Chris Mayer

Africa has had many false dawns. So there are good reasons to be skeptical of yet another rising sun, full of promise. But this dawn has been a long time in the making and has different foundations than before. Already, we’re seeing some amazing changes.

These changes began as Africa opened up its markets. The trend is unmistakable. Many governments have sold off lots of state-owned enterprises, for instance. Nigeria alone privatized 116 entities between 1999–2006. Generally speaking, governments have lowered corporate taxes and beefed up their legal systems. They’ve loosened up on barriers to trade. And inflation rates have fallen. The average inflation rate dropped from 22% in the 1990s, to 8% after 2000. Foreign debts dropped by one quarter. Budget deficits fell by two-thirds.

This is like laying a seedbed for investors to thrive. So the money started to come and settle in Africa. Foreign investment in Africa is up sevenfold since 2000, to $9 billion. Africa’s economy is now about as big as Brazil’s or Russia’s. The continent is young and urbanizing and growing. By 2050, one out of every five people on the planet will hail from Africa.

These things are fairly shocking. The trends are diametrically opposed to what we are seeing in the aging Western economies. Yet there is still a long way to go. The shackles are only starting to come off Africa. And we know from long experience that when people are free, they grow rich.

The proof is in the pudding. Africans increasingly join the world’s consumers. According to McKinsey & Co., in the next few years, the number of households earning more than $5,000 should top 100 million. (This $5,000 benchmark is when most Africans will spend more than half their income on nonfood items.) Already, Africa has more middle-class households — defined as having $20,000 in annual income — than India. And India has more people.

Everyone who has done business in Africa says it is a hard to place to make a dollar. Yet people are figuring out ways. There are a number of studies on this point. One recent study tracked publicly traded companies operating in Africa from 2002–2007. It found that the average return on equity for African companies was two-thirds higher than for comparable companies operating in the sexy markets of China, India, Indonesia and Vietnam. Another survey of U.S. companies showed that they enjoyed their best returns when they invested in Africa compared to any other region.

These investments are in many different sectors, though Africa has always been a resource story to most investors. No doubt, this is an exciting part of the puzzle that is Africa: the long list of commodities in which Africa is amazingly rich. For instance, about 40% of the world’s gold is in Africa. And this is just what we know about. For the most part, Africa is unexplored.

As Paul Collier points out in The Plundered Planet, the typical Western country has $114,000 of subsoil assets per square kilometer on average. This is despite more than two centuries of intense exploration and extraction. In Africa, the number is about $23,000 of known subsoil assets. As Collier concludes, “It is highly unlikely that this massive difference is due to a corresponding difference in what is actually there. Rather, the difference in known assets is likely to indicate an offsetting difference in what is awaiting discovery.”

It means a long resource boom in Africa could be in the cards.

As I say, there are reasons for skepticism. Collier, too, notes the struggles of the 1970s commodities boom. The oil boom of 1973–83, for example, didn’t do Nigeria a lot of good. But the 2003–08 boom was another story altogether. Nigeria is now free of debt and has $70 billion of foreign-exchange reserves. As Collier says, “The contrast between Nigeria’s dysfunctional management of its first oil boom of 1973–83 and its brilliant management of the second boom of 2003–08 cautions against the gloomy cynicism that until recently bedeviled investor thinking about Africa.”

One more point from Collier. In a piece called “The Case for Investing in Africa,” he points out that investors have small exposure to Africa in their portfolios. Yet given the West’s stagnant state and the rapidly growing African economies, this could change. “At present, the typical investment portfolio has massive exposure to the [Westernized] countries and negligible exposure to Africa,” Collier writes. “This looks unlikely to be appropriate for the coming decades.”

There are many ways to invest in Africa. Right now, I’m attracted to certain African gold outfits that are super cheap.

From the bird’s-eye view, there are three main gold basins in Africa. The most famous is in South Africa. This area has been in decline for a long time. Plus, many of the mines are deep underground and high cost. I’m not interested in the South Africans. The other two regions, though, are more promising and growing — West Africa and the Tanzanian regions. In fact, few gold bugs realize this, but the rest of Africa produces more gold than the once-prolific South Africa.

In the past, “the rest of Africa” has been a scary place for investors. That’s starting to change, too. The Fraser Institute scores, widely tracked by investors, attempt to rank mining jurisdictions by attractiveness based on standards of governance and the like. African rankings have improved. Countries such as Mali and Tanzania now rank ahead of South Africa. They are on par with China, Russia and Peru.

So gold miners — and investors — face a choice. You can pay up and stay in friendly jurisdictions working more-challenging ore bodies with lower grades. Or you can take a greater risk for the relatively unexplored potential of Africa.

Right now, I think investors ought to give a hard look to African gold miners. There are sizable companies here with quality assets. They also have good track records managing the risks of being in Africa. The exploratory upside makes for a mouthwatering prize. And most are so much cheaper than their beloved Western counterparts that it is worth the risk.

Regards,
Chris Mayer
Whiskey & Gunpowder

August 30, 2010

Chris Mayer

Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. Graduating magna cum laude with a degree in finance and an MBA from the University of Maryland, he began his business career as a corporate banker. Mayer left the banking industry after ten years and signed on with Agora Financial. His book, Invest Like a Dealmaker, Secrets of a Former Banking Insider, documents his ability to analyze macro issues and micro investment opportunities to produce an exceptional long-term track record of winning ideas. In April 2012, Chris released his newest book World Right Side Up: Investing Across Six Continents

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