August 22, 2009

Market Insights - 22 August 2009

Dear Friends & Fellow Investors
Here is the last update for August. Next week, we will take a break and be back in early September.
In case of questions, please email: Enjoy reading!

In This Week's Issue
▪ Weekly Snapshot
▪ Chart of the Week
▪ Video of the Month
▪ Video of the Week
▪ More On Correlation
▪ More on ETFs
▪ Recommended Read
▪ Energy Markets
▪ A Lesson In Economics

Weekly Snapshot
• Oil price reached $74.72 on Friday - highest level of 2009 (Reuters)
• Bernanke: US economy on verge of recovery and worst of crisis is over, but challenges remain (AP)
• Sales of existing homes in the U.S. jumped 7.2% in July (Reuters)
• Japan’s economy grew by 0.9% in Q2 or 3.7% at an annualised rate (Economist)
• US mortgage delinquencies hit record high in Q2 - more than 4% of all borrowers in foreclosure (AP)
• US index of leading economic indicators rose 0.6% in July, 4th month of positive gains (
• PetroChina to buy natural-gas for US$41 billion, Australia’s biggest-ever trade deal (Economist)
• Canada consumer prices down -0.9% in July (
• On Wednesday, the Shanghai Composite Index closed at 2,761 - 20% down since early August (Yahoo!)
• German producer prices down -7.7%, largest fall in 22 years (
• 20% of Spanish mortgages may be at risk (
• German investor confidence rises to a 3-year high (
• US housing starts in July decreased 1% to 581k and are now down 37.7% over the last year (
• US wholesale prices dropped 0.9% in July, more than expected - hit record-low over past 12 months (AP)

Chart of the Week
Nice overview of the European economies. Interactive map is available at

Video of the Month
To put the recent comments by Fed Chairman Ben Bernanke (see above) into proper context, please consider this must see video! Professor Elisabeth Warren, chair of the congressional oversight panel, gives a scathing review of PPIP (the public-private investment plan) and questions the US policy responses that have still left toxic assets on the balance sheets of some of the biggest banks. Watch her response on the MSNBC question: In hindsight was Paulson right? If Congress did not write that $700 billion check would banks have collapsed?

Click here to watch the interview

Video Of The Week
Please consider: Unusual Relations: Stocks, Commodities and the Dollar Move in Sync

Edward Morse, head of economic research for LCM Commodities, gives a concise overview of the relationships of various asset classes. In his view, the currently near perfect correlation between various markets is unusual and cannot last because of basic fundamentals and market cycles which are important components of prices for commodities. He also predicts that both oil and gold will be range bound for the foreseeable future and that the US$ will gradually depreciate over time. While his views aren't at all surprising, what strikes me is the clarity and serenity with which he explains his views. I highly recommend spending 5 minutes to watch this.

More On Correlation
As our video of the week suggested, correlation between various markets and asset classes has been unusually high. The downside of this symptom, clearly evidenced during the financial crisis of 08/09, has also been a major blow to the widely accepted investment mantra of diversification, a main pillar of modern finance. As we discussed in "Thoughts about Markets" (Market Insights11-July-2009), diversification doesn't always work and when it doesn't, the effects can be devastating (see chart below).

Not much has change with regard to the same markets as the chart above depicted. However, notable exceptions (see chart below) are the outliers; emerging markets (light green) were outperforming and real-estate (turquoise) was still lagging behind the rest of the markets since the beginning of this year.

Aside from fixed income, global equities probably showed the highest correlation in the past 2 years. In plain language, if you thought you were diversified by investing in various overseas stock markets, you were mistaken. No matter where you invested in 2008, there was simply no place to hide.

Despite the fact that all these markets are seemingly working in tandem, there are some interesting exceptions. In the above mentioned video of the week, Edward Morse pointed out copper, heralded as the "new gold". When you look at the comparative performance of the two commodities, it becomes clear where "the new gold" got its name from.

More On ETFs
Please consider: Leveraged and Inverse ETFs: Not Right for Everyone

Recently, there has been a growing awareness among financial services providers and brokers that certain ETFs, while popular, may need a fair bit of warning for unsuspecting investors. Perhaps too many investors have been burnt from an investment choice that was supposed to provide some enhancement to their portfolios. The basic concept of these leveraged and inverse ETFs is deceivingly attractive. If, for instance, you were pessimistic about the US stock market in the near term, you could consider an inverse ETF, providing an opportunity to rake in some profits during market declines. By contrast, if you were bullish about the US market earlier this year you could have bought a leveraged ETF to take in additional upside potential in the hope of recouping some losses you may have had in 2008. But not so fast...

We discussed ETFs on numerous occasions, most recently at: Market Insights - 1 August 2009 and specifically with regard to leveraged ETFs in: Market Insights 6 June 2009

The warnings and disclosures are available via prospectuses, fine print etc. and a thorough and experienced investor would take the time to read those. But as I pointed out before, all these ETFs are available under the same ETF umbrella and they can be bought and sold just like any other share. You don't ever have to read a prospectus, just place an order with your broker as if you would with any stock transaction. That creates somewhat of a dilemma for the brokers and more warning signals are being sent out now.

The examples provided in the Schwab article above are not new but they help to remember how vast the difference can be between perception (naïve expectation) and actual performance.

It is somewhat unfair to consider an average investor "naïve" and if our regulatory system were to operate with a common sense approach (as we discussed at great length in: Market Insights - 15 August 2009), a simple minimum requirement for investment experience and/or financial net worth would do the trick in preventing massive damage. In terms of the brokers, they could have easily qualified their clients before such transactions were allowed. The fact that is hasn't been done (yet) and presumably the brokers have been waiting until someone complains (the buyer beware approach), speaks for itself.

Albeit on a different scale, the practice is not unlike the "no-doc" or "zero down" mortgages. A combination of greed and ignorance can be lethal and the key here, as with the sub-prime mortgages, is leverage. Typical margin requirements to trade stocks are 50% in the U.S. i.e. a leverage of 2:1. Increasing that leverage creates additional risks in addition to the often highlighted upside potential. Let's face it, leveraged and inverse ETFs are essentially derivatives, the famously quoted "financial weapons of mass destruction". Anytime the typical 2:1 leverage is exceeded, either via ETFs or other derivatives, an average investor should be pre-qualified in the same way you have to qualify when trading options or other derivatives.

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Good luck & good trading!

Neither the information nor any opinion contained in this communication constitutes a solicitation or offer by us to buy or to sell any securities, futures, options or other financial instruments or to provide any investment advice or service. Each decision by you to do any investment transactions and each decision whether a particular investment is appropriate or proper for you is an independent decision to be taken by you. In no event should the content of this email be construed as an express or an implied promise, guarantee or implication by or from us that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance.

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