Archive for September 30th, 2012
Sunday, September 30th, 2012
Back to Business For Now … Quarterly Strategy Report
by Alfred Lee, Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management Inc.
In this report [download PDF], we outline our strategic and tactical portfolio positioning strategies for the fourth quarter using various BMO Exchange-Traded Funds.
- After much speculation, the U.S. Federal Reserve Board (Fed) finally officially announced its third round of quantitative easing (QE3) on September 13. Given this round was highly telegraphed, we believe a significant amount of the market reaction has already been priced in compared to its two predecessors. As a result, it is likely the effect on risk assets will be short- lived this time around. However, over the quarter, inflationary assets will likely be driven higher.
- Concerns of an immediate European sovereign debt crisis appeared to have abated, after the announcement of the European Central Bank’s (ECB) Outright Monetary Transactions programme (OMT). Five-year yields of Spanish and Italian debt had declined to as low as 4.2% and 3.7% respectively in early September. However, recent austerity strikes in Spain have caused yields to rise, and measures of the European economy such as Purchasing Manager’s Index (PMI)1 continue to contract, now at 46.0, below the critical 50 level, suggesting significant concerns about the European economy still remain.
- China also remains a concern, as data suggests its economy continues to contract. Despite an announcement from its economic planning body that it has approved a US$157 billion infrastructure expenditure, its PMI continues to indicate that the economy is deteriorating. Given both the direct and indirect exposure to China’s economy through Canadian equities, our strategy has been to use a core-satellite approach, combining lower beta stocks with cyclical areas exposed to the U.S. economy.
- Investor sentiment dramatically improved over the third quarter, with the CBOE/S&P Implied Volatility Index (VIX)2 falling to a low of 13.3, a level not seen since June 2007 and well below its long-term average of 20. Put/call ratios for the S&P 500 Composite (SPX) have also been on the decline, further indicating that investor confidence has improved, for the time being.
- U.S. equities continue to deliver positive surprises on earnings (ahead of expectations), though a closer look shows much of this continues to be cost cutting. The earnings surprises with stocks in the SPX have been more impressive than that of the S&P/TSX Composite (S&P/TSX) as per the table below.
- The key risk remaining outside the OMT program in not being an effective measure in removing a tail-risk event over the quarter is the looming U.S. fiscal cliff, which will be partly dependent on the upcoming U.S. Presidential elections. If concerns of Europe stay on the sidelines, investor focus would more than likely shift to the U.S., where at year end tax and spending cuts are set to expire. This could potentially be a major setback to the global economic recovery. As a result, even though we have slightly increased the cyclicality in our tactical strategy, we remain defensive from a strategic and overall level.
Things to Keep an Eye on…
Interest in commodities as an investment has been placed on the backburner over the last year, given increased volatility and waning optimism for global growth. However, with market anticipation for central bank intervention, commodity prices have surged 18.2% since June 21, marking a short-term rotation into inflationary assets.
Recommendation: As the commodity sub-groups react very differently to macro-economic events and monetary stimulus, we recommend targeting the commodity exposure in your portfolio strategy. Gold and silver prices have reacted favourably in past periods of QE, as did oil prices. For energy exposure, oil and gas companies remain attractively valued and pay a dividend. The BMO Precious Metals Commodity Index ETF (ZCP) can be used for precious metals exposure and the BMO Equal Weight Oil & Gas Index ETF (ZEO) for energy company exposure.
Cyclical stocks have been rallying against defensive stocks since July, after Mario Draghi asserted to the market that he would “do whatever it takes” to save the Euro.Speculation through the summer that the Fed would announce monetary stimulus, and the announcement of the ECB’s OMT program, also gave fuel to the rally in riskier assets, as depicted by the recent trend in the Dynamic vs. Defensive Stocks Ratio.
Recommendation: We still favour lower beta equities over the long-term and still continue to recommend the BMO Low Volatility Canadian Equity ETF (ZLB) as a core position. The recent turn downturn in the Dynamic vs. Defensive Stocks Ratio confirms our view of that risk appetite will eventually abate.
U.S. housing, ground-zero to the 2008 financial crisis, continues to show signs of stabilization. This is encouraging given it was a source of employment and wealth to the U.S. economy from 2004 until the financial crisis. A recovering U.S. housing market would provide a lift to many U.S. banks and financial firms.
Recommendation: As a tactical position, the BMO Equal Weight U.S. Banks ETF (ZUB) can be used to provide exposure to financial firms in the U.S. which have been highly correlated to the health of the U.S. housing market. As depicted in the chart to the left, the Dow Jones U.S. Large-Cap Banks Equal Weight Index (C$ Hedged), which ZUB tracks, has been correlated to the S&P/Case Shiller 20-City Index (Seasonally Adjusted).
Changes to the Portfolio Strategy:
- We are slightly increasing the equity exposure of the asset allocation mix in our strategy, as the recent moves by both the Fed and ECB is supportive for riskier assets over the short-term. In addition to adding to our equity exposure, we are also slightly increasing the cyclicality within the stock component of our strategy, which is outlined in more detail in the following sections. As the core of our strategy remains defensive, we are utilizing tactical positions to increase our exposure to areas that are more sensitive to the effects of stimulus. However, we do not believe the low levels in equity market volatility (and VIX) are sustainable given the breadth of macro-economic and geo-political concerns that remain. A major concern over the next quarter on asset allocation is the impact of the U.S. elections and also the U.S. fiscal cliff.
- Our fixed income strategy continues to use a core-satellite approach with the BMO Aggregate Bond Index ETF (ZAG) to gain exposure to the broad Canadian bond universe. More targeted fixed income ETFs are then added to tilt the fixed income exposure in terms of duration and credit. Although the Bank of Canada continues to take more of a hawkish tone in monetary policy compared to its international counterparts, many factors including high unemployment and the loonie trading above parity may delay rate hikes until the latter part of 2013. As a result, we are eliminating our position in the BMO Short Federal Bond Index ETF (ZFS) and repositioning it to increase our weighting in the BMO Mid Corporate Bond Index ETF (ZCM). Equities:
- Over the last quarter, there has been a remarkable improvement in the breadth of the market rally. Currently, 71.7% of the SPX stocks are trading above their 50-day moving averages (MAs), compared to only 61.8% at the end of the second quarter. Although the Eurozone economies will likely continue to struggle, the effectiveness of the OMT in keeping countries like Spain and Italy out of the headlines will be critical in determining whether the market rally continues over the fourth quarter. Though no panacea to their economic woes, like the Long-Term Refinancing Operations (LTRO)3 it kicks the proverbial can down the road.
- The Dow Jones Industrial Average was our preferred means of obtaining exposure to broad U.S. equities in 2011. As we have recommended several times earlier this year, however, recent signs of “on-shoring” and improving U.S. economic data has benefitted the more locally based mid-cap companies in the SPX. As a result, we are eliminating our 9% position in the BMO Covered Call Dow Jones Industrial Average Hedged to CAD ETF (ZWA) and placing 6% to increase our position in the BMO S&P 500 Hedged to CAD Index ETF (ZUE)4.
- The remaining 3% from eliminating ZWA, will be used to initiate a new position in U.S. financials since the sector is exposed to an improving U.S. economy and a stabilizing U.S. housing market, as mentioned in the previous page. Furthermore, on a sector basis, U.S. financials are trading at attractive fundamentals relative to both their historical price-to-earnings (P/E) ratios and compared to the SPX. In addition, we are trimming 2% from ZAG, to add 1% to each of our BMO Canadian Equity Dividend ETF (ZDV) and the BMO Equal Weight REITs Index ETF (ZRE) positions. There remains a secular demand for yield and the recent under-performance of dividend equities and REITs may be an opportune time to accumulate.
- As previously noted,a number of factors continue to be a tailwind for precious metals right now. Both the ECB’s OMT program and the Fed recently adding monetary stimulus will be supportive of gold and silver prices. In addition, gold prices tend to be seasonal, gaining an average 6.7% in the fourth quarter over the last ten years. From a technical perspective, gold has broken out of its downtrend pattern that it has been in since the end of the first quarter, with faster indicators such as stochastics turning up as well, showing a gain in momentum. Its recent technical strength potentially leads to more buyers coming into the market. As a result, we are taking 1% from cash to add to our BMO Precious Metals Commodities Index ETF (ZCP). Below we outline all of the respective changes to the portfolio.
Conclusion: Though very short-term indicators suggest a consolidation, the recent actions by the central banks are supportive for risk assets. A combination of an increased appetite for risk and attractive fundamentals leads buyers coming back into the market and potential further short-covering. The major concern that eventually leads to a headwind later in the quarter is the U.S. “Fiscal Cliff.” Although we slightly increased the cyclicality in the tactical portion of our strategy we will use the recent underperformance in lower beta and yield oriented areas as accumulation opportunities for the strategic portion of the strategy. Overall our ETF portfolio strategy remains defensive.
1 CBOE/S&P 500 Implied Volatility Index (VIX): shows the market’s expectation of 30-day volatility, annualized. It is constructed using the implied volatilities of a wide range of S&P 500 index constituent options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the “investor fear gauge”.
2 Purchasing Managers’ Index (PMI) is an economic indicator on the financial activity reflecting purchasing managers’ acquisition of goods and services. Data is for the PMI are compiled by monthly surveys polling businesses that represent the make up of the respective sector. The surveys cover private sector companies, but not the public sector. A number above 50 indicates economic expansion, whereas a number below 50 suggests economic contraction.
3 Long-Term Refinancing Operations (LTRO): a major financing method used by the European Central Bank to provide liquidity to its member banks. Although the operation has been in existence for well over a decade, its rules were recently revised to make it considerably easier for banks to obtain funding. First, through LTRO banks can now post collateral to borrow funds for three years rather than several months. Second, the eligible collateral to obtain funding has been relaxed significantly.
4 On September 21, 2012 the BMO U.S. Equity Hedged to CAD Index ETF was changed to track the S&P 500 Hedged to C$ Index. Accordingly, the name of the ETF was changed to BMO S&P 500 Hedged to CAD Index ETF.
Sunday, September 30th, 2012
by John Hussman, Hussman Funds
In the context of historical evidence and outcomes, present market conditions give us no choice but to remain highly defensive. Valuations remain rich on the basis of normalized earnings (which are better correlated with subsequent returns than numerous popular alternatives based on forward operating earnings, the Fed Model and the like). Investor sentiment is overcrowded on the bullish side even as corporate insiders are liquidating at a rate of eight shares sold for every share purchased – a surge that Investors Intelligence describes as a “panic.” Market conditions remain steeply overbought on an intermediate and long-term basis, with the S&P 500 still near its upper Bollinger bands (two standard deviations above the 20-period moving average) on weekly and monthly resolutions. We continue to observe wide divergences in market action, from century-old criteria such as the weakness in transports versus industrials (which suggests an unwanted buildup of inventories) to more subtle divergences and signs of exhaustion in market internals.
Overall, we continue to estimate a steeply negative return/risk for stocks on horizons from 2-weeks to 18 months. I recognize that this is easy to treat as disposable news, given that the ensemble methods we developed to capture both post-war and Depression-era data have indicated a negative return/risk profile for stocks since April 2010, yet the S&P 500 is 18% higher today than it was at that time. Central bank interventions have certainly played a role in that gain. But then, our prospective return/risk estimates have been in the lowest 1% of historical data only since March, and the market loss that would erase the intervening gain since April 2010 is one that we would consider small from the perspective of present market conditions. The average cyclical bear market has historically wiped out more than half of the preceding bull market advance, and stocks have typically surrendered closer to 80% of their preceding bull market gains when the cyclical bear is part of a “secular” bear period such as the one we’ve experienced since 2000 (see the discussion of cyclical and secular fluctuations in A False Sense of Security). I remain convinced that we will observe numerous points in the market cycle ahead where the evidence will support a significant and even aggressive exposure to market fluctuations. Now is not one of those points.
While our estimates of prospective return/risk in stocks remain among the most negative instances we’ve observed in a century of market history, it is important to note that these estimates are largely independent of our conviction that the U.S. economy has already entered a recession. They are also independent of our concerns about instability in the European banking system. With regard to Europe’s banking strains, the capital needs of Spanish banks were estimated at modest levels last week only due to the heroic assumption that distressed banks would be able to massively deleverage their balance sheets without amplifying their losses – an assumption that ZeroHedge refers to as deus ex-fudge while begging the question “just who will these banks sell said debt to?”
Both in the U.S. and in Europe, investors seem to believe that the most important challenges are political, which shows up in analyst after analyst spouting the relentless, vague, milk-toast analysis that “at the end of the day, the U.S. Congress and European leaders will do the right thing.” The trouble is that the U.S. and Europe face deep-seated economic problems, not just political ones. Even if the capital needs of Spanish banks are somehow not as wildly underestimated as Greece’s were, or as Spain itself asserted only months ago, half of the continent still carries debt loads that are incongruous with a common currency. Nearly the entire continent is already in recession, which means that those debt loads are likely to increase quickly over the coming year, despite austerity efforts.
Here in the U.S., the federal government is running a deficit approaching 10% of GDP despite suppressed interest costs. If addressing that deficit was just a political issue of doing the “right thing,” what would that right thing be? With total federal revenues at $2.3 trillion last year, and spending at $3.7 trillion, the gap itself represents more than half of total revenues and more than a third of total spending. That gap will not be closed even if lawmakers were to agree to an immediate repeal of the Bush tax cuts in their entirety. Assuming that all of the desired revenue actually showed up, the bump to revenues would only be about $100 billion a year – reducing the deficit by less than one-tenth. In the event of a recession (which we believe is already in progress), the increase in government debt – merely as a passive cyclical response to economic weakness – would swamp that effect even if all the tax cuts were repealed. Likewise, even in the current budget, less than $1.3 trillion represents discretionary spending that is negotiated between the President and Congress. The other spending represents mandatory outlays for Social Security, Medicare, military retirement, and so forth. Well over half of discretionary spending represents military spending. To balance the budget with spending cuts, Congress would have to wipe out discretionary spending altogether, including military outlays. Observers who believe that the fiscal cliff is simply a matter of political disagreement have vastly underestimated the depth of the challenges here.
Economic weakness makes it extremely difficult to reduce budget deficits, which is why deficit reduction plans invariably assume that the economy will grow at nominal rates of 5-6% annually or more. As for spending reductions, we’ve seen the impact of austerity measures in deepening European recessions. Does anyone believe that the U.S. experience would be different and that spending cuts would not suppress economic activity and thereby impact revenues? None of this is to say that deficit reduction efforts should be abandoned, but aggressive timing would worsen an economic downturn, and even in a recovery, progress is likely to be painstakingly slow.
Meanwhile, the Federal Reserve now holds $2 trillion more on its balance sheet than it did three years ago. If it ever has to disgorge this debt, even over time, the sale would crowd out 20% of U.S. gross private domestic investment for 5 years running. These problems are more than a simple political issue of “doing the right thing.” While central banks have successfully created an environment of blissful ignorance of deeper economic realities, they have also encouraged policymakers to waste time that should not have been wasted.
Economists know that there are three ways to deleverage an economy: austerity – where debt growth is held below the rate of economic growth; restructuring – where bad debts are written down or renegotiated; and monetization – where money is printed to make lenders whole at broader expense. In this regard, Ray Dalio of Bridgewater has good-naturedly called the recent experience a “beautiful deleveraging” because it has involved some mix of all three. But it is precisely that beauty that has made it so ineffective, as the global economy and the global banking system have hardly deleveraged at all in the wake of the last credit crisis. The insufficiency of restructuring measures and the excessiveness of monetary interventions have combined to create an environment of moral hazard where increasing debt burdens have been tolerated without durable concern. The hard decisions have been put off to the point where the size of the problem is likely to overwhelm the ability of hard decisions to address it without a crisis.
In regard to a U.S. recession, keep in mind that the consensus of economic forecasters – not to mention central bankers – has never recognized the start of a recession in real-time, largely because their assessments typically revolve around a “stream of anecdotes” approach that treats each new economic report with equal weight, without distinguishing leading/lagging and upstream/downstream structure. For example, we’ve noted that real consumption growth and real income lead new factory orders, which lead employment. Yet observers have already largely dismissed the soft data on income, consumption and factory orders thanks to last week’s single outlier on new weekly unemployment claims. As for the payroll report this Friday, we fully expect that September payroll growth will ultimately be reported as a significant loss in jobs. The main wrinkle, as I’ve noted frequently, is that the “real-time” employment figures in the early months of a recession are often hundreds of thousands of jobs off from where they are ultimately revised (see the economic notes in Late Stage, High Risk). So while Friday’s employment report seems likely to be disappointing, the data tends to be heavily revised, and even the seasonal adjustments amount to hundreds of thousands of jobs, so our expectations for a negative figure may or may not be realized in the initial report.
Last week, the second quarter GDP growth figure was revised down to 1.3%, from the previous estimate of 1.7%. Durable goods orders plunged at a 13.2% rate in August, largely on reduced transportation orders, but even ex-transportation, new orders dropped at the sharpest rate since 2009. It is also notable that Gross Domestic Income – the theoretically equal “income” companion of gross domestic “production” – grew at an annual rate of just 0.1% in the second quarter. The difference between GDI and GDP is nothing but a statistical discrepancy, so the two series track each other very closely over time despite short-term disparities. Because GDI has often led GDP at recessionary turns, Alan Greenspan was well-known for paying close attention to GDI – though not closely enough to recognize that the economy was already in recession when he was interviewed by Business Week in mid-2008, fully two-quarters after that recession had actually begun.
The chart below presents the 6-quarter growth of real gross domestic product (GDP) and real gross domestic income (GDI) since 1950. A good look at this chart provides some insight into why recession concerns have had a “Chicken Little” quality in recent quarters. Note that by the time the 6-quarter growth in income and production has slowed below 2.3% in the past, the economy was always either approaching or already in recession. It’s also worth observing the weakness in GDI growth approaching the 1990-91 and 2008-2009 recessions.
In the present instance, the 6-quarter average of real GDI and GDP growth has been below 2.3% for nearly a year, with no apparent recession, and in fact has bounced around that threshold since 2010. The monetary interventions of the past few years have helped to kick the recessionary can down the road in short-lived fits and starts. Still, they certainly have not been effective in producing sustained recovery (nor should they be expected to – being largely a manipulation of financial markets with no reliable transmission mechanism to the real economy).
The key question is whether the absence of an obvious recession should be taken as an indication that the deterioration in income and output growth can be ignored – in effect, whether we should assume that this time is different. From our standpoint, the evidence from a wide variety of economic series, including but not limited to broad measures like GDI and GDP, continues to indicate that the U.S. economy most likely entered a recession in the middle of this year.
I want to emphasize that I don’t hope for a recession – that is just the conclusion that I believe the best reading of the evidence supports. Sure – if there is no recession, I clearly would rather not have warned of the risk, but I would still prefer to avoid a recession even though that’s what our analysis indicates. It would be a relief to see the data shift away from a recessionary pattern in a durable way, and I would be happier still for stock market valuations and market conditions to support a significant exposure to market risk. Both of those will arrive, but they are not here at present, and I expect there will be some downside first. Our economic challenges will be addressed in time, but they are likely to involve much greater restructuring and much slower progress on deficit reduction than the capital markets seem to contemplate. Europe will solve its problems, but most likely through a departure of stronger countries from the Euro, followed by a combination of aggressive restructuring and monetization. We will get through all of this, and both the economy and the financial markets will do fine in the longer-term, but to imagine that there will not first be major challenges and disruptions is a leap of faith – and a leap over a century of economic and financial history that screams otherwise.
The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Only comments in the Fund Notes section relate specifically to the Hussman Funds and the investment positions of the Funds.
As of last week our estimates of prospective return/risk in stocks remained strongly negative. Strategic Growth Fund remains fully hedged, with a “staggered strike” position that raises the strike prices of the put option side of its hedge closer to market levels, at a cost of just over 1% of assets looking out to early 2013. Strategic International Fund remains fully hedged. Strategic Dividend Value is hedged at 50% of the value of its stock holdings, its most defensive stance. Strategic Total Return continues to carry a duration of about 1.4 years (meaning that a 100 basis point change in interest rates would be expected to impact the Fund by about 1.4% on the basis of bond price fluctuations), with about 4% of assets in precious metals shares, and a few percent of assets in utility shares.
Our unusually defensive stance here, across the menu of financial instruments, reflects the unusually depressed profile of prospective returns in the financial markets, where our estimate of the likely 10-year nominal total return for the S&P 500 remains near 4% annually, 10-year Treasury bonds yield just 1.6%, the Dow Jones Corporate Bond Index yields 2.7%, and even 30-year Treasuries are priced to achieve a nominal yield-to-maturity of just 2.8%. This situation has resulted from ill-conceived monetary policies that force all assets to compete with near-zero interest rates, and have left their prospective returns accordingly diminished. Further quantitative easing seems unlikely to depress these prospective returns materially lower. The compensation for financial risk-taking is likely to improve as a result of ongoing economic, financial and international risks, but that transition from low prospective returns to more meaningful prospective returns is likely to involve significant price declines in the financial markets.
Copyright © Hussman Funds
Sunday, September 30th, 2012
Commodity Stocks: Improving Returns With No Extra Volatility
By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors
Commodities are the necessary building blocks of the world. Glance around you—commodities are what the world needs to live and prosper and are everywhere you look. The world’s seven billion people need resources, and that’s why we recommend investors consistently allocate a portion of their portfolio to a natural resources investment.
Not every investment is the same, though. Even within the commodities space, when looking at measures such as correlation, performance and risk, two indexes can have very different effects on a portfolio’s results.
Take two popular commodity-related indices for example, the Dow Jones-UBS Commodity Index (DJUBS) and the Morgan Stanley Commodity Related Index (CRX).
The DJUBS is made of futures contracts on various physical commodities that represent major commodity sectors such as agriculture, energy, grains, metals, livestock and precious metals. Basically, futures are contracts between a buyer and seller, where the buyer agrees to purchase a specific commodity for a specific price and specific time in the future.
The CRX is comprised of stocks involved in commodity related industries, such as energy, non-ferrous metals, agriculture and forest products.
Yet, while both indices are diversified across various commodities, their correlations to the overall market differ.
Take a look at the matrix looking at 10 years of data. The table lists the S&P 500 Index, which represents the overall U.S. stock market, and the two commodity indices. When two asset classes or investments are perfectly correlated to each other, their performance moves are in sync and they have a correlation of 1; 0 means that the two investments have no correlation to each other.
Over the past decade through June 30, 2012, you can see the DJUBS and the S&P 500 have had a correlation of 0.80. The CRX and the S&P 500 had a correlation of 0.62. This means the CRX is less correlated to the overall market than the DJUBS.
And why is a low correlation beneficial? In a diversified portfolio, it can reduce an investor’s volatility.
In the article “Material World,” Financial Planning found that a low correlation is a “valuable feature” for natural resources mutual funds. When author Craig Israelsen compared the correlation to the overall market to the 10-year annualized returns of 18 natural resources funds with 10 years of performance records, “a clear pattern” emerged. “Natural resources funds with lower correlations (that is, closer to zero) had better performances during this span,” he says.
Over the past 10 years, this pattern was prevalent in the CRX, as commodity producers far outperformed the index of commodity futures.
How to Optimize Your Portfolio with Commodities
So how do correlations and long-term performance translate to your portfolio? One way to look at this would be to create an efficient frontier, which charts a range of allocations to commodities and the overall market to see which portfolio would be most efficient, i.e., which portfolio enhances returns without adding risk.
To find the optimal portfolio between commodities and the overall market, the efficient frontier plots different portfolios, ranging from a 100 percent allocation to an investment in the S&P 500 and gradually increasing the percentage of commodities. Each dot along the path of the efficient frontier represents an incremental increase toward a 100 percent allocation to commodities investment.
First, we chart the efficient frontier of the DJUBS and the S&P 500. A 100 percent allocation to the S&P 500 would result in a portfolio achieving a 5.9 percent return and 20.3 percent annualized volatility.
Assuming the portfolio was rebalanced each quarter, our research found that a portfolio holding 25 percent allocation to the commodities futures and 75 percent allocation to an investment in U.S. equities would decrease an investor’s return by about 0.17 percent while decreasing volatility by a little more than 3 percent. Simply, the addition of commodity futures yields less volatility for about the same return.
A different picture emerges when you chart an efficient frontier for a portfolio invested in commodity equities and the overall market. In a portfolio of 25 percent commodity equities and 75 percent U.S. stocks, an investor reduces their risk by almost 1 percent while increasing their return by nearly 1.5 percent.
How Resourceful Is Your Portfolio?
The charts above illustrate how the power of commodities enhances a portfolio, although a 25 percent allocation may be a little too aggressive. For reference, about 15 percent of the S&P 500 Index is made up of energy and materials companies.
The Global Resources Fund (PSPFX) uses the CRX as its benchmark, and we’re pleased to say that over the past 10 years, the four-star fund* has outperformed its benchmark, resulting in even greater returns for shareholders.
Put commodities to work in your portfolio today.
* The Global Resources Fund earned a 4-star Morningstar Overall Rating™ among 121 natural resources funds as of 8/31/2012. The Global Resources Fund earned a 3-star Morningstar Overall Rating™ among 124 natural resources funds as of 6/30/2012.
Copyright © U.S. Global Investors
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Sunday, September 30th, 2012
U.S. Equity Market Radar (October 1, 2012)
The S&P 500 Index declined 1.33 percent this week, as the market’s euphoria over the Federal Reserve’s decision to conduct open-ended quantitative easing via purchases of mortgage-backed securities and keep interest rates exceptionally low through mid-2015 to boost employment faded. The market continues to struggle with the uncertainty in Europe. Speculation about the Spanish bank stress test continued for much of the week until the results were released on Friday.
- The utility sector rose 0.93 percent and was the only positive sector this week. The utility sector has been the worst performer over the past month and quarter and is a classic defensive, “risk off” group. Risk off was in vogue this week and the sector benefitted from that.
- The health care sector registered the second best performance this week, but did decline 0.25 percent. Cerner Corp was the best performer within health care and rose nearly 4 percent on Friday as a competitor Allscripts Healthcare Solutions Inc. said it is exploring a sale or leveraged buyout. Amgen, Dentsply International and DaVita were also strong performers this week.
- Accenture Plc. was the best performing stock in the S&P 500 this week as the company rose by more than 7 percent. The company reported earnings and raised guidance after the close on Thursday, citing very strong outsourcing trends.
- After a strong run, cyclical sectors have underperformed for the last two weeks as technology, materials and financials were the worst performers this week.
- The technology sector experienced broad-based weakness as market leader Apple fell by more than 2 percent. Netapp, Advanced Micro Devices and Micron Technology were among the week’s worst performers in technology.
- Jabil Circuit was the worst performer this week in the S&P 500, falling by more than 13 percent as the company reported a mixed earnings report, and guidance for the upcoming quarter and 2013 disappointed, a weak global economy was the primary culprit.
- While debasing the value of their paper currencies in the long term, renewed money printing in the developed world may have the ability to send asset prices higher in the near term.
- The market will now shift to earnings preannouncements and the upcoming elections, which could cause some volatility.
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Sunday, September 30th, 2012
The Economy and Bond Market Radar (October 1, 2012)
After rising for the past month treasury yields fell this week as the euphoria surrounding the recent central bank moves dissipated. Bond yields have risen during prior quantitative easing periods as expectations for economic growth pick up. However there are always fits and starts to the process and this week the market refocused on Spain’s continued troubles and some weak data points in the U.S. The chart below shows that durable goods orders for September plunged 13.2 percent, well below estimates. Much of the drop was attributable to aircraft orders but even ex-transportation orders fell 1.6 percent when expectations were for a small gain.
- Consumer confidence unexpectedly rose sharply in September hitting a seven-month high. Consumers were much more optimistic regarding the economic outlook than in August.
- Weekly initial jobless claims fell to a two-month low and are showing some modest improvement.
- The S&P/Case-Shiller’s seasonally adjusted 20-city home price index rose 0.4 percent in July.
- Durable goods orders in September plunged by 13.2 percent, the largest decline in over three years.
- The Business Roundtables’s third quarter CEO Economic Outlook plunged to 66 from 89.1 in the second quarter. CEO’s confidence is the weakest since the third quarter 2009 on concerns surrounding the “fiscal cliff’ and a weak global economy.
- There was considerable speculation about the prospects for government policy action that would support the economy or stock market. The Chinese markets will be closed next week for a holiday and this is often when the government announces policy changes.
- Interest rates are likely to remain very low for the foreseeable future.
- Europe remains a wildcard with the markets shifting focus on a weekly basis.
- China also remains somewhat of a wildcard as the economy has slowed and officials appear in no hurry to take decisive action.
- Brazil raised its inflation view and dimmed hope for additional rate cuts. Brazil was one of the first countries to cut interest rates around this time last year.
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Sunday, September 30th, 2012
Gold Market Radar (October 1, 2012)
For the week, spot gold closed at $1,772.10 down $1.00 per ounce, or 0.06 percent. Gold stocks, as measured by the NYSE Arca Gold Miners Index, lost 2.01 percent. The U.S. Trade-Weighted Dollar Index gained 0.76 percent for the week.
- Gold prices continued to remain firm over the last couple of weeks.
- Gold stocks, on average, lost a little ground over the past week but pretty much are at the same levels as two weeks ago. The important point is that the strong march upward was not followed by an equally strong reversal in prices.
- Central banks continue to buy gold to supplement their reserve base. Ross Norman, CEO of brokerage firm Sharps Pixley, noted that banks are clearly concerned about bolstering their reserves with asset classes that maintain their value in the long run.
- South African gold mining shares traded lower than their North American peers over the course of the week.
- Strikes at Gold Field and Anglogold shut down as much as 39 percent of the country’s capacity. Angolgold noted there were work stoppages at all of their operations. Harmony Gold remained unaffected by the strikes.
- Higher wages and strike-related downtime are likely to depress the margins for the South African gold miners.
- Klondex Mines reported a drill intercept which carried 2,910 gram/ton (85 ounces/ton) over a 1.5 meter at their high-grade Fire Creek project in Nevada over the past week.
- In addition, earlier this month Paul Andre Huet joined Klondex Mines as its new President and CEO. Huet brings 25 years of high-grade, narrow-vein gold mining experience to the table for Klondex. Previously Huet led the team which built and permitted the Hollister Mine and was Mine Manager at Newmont’s Midas mine, both of which are in Nevada.
- While North American gold producers have been reluctant to buy their junior peers at greatly reduced prices, the Chinese gold producers have been on a shopping spree. Zhongrun announced plans to buy a 42 percent stake in Noble Minerals which has a gold mine in Ghana that is expected to recapitalize the operations to produce 150,000 ounces per year. Shandong Gold also announced plans to buy a 51 percent stake in Australia’s Focus Minerals, Zinjin Mining bought Norton Gold Fields, and China National Gold is in talks to buy a stake in African Barrick.
- While we have had a strong move in the gold price, two things are missing – China and India. Gold demand in India has plunged due to a weaker currency, slower economic growth and higher taxes. Chinese demand in the second quarter was 145 tons, down 43 percent from the first quarter. The slide in the Shanghai Stock Exchange Composite Index continued into the third quarter with the index hitting three-year lows. The return of these two players to the market should give gold a meaningful lift in prices but we need to see an improvement in their growth prospects.
- South Africa remains challenged by the labor strife. Junior mining companies and new IPOs will likely be challenged to raise new funds to further their development in the near term.
- Earnings reporting season for the gold stocks will start in October but with the dip in prices early in the quarter and subsequent rebound, we may not see meaningful quarter-over-quarter growth metrics. In addition, with the completion of the third quarter and the rise in prices into the quarter end, we may see some profit taking in early October. Don’t get too bearish though, the governments around the world are just warming up the printing presses.
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Sunday, September 30th, 2012
Energy and Natural Resources Market (October 1, 2012)
- Natural gas jumped 14 percent this week to the highest level this year as concern eased that stockpiles will reach storage limits before winter weather boosts demand for the heating fuel. Weekly Department of Energy data showed inventories increased by 80 billion cubic feet to 3.576 trillion in the most recent week while peak working gas capacity is about 4.239 trillion, department data shows. The futures have rebounded 73 percent from a 10-year low in April as rising power-plant demand eroded the biggest supply glut in six years.
- U.S. farmers maintained their record pace of harvesting corn and soybeans during the past week but farmers were not fully running their combines due to some rainy weather.
- Dow Jones reported that Anglo American, the world’s third-largest producer of coking coal, plans to reduce coking coal output in the coming months as it reviews its existing operations and projects due to weak coal prices and high costs.
- Baoshan Iron & Steel Co., China’s largest listed steelmaker, suspended production at a plant after demand fell for slabs used to make ships and bridges. “A downturn in demand in the downstream slab market” prompted the stoppage, the company said in a statement to Shanghai’s stock exchange yesterday, without elaborating on when production may resume. Production was suspended “to avoid increasing our operating losses,” it said.
- The People’s Bank of China (PBOC) has injected a record amount of money into the financial system this week to alleviate short-term liquidity concerns. The PBOC issued Rmb365 billon of reverse repurchase agreements over the past three days, the largest weekly amount in history. The cash inflow was effective immediately, causing the seven-day repurchase rate to fall 100 basis points from the three-month high of 4.75 percent reached earlier in the week.
- The Financial Times reported that South Africa would allow “fracking” in what could potentially be the fifth-largest shale gas reserves in the world and provide a major boost for energy, jobs and reduced pressure on coal production. South Africa has lifted its two-year moratorium on fracking; now all it needs is to find the water for the process in the Karoo desert. European nations that host shale gas are perhaps hoping that successful development of South Africa ‘s gas will encourage work in their countries.
- The Financial Post reports that “When the Fukushima nuclear disaster unfolded in March last year, even the most optimistic investors knew the uranium market was in for a rough ride – they just didn’t think it would last so long. Eighteen months after the incident, uranium prices continue to hit new lows. The spot price sunk 50 cents to $46.50 a pound this week, which is the lowest level since 2010, according to Ux Consulting. Investors briefly drove the spot price above $135 in 2007. The long-term price has also declined, though it is higher at $60, reflecting the fact buyers will pay more for material delivered mid-decade or later.”
Sunday, September 30th, 2012
Emerging Markets Radar (October 1, 2012)
- China’s official Xinhua News Agency released two very important announcements today. First, the Communist Party of China will hold its 18th congress on November 8, 2012. Second, China charged former Chongqing boss and leadership challenger, Mr. Bo Xilai, for crimes including corruptions and his responsibilities in the murder of a British national, Neil Heywood. This should put to rest speculation over the leadership transition and other political issues, therefore removing a political risk premium from the equity market in China and Hong Kong.
- The A-shares market rebounded for the last two days of the week after the Shanghai Composite Index reached a three-year low at the 2004 psychological level. The market saw domestic fund companies and government pension plans buy into cheapness.
- Philippine’s government reported a surprise budget surplus for August 2012, though through slower spending growth.
- Indonesia’s central bank still expects GDP growth at 6.4 percent for 2012, and to improve its current account deficit in 2013.
- The Czech central bank cut interest rates by 25 basis points this week in an effort to boost economic growth.
- Singapore’s August industrial production contracted 2.2 percent, below consensus. The contraction was led by transportation engineering (down 20 percent) and electronics (down 7.3 percent).
- Thailand announced August export was down 6.9 percent, versus consensus down 5.8 percent. Exports to all key market contracted, led by Europe (down 23 percent), ASEAN 5 (down16.8 percent), Japan (down 12 percent), and China (down 8.6 percent).
- Guangzhou city in Guangdong province limited pre-sales for some home projects that have “excessive high prices.”
- Driven by domestic construction and consumption, Thailand bank loans are growing more than 15 percent year-over-year.
- The tension between Japan and China caused Japanese vehicle sales to slow in China and cancellations of Chinese tourist bookings to Japan. In the event of a military conflict between the two countries, global trades and economic recovery will be affected.
- The Brazilian central bank raised its inflation forecast for 2012 to 5.2 percent from 4.7 percent, citing recent fiscal stimulus. Stimulative monetary policy action now appears unlikely.
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Sunday, September 30th, 2012
The world’s largest hedge fund is not located in the top floor of some shiny, floor-to-ceiling glass clad skyscraper in New York, London, Hong Kong or Shanghai. It isn’t in some sprawling mansion in Greenwich or Stamford which houses a state of the art trading desk behind a crocodile-filled moat. Instead it can be found in tiny, nondescript office in Suite 225 located on 730 Sandhill Road in Reno, Nevada.
“That’s not possible” one may say – the world’s largest hedge fund is Ray Dalio’s Bridgewater, which at last check had about $100 billion in AUM (and which has so far had a less than stellar performance in 2012, underperforming the S&P by a substantial margin). Turns out it is: the fund which was at $117.2 billion as of June 30, and which has lately been growing at a pace of about $15 billion per quarter (which would put it at about $130 billion currently), is none other than Braeburn Capital, a Nevada-based asset management corporation.
Who is Braeburn?
Braeburn is a subsidiary of another far more famous company, which since 2006 has had one simple task: manage the cash of the parent company.
At Braeburn’s inception, the cash pile was modest, yet absolutely massive in unlevered terms, at just over $10 billion. Fast forward 6 years, and the massive cash pile has now grown to be epically gargantuan. Of course, the parent company in question is none other than Apple, whose publicly reported cash horde at June 30, 2012 was a whopping $117,221,000,000. This is the AUM of Braeburn.
Any substantial follow up diligence on Braeburn will not reveal much if anything.
CapitalIQ has the following description of the firm: “Braeburn Capital Inc. is the asset management arm of Apple Inc. The firm invests in the public equity markets. Braeburn Capital Inc. was founded in 2006 and is based in Reno, Nevada.” And that’s it – there is no breakdown of which “public equity market” investments Braeburn is invested in, as is to be expected.
Bloomberg provides the following minimalist information:
Some more useful information cn be found in the Nevada Annual Report of tax-filing entities:
- Entity Name: BRAEBURN CAPITAL, INC.
- Filing Status: Active
- Date Filed: 10/03/2005
- Type: Domestic Corporation
- File Number: E0667452005-7
It also lists the firm’s principals:
730 Sandhill Road
Reno, NV 89521
730 Sandhill Road
Reno, NV 89521
730 Sandhill Road
Reno, NV 89521
The LinkedIn profile of Braeburn CIO Steve Johnson is also rather bland:
As is that of Braeburn Portfolio Manager Ted Mulvaney, who before taking over capital allocation of tens of billions worked at a fund named for a Douglas Adams planet.
Oddly enough, the only actual personnel link between Braeburn and Apple can be found in the profile of principal Gary Wipfler who just happens to be the official Treasurer, and thus as expected, the person responsible for the mega cash stash of the behemoth tech company.
For some other clues on Braeburn one has to go to the NYT, and a certain article discussing AAPL’s ability to legally and quite successfully bypass American corporate tax laws.
In 2006, as Apple’s bank accounts and stock price were rising, company executives came here to Reno and established a subsidiary named Braeburn Capital to manage and invest the company’s cash. Braeburn is a variety of apple that is simultaneously sweet and tart.
Today, Braeburn’s offices are down a narrow hallway inside a bland building that sits across from an abandoned restaurant. Inside, there are posters of candy-colored iPods and a large Apple insignia, as well as a handful of desks and computer terminals.
When someone in the United States buys an iPhone, iPad or other Apple product, a portion of the profits from that sale is often deposited into accounts controlled by Braeburn, and then invested in stocks, bonds or other financial instruments, say company executives. Then, when those investments turn a profit, some of it is shielded from tax authorities in California by virtue of Braeburn’s Nevada address.
Since founding Braeburn, Apple has earned more than $2.5 billion in interest and dividend income on its cash reserves and investments around the globe.
Naturally, Apple is less than eager to discuss the role of its Nevada asset manager:
Apple declined to comment on its Nevada operations. Privately, some executives said it was unfair to criticize the company for reducing its tax bill when thousands of other companies acted similarly. If Apple volunteered to pay more in taxes, it would put itself at a competitive disadvantage, they argued, and do a disservice to its shareholders.
There is much more in the NYT article, but in short, while Apple for now uses Braeburn primarily in its capacity to find legal tax loophole all around the world and avoid paying taxes, there is no denying that with a cash balance that in a two years may be well over $200 billion, applying even a modest amount of leverage would make AAPL the best capitalized bank, mutual fund or asset manager in the world.
What’s more, Braeburn has no reporting obligations: there is no Investment Advisor Public Disclosure (IAPD) entry on Braeburn for the logical reason that it is not an investment advisor: it merely manages an ungodly amount of cash for AAPL’s millions of shareholders. There is also no SEC filing 13-F filing on Braeburn’s holdings. As such, not confied by the limitations of being a “long-only”, it is in its full right to hold any assets it feels like, up to and including CDS on housing, puts on Samsung, or Constant Maturity Swaps that pay if the 10 Year collapses. It just doesn’t have to report any of them.
Nobody knows: and that’s the beauty of Braeburn. It is the world’s largest hedge fund that is not really a hedge fund, nobody has heard of, and nobody knows just what assets it holds.
Which is precisely what Apple wants. Incidentally, what Apple probably wants more is to keep the status quo as is. However, with the topic of finding effective tax loopholes which are perfectly legal, yet which apparently are unfair, serving as the basis of the entire presidential race to date, what Apple can be absolutely certain of is that once the farce culminating on November 6 is over, the government’s eye will finally turn to minimizing “externalities” among such companies which have been able to pass through corporate tax savings to end consumers by abiding within the legal system that countless other muppet congressmen, senators and presidents have developed over the ages.
Because while AAPL may have built the iPhone, very soon it will be only fair that it share its profits acquired over the years, and thus its cash balance, which at last check was double that of the US Treasury, with the general public.
At that point Braeburn will almost certainly be a household name.