A miracle waiting to happen: South Africa may be volatile, but there is huge potential. Richard Thomson reviews the investment opportunities

Six months ago, as the killing in the townships seemed to be dragging South Africa inexorably to the brink of civil war, only a few brave souls dared suggest things might settle down as quickly and smoothly as they have.

But the election passed off relatively quietly and the new multi- coloured government of national unity has agreed on crucial areas of policy.

Above all, the respected finance minister, David Keys, has remained in place and his recent moderate budget has drawn the admiration of the international financial community. So is it now time to invest in South Africa?

The expected surge in economic activity is an encouraging background. International sanctions have been lifted, and after four years of stagnation the government expects the economy to grow by about 3.5 per cent this year, and up to 5 per cent in 1995. 'The country could manage at least 3 per cent almost indefinitely,' said Michael Coulson, an analyst at Credit Lyonnais Laing.

Cashing in on the excitement, several internationally known companies are issuing bonds on international markets as a way of attracting overseas investors. Liberty Life, for example, will be pricing a dollars 350m convertible bond issue next week. Both Credit Suisse and Robert Fleming have recently launched funds centred on South Africa, while Save & Prosper is soon to launch a unit trust, managed by Robert Fleming.

But the investment picture is more complex than mere economic statistics. 'South Africa cannot expect a charitable ride simply because it is now back in the international fold,' said Michael Spriggs, southern Africa analyst with Warburg Securities. 'It is in competition with a host of other emerging markets, particularly the Asian tigers.'

Additionally, it is shackled by exchange controls. South Africa once tried and embarrassingly failed to abolish them in the 1980s, and does not want to repeat the mistake. 'I don't want to defend the existing situation,' Mr Keys said recently. 'I think it's awful.' Unfortunately, he added, the conditions for doing away with controls will probably not apply for some time - taken to mean at least 18 months to two years.

In the meantime, foreign investors have to buy shares in financial rand, the pool of South African currency outside the country, which stands at a 25 per cent discount to the commercial rand, the domestic currency. Inevitably, this severely limits the number of domestic sellers, so the market in most South African shares is fairly illiquid, even though the Johannesburg Stock Exchange is about the ninth-largest in the world in terms of market capitalisation.

In the past few months, however, the Johannesburg market has put on an impressive sprint in anticipation of vast foreign interest. From 3,800 last October, the All Share index reached 5,972 in mid-June.

In the long run, the foreign 'wall of money' will no doubt materialise. Warburg believes that of the estimated dollars 120bn invested in emerging markets worldwide, some dollars 20bn will eventually find its way to South Africa. 'I've seen evidence of a lot of money,' said Marina Lloyd, who will be managing S&P's new fund. 'But if it doesn't happen soon, the market will fall.'

So the market is expensive and may be uncomfortably volatile for the foreseeable future. Yet there is value for discerning investors. Most recent buying has been concentrated on the big, well- known stocks. 'It's getting harder and harder to identify value in the major industrials,' said Mr Spriggs. Second-line stocks are looking considerably more attractive.

The retail sector is one of the most likely beneficiaries of growing wealth among South Africa's black population. Ms Lloyd recommends Pick & Pay, a kind of South African version of Woolworths, as a promising and not over-priced stock.

The government's reconstruction programme, involving substantial infrastructure projects, together with a desperate need for new housing to replace South Africa's notorious shanty towns, will provide obvious opportunities for the construction sector.

Murray & Roberts, the country's largest building supplies company, is already attracting a lot of interest from investors. Ms Lloyd dismisses it as too expensive, however, seeing more value in LTA, a slightly smaller competitor.

Most companies in the construction, pharmaceuticals and electronics sectors are probably over-priced at the market's current level. But a number of recovery stocks still offer value, such as Iscor, the steel group, which has just emerged successfully from a savage restructuring.

Where does all this development leave the stocks that foreign investors know best, the mining and mineral companies? They will probably benefit little directly from South Africa's new economic growth, since the industry is already mature. The story here is rather of external pressures - in particular, the gold price.

Credit Lyonnais Laing is enthusiastic about South African gold shares, believing them to be cheap in comparison with those of other countries.

But Andy Smith, gold analyst at UBS, says there is no sign of the gold price rising. It has hardly reacted to news that should have pushed it higher, which suggests there is little underlying strength in the market.

In general, it is still early days for investment in the new South Africa. Uncertainty is inevitable at this stage. That there is value to be had over the long term, however, is virtually certain.

(Photograph omitted)