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Rorschach tests and other psychological parlor games can be a lot of fun if not taken too seriously. Those who must see meaningful patterns in every ink blotch and set of squiggles are condemned to spend their lives as technical analysts, scorned by polite company everywhere (yes, I'm a technician; no irate emails, please).

As my French friends would say, if I have any left after the present spat, "

c'est la vie

." Or, as my fellow free market economists would sneer, "there is no phrase in French for

laissez faire

."

Back to the parlor game of word association. If I said "South Africa," sooner or later someone would blurt out "gold." The South African economy, both before and after apartheid, has been based on the extraction of high-value commodities such as gold, diamonds and platinum. Gold is in its most pronounced and sustainable bull market since the Carter administration, and the South African rand (ZAR) has been the strongest-performing currency against the U.S. dollar so far in 2003, up 6.74%.

The Chicago Mercantile Exchange has a futures contract on the rand, but it's very thinly traded, with an open interest of only 5,920 contracts. By the way, the second-best performing currency of 2003 is the Mauritius rupee, up 6.64%.

The ZAR Won't Rise Too Far

Despite the obvious allure of gold, the rand has rallied the old-fashioned way: It simply yields a lot more than do comparable U.S. dollar deposits. The rand's late 2001 crash against the greenback didn't begin to reverse until the interest rate gap between the Johannesburg interbank agreement rate (JIBAR) and LIBOR began to expand in early 2002. The current rally has taken the rand back to its precrash level, and as any self-respecting technician will tell you, a market must clear its precrash level on the way back up to qualify as a genuine reversal.

The ZAR and Its Ministers
The rand has been the strongest-performing currency against the dollar

Source: Bloomberg

More important in terms of currency trading and stability, a high-rate gap such as the rand-U.S. dollar gap, especially one in which the dollar rate is as low as it is today, reflects the market's expectations of a weaker rand in the absence of high rates. High South African interest rates both raise the risk of American investors holding South African assets and dampen the return on those assets themselves.

Strong Currency, Weak Stocks

Returns on South African stocks have been lagging despite the obvious boost from gold prices. Those who associate a strong currency with strong equities should take note. The

Financial Times

/Johannesburg Top40 Tradeable Index, which has 41 members (don't ask), is down close to 9.1% so far in 2003 in rand terms.

Gold miners

Gold Fields Ltd.

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and

Harmony Gold

(HMY) - Get Harmony Gold Mining Co. Ltd. Report

are down 12.5% and 16.2%, respectively.

SABMiller

, which bought Miller Brewing from

Altria Group

, has lost 17.95% so far in 2003. But it's not all bad:

Rainbow Chicken

is up more than 19% on the year.

The absolute value of the HSBC index of South African gold miners describes a simple pass-through relationship between bullion prices and mining stocks. An American investor looking to play gold prices would have no apparent advantage in investing in South African mining stocks over just buying bullion or gold futures. In recent weeks, the HSBC index has headed south, along with a minor retracement in bullion prices and a strong rand.

However, the relationship need not be as inelegant as just trying to ride a price trend. Mining stocks always move in an accelerated fashion to the upside as a function of metal prices. The relative performance of the HSBC index to the currency-adjusted Top40 as a function of gold prices describes a call option on gold prices.

Stocks as Good as Gold
Returns on SAF gold stocks lag behind despite the boost from gold

Source: Bloomberg

While the mechanics of trading commodity linkages to relative index movements may best be left to the hedge fund crowd, the implications of the quick move down by the HSBC index are unmistakable. Either the rand or gold or both have seen the end of their rallies for the time being. If South African gold stock investors sensed otherwise, the HSBC index would remain buoyant in anticipation of further gains.

A Golden Relationship
The HSBC index vs. the Top40 offers a good investment

Source: Bloomberg

I should emphasize the phrase "for the time being" in regards to the gold rally. I am still bullish on the metal longer term out of fear that central banks' reflation efforts might succeed too well. For those who wish to trade gold, I recommend simply trading the futures and not messing with the stocks. Gold stocks are not gold stocks: Over the past five years, the HSBC index of South African gold miners has outperformed the HSBC index of Australian miners by 58%.

Picking different gold miners in different countries with different currencies and political systems is likely to be as rewarding as trying to pick the next hot mutual fund.

Howard L. Simons is a special academic adviser at Nasdaq Liffe Markets, a professor of finance at the Illinois Institute of Technology, a trading consultant and the author of

The Dynamic Option Selection System. Under no circumstances does the information in this column represent a recommendation to buy or sell securities. The views expressed in this article are those of Howard Simons and not necessarily those of NQLX. As a matter of policy, NQLX disclaims the private publication of materials by its employees. While Simons cannot provide investment advice or recommendations, he invites you to send your feedback to

Howard Simons.

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