Inflation in South Africa & the Global Commodity Cycle

Your editor is forced to do his newsgathering the old fashioned way today. It's a good thing the Sunday Times here at our bed and breakfast is free. In Zimbabwe, we'd have to pay $2.6 million to read the same paper! That converts to about 650 rand, according to the paper, or about one Aussie dollar.

How bad is inflation in Zimbabwe? "The price of the Sunday Times has gone up 65,000% since this time last year, when it cost Z$4,000." It's not just newspapers either.

"A Johannesburg businessman, Chris Mugari, who visited Zimbabwe three weeks ago, paid between Z$2 and $2.5 million for a loaf of bread. A pint of beer cost him Z$5 million in a liquor store and anything between Z$12.5 million and Z$20 million in a reasonably attractive bar or in a good restaurant."

Some of the South Africans we've spoken to in the last six days worry that this country is headed in the direction of Zimbabwe. We didn't see any signs of it yesterday, though. We had two huge draft beers and a burger for lunch at a nearby café and paid 102 rand (with chips too). That seemed like a bargain.

The cost of living is cheap here. But it's going up, just like it is everywhere else. The government announced on Friday that the retail price of petrol and diesel would go up. Petrol is going up 61 cents to R8.25 litre. That's an increase of 7.98%. Consumer price inflation in South Africa is running at about 8%. Curiously, the Friday release of producer price inflation has been delayed "indefinitely," according to Statistics SA.

If you had to guess, you'd say producer prices-especially energy and raw materials-are going up. More inflationary fuel for the fire.

On the same page of the paper with the petrol story, you'll find a graph showing, "What wheat is worth." According to the graph, it's about US$12 per bushel. Wheat, gold, oil, corn... what is going on here?

There's a whiff of panic in the commodity markets, isn't there? Bullish buying has turned into investment hoarding. What comes after that? If this were a normal commodity cycle, high prices would signal producers to crank up production. Supply would increase to meet demand, and prices would fall.

This is probably not a normal cycle. Soft commodity prices are distorted by government subsidies, for example. This is true in developing and developed economies. In the developing world, government subsidies of food and petrol have kept official inflation low. Those subdivides have also prevented higher prices from discouraging demand.

The trouble today for governments that subsidise food and petrol is that it's getting really expensive. With oil over $100 and grain prices soaring, paying wholesale rates on the global market is going to be a drain on local currency reserves. Sooner or later these governments will have to allow prices to rise. As we've seen in Burma, China, and even Italy and other places, suddenly soaring food prices are not a political winner.

Demand will have to fall. But prices will probably fall too. It's hard to say how much investment demand is responsible for rising commodity prices. But judging by the action in global stock markets, investors are a lot happier buying gold, corn, and soybean futures than they are buying stocks. New York fell by 3% on Friday on more weak data from the U.S.

Stocks of commodity producers continue to rise as well. This is a bit surprising considering the higher energy and borrowing costs eating into profit margins for commodity producers. But higher metals and resource prices are dragging up the resource stocks with them.

Here in Johannesburg, the platinum mining index was up 4.97% on Friday. The gold mining index rallied by 3%. AngloGold Ashanti finished 6.16% higher on the day. Impala Platinum was up 5.83% and Kumbla Iron Ore rose 5.35%.

Could resource stocks be the new cash?

Last year we reckoned the bear market would make most stocks a loser in 2008. On Friday, UBS (of subprime infamy) put out the word that credit market losses related to America's housing decline would top US$600 billion-or about $450 billion higher than losses so far.

With financials facing more losses and the U.S. central bank likely to lower rates, there's more inflation in commodities as far as the eye can see. For starters, investors will eventually quit their bargain hunting in financials and get on board the resource express.

But with inflation becoming a real problem all over the world, the total return on cash-even with higher interest rates-begins to look sluggish compared to resource shares. Cash is safer. But who wants to be locked up in fixed income investments for any length of time with inflation threatening to rocket up? A show of hands?

Well, we won't count hands. Instead, we'll watch resource shares. There is a limited supply of publicly listed resource stocks. There is a huge amount of cash on the sidelines that may want to put itself back to work in shares. But not just any shares. You do the maths. A big bubbly move in resource shares may be just around the corner.

We'll have more to say when we're back in Melbourne Tuesday. And South Africa? Well, it is not nearly as gloomy as we expected. We even drove past an outdoor concert venue where a giant screen showed a picture of Celine Dion wailing away on one of her songs.

Is Celine Dion the new Elvis? We know it's not a financial subject. But she is so popular everywhere. What explains it? One answer: energy. Some entertainers consistently put out a huge amount of energy. Crowds appreciate this, even if the entertainer is a bit weird. We're all a bit weird.

We've really enjoyed our brief stay in South Africa. Granted, you don't get a really full picture of a place when you're out in the suburbs, travelling by taxi between one gated business park and another. But the parts we've seen are not nearly so dismal and dire as what we've heard about. No massive potholes, although the traffic is quite heavy.

As far as the power crisis goes, yes, the power blinks out several times a day. That's annoying. It shows you how much we take electricity for granted. Eskom, the state run power company, has awarded contracts for two new coal-fired boilers to be built. But that won't happen until 2012. And French President Nicholas Sarkozy was in town last week, agreeing to supply French engineering talent to help get the ship righted.

The people we've met seem to take the crime and the power situation in good stride. You can probably get used to living inside walled compounds with electrified fences. You seem them everywhere. Of course they are useless when the power is out. But it is amazing how the passage of time can make what seems extraordinary rather ordinary.

One day you're used to flipping the light switch on and getting light, the next you're ready for random 15 minute intervals throughout your day where the lights go out. People adapt.

But you wouldn't call it progress, would you? A world where you travel in cars with tracking devices between one guard post and another isn't exactly a free and open place. Yet what's happening here is probably a preview of the security arrangements you will have to get used to in some parts of the world in the next five years.

It is not just the energy problem. That alone would be difficult for government's to meet, especially those that haven't planned for it (and how many have?). What you're seeing here in South Africa is the inability of large central governments to meet the basic security needs of their citizens.

Government's can't guarantee law and order any longer, at least not everywhere. Certain hubs and nodes can be protected by "hardening" them, putting up fences, guardhouses, and controlling who gets in. But in between those nodes, it is less safe. And whole densely populated areas are completely outside the security network.

For example, we were told that no one goes down to downtown Johannesburg any longer. Business has moved to the suburbs, in little modern fortresses of commerce. These new protected business parks occupy what used to be farmland. They also can take hours to get to, if you're travelling from your own residential enclave.

In a world of rising energy and food prices, you have to wonder how sustainable this commercial model is too. It is not that different from America's suburban economy. That economy is, "a living arrangement with no future," according to our friend Jim Kunstler. He is probably right.

No tipping point has been reached yet, though. People here are like people everywhere. They work. They try and get their kids into the right schools. They complain about taxes, rising prices, and bad government. The only difference is that in South Africa, there are visible signs of the government's inability to provide for the basic needs of its people. We think we know where this leads... but will leave that for another day. Until then...

Dan Denning
The Daily Reckoning Australia

Inflation in South Africa & the Global Commodity Cycle, 7.2 out of 10 based on 5 ratings

P.S. to get The Daily Reckoning direct to your inbox sign up to our free e-mail newsletter or if you prefer to use RSS, subscribe to the Daily Reckoning RSS feed.

Related Articles:

• None Found