonia Gold Fields.' An influx of diggers followed in short order. One of them, Alec "Wheelbarrow" Patterson, soon became disenchanted by the overcrowding and left to prospect further afield in an effort to seek a quieter life. He discovered rich gold deposits in Pilgrim's Creek, a tributary of the Blyde River, close to where the village of Pilgrim's Rest now stands. News of the strike triggered the first major gold rush in South African history and Patterson's peace was shortlived.

A year later, again in the Eastern Transvaal but more than 100kms due south, the Barber brothers and their cousin, Graham, were prospecting in a rift at the foot of the Ingudu mountains when they came upon a rich gold reef and proceeded to peg a claim. On June 21, 1884, Graham Barber wrote a letter to the State Secretary to inform him that payable gold had been found on Stateowned land. The local magistrate was instructed to investigate and a month later confirmed the find as 'payable.' He declared a township at the base of the hills where the Umvoti Creek enters the De Kaap valley, broke a bottle of gin over the 'Barber Reef,' and named the town 'Barberton.' Hundreds converged to share in the prosperity.

One year later yet again and only a few kilometers away, Edwin Bray discovered the Golden Quarry - so-named because of the huge block of gold visible in the host rock with the naked eye. The mine was later re-christened the 'Sheba Mine.' Today it is one of the oldest and richest in the world, having been in production for more than a century. It still has a life of another twenty years and as recently as eighteen months ago was the scene of a large-scale theft operation. Laid-off mine workers were creeping into the tunnels at night to steal bag loads of newly blasted reef before the morning shift arrived. The thieves confined their search to rocks containing visible gold. It invariably took a day to creep in and a day to crawl out. They made more money, working one night in three, than legitimate colleagues did in three days of official coasting for the company. It goes to show that the limits of labour productivity have barely begun to be tested. Therein lies part of the solution to the problems of ailing gold producer Durban Deep - motivation of the workers.

Although the Struben Brothers lay claim to discovering the first payable gold in 'Johannesburg' itself - in the year 1874 to be exact - their 'Confidence Reef' ran out within twelve months. It was not yet the 'Main Reef.' The honour of finding the key to the ultimate big bonanza in world gold reserves occurred twelve years later and fell to "The Three Georges" - George Walker, George Harrison, and George Honeyball. Today the writer might consider making an offer to their joint heirs for the loan and use of their common name in a gold venture of his own. By George, indeed!

All three of the above Georges - probably the writer as well if truth be told - were 'drifters in search of the yellow metal.' While crossing the veld in early 1886, one of them stubbed his toe on an outcrop of rock on a farm called 'Langlaagte.' He recognized the rock as 'gold-bearing.' Historian Eric Rosenthal relates what happened. He quotes George Honeyball:

"Walker borrowed my aunt's frying pan in the kitchen, crushed the conglomerate to a coarse powder on an old ploughshare, and went to a nearby spruit (stream) where he panned the stuff. It showed a clear streak of gold."

The next day Honeyball traced the line of reef over the fence to his aunt's farm. Six hundred metres away he found a similar outcrop. Within days the claims were verified and registered. Word spread. Diggers flooded adjoining properties and drew up a petition. A reluctant President Kruger had no choice. On 20 September 1886 the area was proclaimed a 'public digging.' The tip of the giant Witwatersrand basin had been discovered. The rest is history. By 1892 there were 40,000 'uitlanders' living in Johannesburg - outnumbering the entire 'Boer' population of the Transvaal Republic. Within a short six year period South Africa's annual gold production had risen from nothing, to 33 tons, constituting 15% of a rising world total of 220 tons. That was 1892.

For all the potential benefits of these gold discoveries, Transvaal President Paul Kruger prophesied differently. He sensed they would lead to conflict:

"Instead of rejoicing you would do better to weep, for this gold will cause our country to be soaked in blood."

In the six years to 1898, production trebled to 118 tons. South Africa's percentage contribution to total world output rose to a new peak of 27%. Then war broke out. For the following three years gold production came to a virtual standstill. It took another six years - on top of the first six years - before production recovered. It finally breached the 180 ton level and 30% of world production in 1906. By 1920 the figure had risen to 250 tons. For the first time, South Africa's contribution topped 50% of an increased world total of 500 tons. The country had become by far the most dominant player.

By the time the Second World War began, gold had been discovered on the Far West Rand. Then, in 1941, deep level mining began in the Klerksdorp area. This led to the opening of Anglo's legendary 'Vaal Reefs' mine. Finally, in 1946, a core was extracted while deep-drilling at 1,2kms below surface at Odendaalsrus in the Orange Free State. It produced an incredible grade of more than 800gms a ton. Let us illustrate how rich this was by comparison. In 1910, twenty five years after start-up, the industry's recovered grade was averaging 11,5gms of gold per ton mined. Forty years later - by 1952 - it had declined to below 6,5gms even though total output of gold was largely unchanged at 430 tons.

By 1966 - twenty years after the discovery of the Free State goldfields - average industry grade had more than doubled to an all-time high of 13,68 gms per ton. In 1970 South African gold production reached a record level of 1,000 tons. It has never been exceeded. A year later the country's contribution to the world total hit 79,1%. That figure has also never been bettered.

In 1970 gold was trading at its long-standing official level of $35 an ounce, set by US President Roosevelt in 1934. Based on 32,000 ounces to the ton, the year's production of a thousand tons was equivalent to 32m ounces by weight of gold. At $35 an ounce it was worth $1,12 billion - not a lot for all that hard work.

Then, in 1971, US President Nixon abandoned his country's foreign creditors, reneged on his obligations to pay a fixed price of $35 an ounce, and closed the gold window. International central banks were no longer entitled to cash their dollar holdings which thereafter became 'irredeemable.' The price of the metal began to rise. By the end of the decade it peaked at $875 an ounce. In the words of William Butler's 'Privateer' for Mid March, 2005:

"The world's FIAT money system was on verge of a total breakdown."

Butler goes on to describe how the US Federal Reserve under Paul Volcker temporarily 'salvaged' the US FIAT system by ending the practice of artificially keeping official interest rates below market-determined levels:

"For more than a year, US 'prime rates' exceeded 20%.'

In the year 1980, although the price peaked at $875, South African production had already declined from its 1970 high of 1,000 tons. It now amounted to only 670 tons or 21m ounces. Despite the fall in output, at an average price of $600 for the year, dollar revenue had leapt in a decade from $1,12 billion to $12,60 billion. Equivalent rand revenues rose from R,84 billion in 1970 to R10,6 billion in 1980. The faster rate of growth in rand revenues was due to a small net weakening in the rand over the decade, from R.75/$ to R.85/$. In 1978 the rand actually traded down to R1,75/$ but a final acceleration in gold from $200 to $875 propelled it through the roof, causing it to double in strength in the same time period as gold quadrupled. The lesson is clear:

When it comes to the contribution gold makes to the South African economy, a sharply rising price can rapidly overwhelm the effects of falling production.


In 1970 South Africa's Gross Domestic Product was R12,7 billion versus gold revenue of R,84 billion - gold contributing 6,6% of GDP. By 1980 GDP had risen five fold to R62,7 billion but gold revenues had exploded twelve fold to R10,6 billion. Gold's contribution to the nation's GDP almost trebled from 6,6% to 16.9%.

By 1994 South African production had fallen from its 1970 high of 1,000 tons, to below 600 tons - in fact to 583 tons - but the industry still employed close to 400,000 people. The figure only includes members of the Chamber of Mines. The total was probably 10% bigger, but we are more interested in relative changes. In 1996, production crunched through a critical level - falling below 500 tons for the first time since 1957. Gold output was now running at less than half its 1970 all-time high.

By end 2003, production had fallen to 375 tons and employment to 167,000. As we write, end March 2005, the latter figure is barely holding above 150,000 and may well fall below before we see a turn. In ten years it has much more than halved.

The depredations of a 20-year bear market in gold from 1980 to 2000, wrought destruction on the rand. By December 2001 it had fallen from below parity with the dollar in 1980 - R,85/$ to be exact - to as high as R13,8/$ by late December 2001. The sell-off in the rand owed much to manipulation by certain private banks and large corporate exporters. The Chief Executive of SACOB, South Africa's Chamber of Business - one Kevin Wakeford - had the courage to pursue these miscreants and eventually one of them paid a fine without admitting guilt. It was Deutsche Bank and in the opinion of some they were fortunate to get off lightly. Kevin was not so fortunate. It cost him his job.

The collapse of the rand created a false sense of well-being in the export fraternity, particularly the mining industry. Inflationary expectations exploded. Costs and wages rocketed. By July last year the rand gold price was the lowest it had been in three years. Unfortunately wages and costs do not react as flexibly when the tide recedes. Instead shafts close and workers are laid off. The challenge presented by DRD Gold - previously known as Durban Roodepoort Deep - is to devise an incentive scheme which takes these factors into account. If the mine can be kept alive, the tide in due course will turn. In time to come the industry could look back on the current crisis with gratitude. If lessons are learned and a mutually more productive working environment can be achieved, the future will be better for all - miners, shareholders and country all.

For the year ending December 2004, South Africa's GDP was around R1,400 billion. Compared to lasts year's gold production of 360 tons or 11,5m ounces, and using the year's closing dollar price of almost $440 an ounce, dollar revenue from gold sales was running at $5 billion. Using a rand rate of R6/$ it was equivalent to R30 billion a year. For the year 2004, it amounted to scarcely more than 2% GDP.

Despite all the above difficulties, South Africa remained the world's largest producer of gold at around 360 tons for 2004, followed by Australia and the US at 261 tons and 259 tons respectively. Renewed dollar weakness this year and next, should ensure a US move into second place during the balance of 2005, pushing Australia into position number three. China comes in at a surprising number four with 212 tons. Russia is catching up fast at 180 tons. Commenting on disappointing Australian production - 50 tons below their peak year of 1997 - Surbiton managing Director Sandra Close said:

"The mining industry is the best hope of redressing Australia's appalling balance of trade."

It is clear that South Africa is not the only gold producer suffering from a strong currency. Australia is bleeding too but both are producers of a wide range of general commodities. A strong currency is the collective price both countries pay for enjoying a global economic environment which is ramping up the prices of the commodities they export. It is likely only the beginning of a sharp medium-term uptrend which will probably accelerate as we approach the end of the decade. The key is to time one's purchases at the bottom of down cycles. That time may now be approaching. The rand gold price could be bottoming out ahead of a major run.

More follows for Subscribers:

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Peter George
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