From the perspective of a U.S. Investor, an allocation to South African equities is largely a bet on the performance of the South African Rand. In fact, over the last 12 months 47.8% of the volatility exhibited in the iShares MSCI South Africa ETF (Symbol: EZA) is attributable to the South African Rand. Meanwhile, just 40.7% of EZA volatility is attributable to global equity market risk, and only 4.1% of EZA volatility is attributable to country specific risk. As a result, positive returns in EZA are likely to be accompanied by strength in the South African Rand, and or, weakness in the U.S. Dollar. As an illustration, stress testing of the South Africa ETF suggests that EZA would rally 10.1% if the U.S. Dollar were to weaken 10% versus the Euro. Importantly, recent volatility of the South African Rand is second only to the Argentine Peso, and that risk translates into more volatile equity returns. Accordingly, the range of potential returns for South Africa is relatively wide, and this helps to explain a portion of South Africa’s negative risk ranking below. Over a one month investment horizon, we estimate that returns for EZA have a 95% chance of remaining between -12.94% and +12.94%. This compares to China’s (MCHI) ±9.62% range and Emerging Markets’ (EEM) ±8.14% range. Although the South African Reserve Bank is expected to raise benchmark interest rates by another 1% this year (potentially stemming Rand weakness), the consensus forecasts suggests 5.2% Rand depreciation vs. the U.S. Dollar through Q2 2014. Lastly, South Africa is not very leveraged to Gold prices. Scenario analysis suggests that a 10% rally in gold prices would yield a 2.35% gain in EZA.
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