The basics of sub-prime loan
It all started in 2001 when US Federal Reserve dropped interest rates to a record low of 1% at the end of the previous bear market which was necessary to stop the US market from entering into a recession. This encouraged easy and cheap borrowing and thus Americans started buying houses as the mortgage repayments were so cheap. Thus the perfect situation was set in which low interest rates and rising property prices would create the housing bubble which we have experienced over the last 5 years.
Financial institutions started realising that they could charge higher interest rates to high-risk customers (who were not able to borrow from a traditional bank) since even if these guys defaulted, they could repossess their properties which were continuing to increase in value. Thus they could not make a loss since even if the customers defaulted on their mortgages they could repossess their properties and sell them at a profit. These high-risk, high-returns mortgages are known as in the US as "sub-prime bonds". High-risk individuals with no job and a poor credit history could suddenly get a mortgage and own property in the space of a few minutes and sub-prime lenders were making a fortune. Investors starting piling their money into sub-prime funds as the good times seemed like they would last forever.
So what went wrong?
The problems began in the middle of 2004 when the US Federal Reserve started increasing interest rates as the US economy starting recovering from a severe bear market. Interest rates continued to increase over the last few years and thus bond repayments increased. This caused many people to default on their bond repayments, not least of all, the high-risk sub-prime borrowers. Then to make things worse, property prices starting decreasing this year, causing a panic in the US as property investors began to sell their properties. So we now have the situation of increasing interest rates and decreasing property prices, which is not good for the sub-prime market. The rising interest rates & high fuel prices have caused a large reduction in the disposable income of these sub-prime borrowers and thus they started defaulting on their mortgages. But these properties that were repossessed are now worth less (due to declining property prices) and thus sub-prime lenders have been making severe losses.
The liquidity squeeze
Recently investors in these sub-prime funds realised the problem and starting withdrawing their investments and this has created a liquidity squeeze. These funds have been forced to liquidate their sub-prime mortgages as the investors wanted their money back and so are forced to incur losses on the mortgages. So what we have at the moment is a severe liquidity crisis as investors have collectively started fleeing from these risky sub-prime funds. Many large US corporations have gone belly up in the last few weeks causing a major world-wide financial epidemic which has affected the entire world.
How does it affect us in South Africa?
There is very little impact as far as SA corporates are concerned. Investec & Old Mutual are two firms which both have a very small exposure to the sub-prime market. However, what this crisis has caused is a world-wide credit crunch to occur. Basically the yield you would get on a high-risk bond (let's say 16%) has gone down dramatically over the last few weeks (to let's say 12%) causing a flight from risky assets such as emerging market equities (for example SA) and thus our stock market has been affected just like the rest of the world.
Looking forward
My personal opinion is that SA equities are below fair value for the first time in many months. Corporate earnings are still expected to grow very comfortably, especially in the financial & industrial sectors. You can now invest in any of the South African banks on a 10% earnings yield (plus the possibility of good earnings growth in the future and 4% cash dividends) when a fixed deposit at any of their branches will get you only 8%. This correction is merely a buying opportunity to anyone who has money to invest. Saying that, we are still prone to international market sentiment & thus the direction of our market is still very highly correlated with international markets, especially the US.
In summary
We have experienced a 300% bull-market in the last four years on the JSE and it is very unlikely that we will ever see such a major bull market to occur again in this country. However, equities are not overvalued, there is no bubble and our bull market has been driven by excellent profits as well as high resource prices. As one of the leading emerging markets in the world, with a developing infrastructure, a sound platform for growth and a burgeoning economy, it would be ludicrous to miss out on the next few years in this incredible growth story of the new South Africa.
I thought that with all the hysteria about Eland Platinum, I would share a few facts that I have managed to unearth in their 2007 financials:
- Employee costs were R19.7m in the 2007 FY.
- The directors paid themselves salaries between R1.934m & R2.459m in 2007!
- The FD Earned over R2m! How many listed companies have FDs earning over R2m just in their salary?
- Eland has not earned R1 in revenue ever.
- However, its operating loss has increased from R3m in 2006 to R52m in 2007.
- Eland has continued using its inflated share price to issue cheap equity including the following share issues:
- 27 493 000 shares on 2nd December 2005
- 20 164 835 shares on 29th March 2006
- Shares in issue have increased from 6.6m shares at the end of the 2005 FY to 60.4m shares at 31.03.2007
- The executive chairman's name is Loucas Pouroulis - Google him & find out about his history..."Loucas Pouroulis" Lefkochrysos
- Eland's only investment is a 64.99% interest in Eland Platinum Mines (Pty) Ltd
- The original project was purchased in October 2005 by Eland Platinum Mines (Pty) Limited from Rustenburg Platinum Mines (Pty) Limited, a wholly owned subsidiary of Anglo Platinum, for R117.25 million
- The company is now trading at a market cap of over R7bn today (R97)!
How does a mine that was bought for R117m just 2 years ago suddenly be worth over R7000m? And why would Anglo Platinum sell a mine of theirs for R117m if it had any potential to be worth R7000m? Either Anglo Platinum execs are the fools...or Eland shareholders are. You decide!
An interesting article that I read was in the Mining Yearbook where Aquarius Platinum CEO Stuart Murray was interviewed. He was asked about potentially acquiring one of one of the "junior platinum" companies. He had the following comments to make about those shares:
"We'll not look at the platinum juniors,"
"They can all crash and burn first,"
"Good luck to the punter who made his money. But we forget about 'Lefko'."
"The question I want to ask of the junior platinum companies is: are you producing cash flow, can you pay off debt and post a return?"
"What we know is that hot air returns to earth."
All the speculation regarding these platinum shares have caused these junior plat share prices to increase spectacularly over the last year. Eland, Wesizwe, Jubilee and Anooraq are a few of the shares which have more than doubled their share prices this year alone. Eland had gone from R20 to R120 in less than a year before a damming article by Barry Sergant appeared on Moneyweb & Mineweb, knocking the share down a cool 35%. Catch phrases such as "the consolidation of the platinum mining sector", "growing output, increasing price of platinum", "acquisition hungry resources companies", "mergers & acquisitions", and "South Africa 's Bushveld complex houses the majority of the world PGM resources" have caused hedge funds, individuals and the like to continue the incredible buying spree of these minnow platinum "farms". Little do these speculators know that mining is extremely expensive & capital intensive. Even if there does happen to be as much platinum underground as they think there is, it may not even be profitable to go ahead and mine the dumps.
But as I always say, good luck to all the speculators in Eland Platinum and every other platinum junior mine, but don't so you never knew the facts...
The JSE has gone past the 29,000 point barrier for the first time in its history. Strong world markets, high resource prices and bullish emerging market sentiment have pushed the JSE higher than it's ever been before.
There are many shares out there that still have incredible growth prospects so hang on in there. Although the market is overvalued on a whole, there are still little gems out there if you look hard enough.
Not much else to report. May the bull continue, but always hedge yourself in case those bears decide to have a feast...
Early on in 2006, when all the "experts" were predicting a 15-20% return on the JSE for the year, I put my neck on the line and predicted a 30% return for the year. I was wrong however, as the JSE returned 37.8% for 2006!
So yet again I will make my prediction for 2007. While the pros now think that the JSE will return 10-15% for 2007, I am predicting that there will be a negative return for 2007.
I think the market is generally overvalued. With JSE shares trading on an average P/E ratio of 17, it will either take an incredible earnings rise by these listed companies, or these shares are grossly overvalued. With the risk free rate of return in South Africa at around 9%, there is very little margin of safety on the JSE. On a P/E ratio of 17, the average share is trading on an earnings yield of around 6%. That means that you are getting around 6% return on historical earnings. So therefore investors expect that future earnings are going to grow dramatically to justify the share price.
If this is not the case, then look for a rather steep correction on the JSE. Good luck for 2007 and let's just hope (and pray) that this year will be a good one for companies and shareholders alike.
What fails to bemuse me is "the madness of the crowds". This same crowd who just a few months ago were predicting the end of the world when the war in the Middle East broke out and interest rates were hiked for the first time in years in South Africa, have now taken to JSE past 24,000 points! Last week the JSE hit another all-time high of 24,188.42 points as investors pumped their money into shares on the back of strong world markets and a resurge in emerging markets.
But how does this manic-depressive market continue this run unabated? How does it just keep on going up non-stop without a correction? How does the crowd explain how they BOUGHT shares on the 11th of May, only for it to drop 18% in a month, SOLD their shares on the 13th of June after this massive drop, and subsequently BOUGHT shares less than 5 months later after the JSE has surged another 33%? When everyone is selling, it is the best time to buy, and when everyone is buying...you should be selling.
And yes, just like in June when the phrase "bear market" was being thrown around wherever you walked, and I predicted that the bull was not yet over, I am now going to predict that the market is heading for a way overdue correction. The JSE closed yesterday at 23,674 points and I would not be surprised if we see the market come down a thousand points before the end of year.
