SASOY is an oil and petrochemical giant by global standards. It is the dominant producer of liquid fuels in South Africa and one of the largest companies on the Johannesburg Stock Exchange. SASOY is the world leader in synthetic fuel production.

At current levels, SASOY is trading at just 8x forward earnings. This is a cheap price to pay for a quality commodity producer at the early stages of the commodity cycle.

While SASOY has historically been dependent on oil prices, the company is diversifying into higher margin petrochemicals. Chemicals can be extracted from the same feedstocks that produce high-grade synthetic white products. SASOY has a massive capex budget to build petrochemical facilities. I believe that global chemical prices are at the early stages of a sustained recovery.

SASOY benefits from the depreciation of the South African rand, so there's a built-in hedge against domestic instability. SASOY's sales are in dollars and costs are in rand. I am not bullish on South Africa, since it is overly dependent on gold, 35% of the population is unemployed, 70% of the population is illiterate, the criminals are armed to the teeth, and the central bank only has US$6 billion in reserves.

The balance sheet is under-geared. Debt only represents 17% of equity. Given the predictability of cashflows, SASOY can support a higher degree of leverage. More debt would increase return on equity (ROE). This would be good news for profitability.

ASL's aggressive hedging strategy protected the company as long as gold remained in a bear trend. Without the hedges, ASL would have had to raise capital over the years by diluting shareholders or increasing debt to unacceptable levels. But, as is now apparent, ASL was taking unacceptable risks with its hedge book.

ASL was short selling gold against future production. To short gold, you need to borrow it at the prevailing interest rate, or "gold lease" rates. Over the last few years, 12-month gold lease rates bounced between 1.5 and 2%. If you borrow gold at 2% and sell the gold into the market, you can invest the proceeds in risk-free government paper at 5%--recapturing the 3% spread between gold lease rates and treasuries. This spread can make gold hedging a very profitable business, by creating synthetic sale prices far above the market.

ASL was also buying gold puts and financing the puts by selling gold calls. While this gave ASL cheap downside protection in the event that gold declined, it created short-term risks in the event that gold rallied (leaving the puts worthless and the calls in danger of being "called").

Since ASL produces physical gold, delivering into short positions, it does not appear to be taking economic risk in hedging--at least on paper. But the counterparties to ASL's derivative positions have the right to demand collateral (or "margin") if the marked-to- market negative value of the hedge book exceeds certain levels.

The great short squeeze of 1999 (which, ironically, I predicted in last year's Taipan Profit Perspectives 2000 Forecast issue) crushed ASL's hedge book. The timing of the short squeeze was terrible: ASL had just exhausted most of its credit line and drew down its cash reserves on capex. ASL was on the verge of rolling over its credit line with its lenders when gold rallied.

Whether it was bad luck or manipulation by savvy traders, ASL was brought to the brink of destruction. This drove the stock down 70% in a matter of days.

ASL worked out an agreement with its counterparties. In exchange for 15% of the equity in the form of warrants, the counterparties granted ASL three years of margin-free trading. While I am upset about the dilution, it is better than bankruptcy. The agreement is contingent upon the successful rolling over ASL's credit facilities. Since 75% of the counterparties are also lenders to ASL, I am bullish on the outcome of the renegotiation (the lenders now have an incentive to push the stock higher).

ASL remains "in play." Lonmin (30% ASL shareholder) attempted to grab ASL with a lowball bid, but the government of Ghana blocked the offer. Other major gold companies are taking a look at ASL. Even with the dilution from the warrants, ASL's reserves are worth at least US$10-$12 per share at current gold prices. The stock is an excellent contrarian play in the US$4-5 range.

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