*** A question of cash...

*** Inflation will eat your handbag

*** Preference shares... and more...

From the illiquid pen of Gary Booysen…

Dear Investment Academy Reader,

We’re a week into our new website and already our faithful IT department is planning tweaks! Sometimes it feels like the world’s just moving too fast. Do you know, in only two days, tomorrow will be yesterday! But all credit to them, they’ve done a wonderful job and there’s tons to keep you entertained at www.fsp.co.za. Have a look, you’ll regret it if you don’t...

Last week, I promised to discuss preference shares and this week I’m delivering on that threat – I mean promise. But before I do... we have another question!

A reader was concerned that by preaching the merits of the stock market, I was going against the grain. Is getting your money out of the money market contrary to conventional wisdom? I sincerely hope so. The contrarian view is a valuable one. Whenever the majority are selling, you should be buying! Buy low, when nobody wants it, and sell high when it’s in greatest demand. It’s the most fruitful way to make profits.

Beware of the inflation monster governments have forgotten about

But, the reader was quite right to have gotten into the money market. With the huge amount we’ve seen wiped off asset prices in the last year, cash was most certainly king. Nevertheless, time moves on. We’ve seen governments around the world respond to the financial crisis with, in the words of Cortex Securities analyst, Viv Govender, “the largest bout of expansionary fiscal policy in history”.

They’re calling it “quantitative easing” otherwise known as printing money. In recent years, we’ve seen Zimbabwe trying out “quantitative easing” and we saw the effects on their currency! Countries worldwide have borrowed money to fund their enormous stimulus plans and, instead of trying to pay back the money, they’re devaluing their currency in order to make their debt smaller. China, the US’s primary lender and the world’s largest holder of dollars (about $2 trillion), is the one suffering, and let me tell you, they’re getting angry. They’ve already called for one world currency and further reliance on Special Drawing Rights. But that’s another story.

We’ve recently seen how foreign currencies have devalued against the rand and, honestly, I see no option other than for South Africa to follow suit. While it’s great for our trade balance in the short-term, and even better for you if you're planning an overseas holiday, it also means our goods become more expensive. With less dollars, yen, pounds or euros per rand, our goods become expensive for foreign, importing countries. They’re already suffering from the global contraction and will soon stop buying. The only thing we can really do is devalue our own currency in line with the rest to maintain the status quo in monetary matters. If we don’t, we’ll see dire consequences for South Africa’s real economy.

The rand might not weaken dramatically compared to these currencies, after all they’re fluctuating themselves – as the rand devalues, so does the dollar, and so the foreign exchange rate remains fixed. Nevertheless, our currency will be devalued. But if the results aren’t seen in the exchange value, it’ll reflect in what you can buy. The common measure of this is our familiar friend, inflation. With the amount of liquidity that’s being pumped into the global system, sooner or later we'll see massive inflation worldwide.

The question is: When will all this happen? One of the primary concerns in economics is how we can gauge the time lapse between policy changes and actual effect. Governments plied the world with bailouts, but nothing seemed to change. The major reason for this is the bailouts were given to banks that then refused to lend out money. Inflation couldn’t hit because, too much currency couldn’t chase too few goods, if the banks were all sitting on the notes. We’ve recently seen interbank lending rates come down, a sure sign that banks are beginning to lend again. But this is the spark that’ll ignite the inflationary fire. My advice is: Get in now before it’s too late. And, whatever you do, get out of cash.

Now before this runs too long, which it already has, let’s turn to preference shares...

Get preferential treatment... share the debt!

Warren Buffett bought preference shares when he sunk $2.5 billion into Goldamn Sachs. This way, he snapped up a guaranteed 10% dividend. Though $2.5 billion will no doubt earn you a little more clout than the average Joe, this doesn’t stop us from grabbing onto preference shares.

All companies are formed of two types of share – ordinary and preference. If you hold an ordinary share (AKA an equity share), you earn the right to share in the profit and vote in the AGM (annual general meeting). You’re essentially one of the many owners of the company. On the other hand, if you hold preference shares, you hold a hybrid of equity and debt. You won't be able to vote, but you have other advantages. Best of all, if the company goes bang, you’ll stand ahead of ordinary shareholders in collecting the leftovers, all thanks to your status as "creditor".

For more information on dividends and preference shares, check out our ultimate paycheque portfolio!

Until next time,

Happy investing,

Gary Booysen
For the Investment Academy