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07/13/2011 11:30 am EST
Two themes have emerged as international markets gain their footing after the Greece imbroglio, and two opportunities in particular are presenting themselves, notes Jack Colombo of the Forbes/ISA Closed-End Fund & ETF Report .
Commodities are this month’s big winners. And within the commodity space, it is becoming clear that exchange traded notes (ETNs) are the way to play commodities.
Why? Raw commodities require playing in the futures market. ETFs have the disadvantage of having to roll over their investments each month into a new forward contract.
If expectations are that the commodity will increase in price, new contracts will be more expensive than the expiring contract. Therefore, investors using ETFs face a headwind in this regard.
ETNs don’t have this problem, because they promise the return of the underlying commodity without having to play the futures market. The only tradeoff here is that of the credit status of the issuer.
This month’s losers were a strange combination of high tech and timber. The iShares S&P North American Tech (IGN) was down 13.29%. This fund invests in companies that supply the technical means for media and wireless communications. The iShares S&P Global Timber & Forest ETF (WOOD) was down 12.55%.
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Commodities have done well in the past month, but we expect a correction in the near term. However, they are an excellent hedge against inflation, since they are a real asset that doesn’t depend on the performance of companies that are involved in extracting them.
In addition to being an inflation hedge, they also have a low correlation with stocks, and an even lower correlation with bonds. This means that commodities are an asset class that can vary independently of stocks and bonds.
We checked out some broad-based commodity funds, and found one that has the best liquidity and is optionable: The iPath Dow Jones-AIG Commodity Index Total Return ETN (DJP).
ETNs have an advantage over other funds in that they don’t have to pay out distributions, and are treated like a zero-coupon debt instrument or a promissory note backed by Barclays. Since this is a debt instrument, the credit rating of Barclays is important (it stands at AA-/Aa3).
The note comes due on June 12, 2036, at which time the investor can receive cash; or she can sell it at any time before redemption.
The fund tracks several commodity sectors. The fund has 34% invested in the energy sector, 29% in the agricultural sector, 16% in industrial metals, 13% in precious metals, and 6% in livestock. The fund tracks 19 futures contracts.
This ETN will tend to be uncorrelated with the broader equity market. Barclays invests in the respective futures contracts and keeps any remaining cash in Treasuries. [The fund currently trades just under $49—Editor.]
NEXT: Emerging and Frontier Market Pick|pagebreak|
Emerging and Frontier Market Pick
A number of emerging and frontier markets have also shown excellent gains.
The biggest winner was the Market Vectors Egypt Index ETF (EGPT), which was up 6.75%. The turmoil in Egypt has calmed down a bit, and this seems like a bounce—the fund was down 10.03% for the last three months, and down about the same amount for the past year.
Despite the speculation of a coming debt crisis, The Spain Fund (SNF) came in second with a gain of 5.13%. Russia also did well, with funds making the top seven.
The big losers were the China funds. The worst performing was the Global X China Technology ETF (CHIB), which was down 14.03%, followed by the Guggenheim China Technology ETF (CQQQ), down 12.73%. China stocks have been plagued by a number of accounting frauds, resulting in trading halts that have lasted for months.
Apparently, having one of the big three accounting firms do your auditing doesn’t help if the company lies about its financials. Perhaps the accountants will learn to go to the bank, see if there is a bank, and if there is, see if the company actually has any cash on deposit.
China has a deflation/inflation problem, and corruption runs throughout the economy. Central planning doesn’t work in the long run…and a misallocation of resources is sure to happen in their economy.
The European economy is tied into a pretzel because of the Greek debt crisis. Austerity measures won’t be enough to stave off eventual default, and taxpayers in Europe won’t always keep throwing good money after bad. Greek social unrest doesn’t help either.
The consequences of a default will hit American banks as well, since they have written insurance in the form of credit-default swaps on Greek bonds held by European banks.
Japan is still dealing with earthquake consequences, including crippling power shortages. However, there is an unlikely island of stability in the world. Latin America, despite its history of musical-chair governments, has stabilized and is seeing solid economic growth.
The Aberdeen Latin America Equity CEF (LAQ) invests in the Latin American market and makes payouts twice a year, in September and December. It doesn’t pay a regular dividend, per se, but makes payouts based on long and short-term capital gains plus income.
It currently trades at a discount to its net asset value of 8.46%, generally in line with its one-year average discount of 8.31%. The average price-to-earnings ratio of its holdings is a relatively low 14.64.
Its largest stock investments are in Brazil at 64%, Mexico at 24%, and Chile at 6%. It is oddly invested in Luxembourg, but at only 3.6%.
The fund presents a good way to invest in the growth of Brazil at an 8% discount. It is not leveraged and 100% invested in stocks. The largest sectors are Financials at 22%, Consumer, Non Cyclical at 17.5%, and Basic Materials at 16.30%. [The fund closed trading on Tuesday at $37.70—Editor.]
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