Panning for Gold on the Final Frontier

09/28/2009 9:25 am EST

Focus: GLOBAL

Carlton Delfeld

Editor, The La Jolla Letter and Pacific Gains

Africa's stock markets and currencies are poised to deliver big returns for intrepid investors, writes Carlton Delfeld in Chartwell Global ETF Letter.

For most investors, investing in Africa brings up the images of corruption, red tape, violence, and low growth. But in many ways it represents the last frontier of emerging markets investing and, critically, small incremental improvements can lead to big gains.

Economic growth in sub-Saharan Africa has averaged 6% since 2004. Africa is resource rich with a high concentration of the world’s natural resources, including 40% of the world’s gold reserves and 30% of minerals reserves. African exports to China have increased by 40% since 2002. China has also been a creditor of sorts to many African countries, providing financial resources to Africa and this is connected to its huge appetite for Zambian copper, Nigerian oil, Tanzanian timber, and South African platinum.

Many sub-Saharan countries have improved in the area of political stability, and one good example of this is Ghana. The profitability of firms in the region may be higher than what one would expect, and the average annual return on capital of the companies examined in a recent Harvard study was 65% to 70% higher than that of comparable firms in China, India, Indonesia, and Vietnam.

From a portfolio point of view, adding a little Africa exposure may help profitability and perhaps decrease volatility. This is because of its low correlation with developed markets. In addition, the correlation between equity markets in different African countries is low, increasing the diversification opportunities within the region.

There are also signs that market reforms are moving in the right direction. A recent World Bank study [named] Rwanda the world’s champion reformer—the first time a sub-Saharan country has claimed the prize. Many African governments have taken note of the success of Mauritius’s increasingly deregulated economy and how this has impacted its growth trajectory and levels of foreign investment.

[South Africa's] Highveld Steel and Vanadium Corporation ADR (OTC: HSVLY) greatly outperforms the industry with an [earnings per share] growth of 167% on a three-year average. This stock would make a great addition to any portfolio.

Materials, in fact, account for the largest portion (27.53%) of the iShares MSCI South Africa Index Fund (NYSEArca: EZA). This fund speaks for itself with 100% of its holdings directly in South Africa. EZA boasts a year-to-date return of 32%, [and is] a highly recommended intermediate-term holding.

(For more on South Africa and its currency, the rand, see this recent Top Pros’ Top Pick.)

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