South African Rand Holds Back EZA

May 10, 2012

The rand, for now, is killing returns for U.S. investors in South Africa.

Investing in countries with so-called commodity currencies has been a way for U.S. investors to turn promising equity returns into off-the-charts total returns because of how these currencies have strengthened against the dollar as commodities have boomed in the past decade.

Unfortunately, the South African rand—one particularly popular commodity currency that had benefited from booming gold prices—looms these days as the ultimate counterexample for U.S. investors in South Africa.

While local gold producers continue to do quite well amid macroeconomic uncertainty following the market crash of 2008, the rand has been the victim of risk aversion in a way that has obliterated returns for U.S. investors.

As an example, investors in the iShares MSCI South Africa Index Fund (NYSEArca: EZA) in the past year have seen total returns of -4.7 percent, while the MSCI South African Local Index has returned 14.09 percent.

That gaping 18.81 percentage point difference is mostly about the rand’s depreciation over the past year—but also about fund fees, tracking error and even hedging costs.

In short, a promising investment for local investors turns horrible for U.S. investors—yet another example of how much currency movements can affect investment returns in globalized markets.


South African Rand vs. MSCI South_Africa


At the same time, the rand presents a unique benefit to South Africa’s gold mining companies.

As the rand has depreciated, mining companies have benefited greatly by selling gold in dollars, and paying operating costs in local rand.

It’s so beneficial that it explains some of the reason why South African equities have performed quite well—for locals, anyway—even as the uncertainty in Europe still looms over the rest of the equity markets.

While the weakening rand is good for South African companies and South African investors, U.S. investors stand to take a harsh hit in returns should the rand depreciate further.

The rand isn’t the only commodity currency that has stumbled in the past year, though others are weakening for reasons linked to central bank rate-cutting programs rather than the risk-off dynamic. The performance of these other commodity currencies is even more surprising considering the monetary easing efforts enacted by the Federal Reserve in the past year.

In any case, the Brazilian real, the Australian dollar, the Canadian dollar and the Chilean peso—all commodity currencies—have depreciated against the U.S. dollar in the past year; that weakness has hurt returns for U.S. investors.

That means U.S. investors who own ETFs like the iShares MSCI Australia Index Fund (NYSEArca: EWA) or the iShares MSCI Chile Index Fund (NYSEArca: ECH) aren’t likely to get the returns they might be expecting.

That said, some investors see the rand making a comeback in the next 12 months.

As Reuters reported, a survey of currency strategists found that many expect the rand to appreciate modestly against the dollar by early next year due to higher local interest rates and an improving global economy. Again, the key word here is “improving.”

Should the Federal Reserve continue in with its easy-money monetary policies, including more quantitative easing, foreign central banks in Brazil and elsewhere may likely return the favor.

As we pointed out last week, we’ve seen similar efforts in Brazil, Japan and Switzerland to curb any appreciation in their respective currencies. In what many have been calling a “currency war,” U.S. investors should remain alert and willing to adjust their exposure accordingly.


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