Precious Metals Rally Pumps Up South Africa ETF

What were once gifts can become curses and what were once curses can become gifts. That is the scenario the once downtrodden, maligned iShares MSCI South Africa ETF EZA.

As has been previously noted in this space, EZA was one of the worst-performing single-country emerging markets ETFs as precious metals prices tumbled. For example, EZA tumbled 26 percent last year, a decline that was nearly 1,000 basis points worse than the MSCI Emerging Markets Index. South Africa, Africa's second-largest economy behind Nigeria, entered 2016 vulnerable to losing its already tenuous grasp on its investment-grade credit rating.

But over the past month, EZA is up just over 13 percent, outpacing the ETFS Physical PM Basket GLTR by nearly 400 basis points over that stretch. The ETFS Physical PM Basket is a relevant comparison because it offers access to physical gold, silver, platinum and palladium.

A Look At South Africa

South Africa is a major gold producer, the world's largest platinum producer and second-largest palladium producer behind Russia.

"After a brutal 2015, South African gold miners are staging an impressive rally while average short interest across South African equities has been rising as the country faces rising inflation and a collapse of its currency. These developments come ahead of one of the most anticipated government budgets which the government hopes will restore investor confidence," said Markit in a new note.

South Africa is the world's largest platinum-producing country and the second-largest palladium producer behind Russia. That is to say, although the materials sector is not a significant part of EZA, price action in those metals looms large for South African equities.

Second, investors, to the extent that they can be, appear comfortable with the fact that South Africa could very well be the next emerging market to suffer a sovereign credit downgrade at the hands of one of the major ratings agencies. Maybe Turkey will beat South Africa to that dubious punch, but a rating downgrade is still on the table for Africa's second-largest economy.

For its part, EZA's materials weight is surprisingly light at 6.5 percent. Financial services and consumer discretionary stocks combine for nearly two-thirds of the ETF's weight.

"Average short interest across the Johannesburg Stock Exchange (JSE) and the TOP 40 index has increased by 13% and 24% to hit 1.5% and 0.9% of shares outstanding respectively year to date," said Markit. "This trend is led by consumer related shares as short sellers trade the impact of the country’s rising inflation and weakening economic growth. To this end consumer discretionary retailers have seen average short interest increase by 38% while consumer staples have seen demand to borrow rise by 35%."