In May 2007 I put up two posts on this blog related to uranium.  The first was “Uranium Mania” which discussed the astronomical price chart for uranium prices.  One of the easiest ways to gain exposure to the commodity price, as opposed to the producers, is via Uranium Participation Corp (U).  Interesting how that post was written very close to the peak of uranium prices.

At that time, my thinking was that any exposure to uranium would best be accomplished with a combination of U plus Cameco.  Here’s the chart for Cameco over the past three years:

Very different performance patterns between the commodity and one of its major producers.  But it wasn’t until mid-August of last year that Van Eck came out with the first nuclear energy related ETF, the Market Vectors Nuclear Energy ETF (NLR).

For some reason, BGI with its newly listed iShares Global Nuclear Energy ETF (NUCL), must feel like being “second to market” ain’t half bad if the longer term outlook is strong.  I’m posting this blog after having seen this article in Canada’s Financial Post which gives some bullish views given the recently depressed price and a demand situation here in Ontario.  My interest is more related to significant energy policy shifts in the US (regardless of who wins the White House) and even more importantly, the choices made in the emerging world.  The developed world (well, mainly the US) complains about the relative lack of participation of the developing world in environmental policies such as Kyoto.  However, evidence from the annual reports of major uranium producers suggest that the market for them is the emerging world and that’s where they see the future growth.  Who would call that surprising?  Aside from foreign policy roadblocks for concerns that perceived unfriendly regimes would produce weapons grade materials, the necessity for the developing world to access nuclear energy is clear.  How can they compete with the US, China and larger (& more powerful) nations for oil?  I think they need alternative energy sources even more than the big guys.  I’m still a longer term bull for uranium.  The question is whether the exposure should be to uranium prices, the producers or a combination.

Well, aside from Uranium Participation Corp traded in Toronto, there are also uranium futures traded on the NYMEX.  The futures contracted started trading about the same time as my blog from May 2007 … as usual product development seems to be a decent market top provider.  And yes, it’s cash settled … no jokes about delivering 250 pounds of uranium.  That’s about it.  I’m kind of surprised that firms like ETF Securities in London or PowerShares (with their association to Deutsche Bank) haven’t created a uranium price tracker given their expertise in ETFs with futures based underlyings.  It’s just a matter of time.  I’m thinking that it would be nice to have this now and NOT near the next intermediate term top.

To go after the producers, like I said before, we now have two ETFs.  From a year ago, my simplified approach was to put it all in Cameco but for the passive fan, the ETFs would be the way to go.  Since NUCL only came out only about two weeks ago, we can’t do much comparison shopping.

Both have global exposures.  The newer NUCL is about 20bps cheaper in fees but with less holdings at 25 versus 38 for NLR.  The list of holdings for NUCL and NLR show some clear differences in the top 10’s in each as well as proportional weightings.  But what seals the deal for NLR over NUCL is the sector allocations.  Take note that for NLR, the breakdown of the top three sectors is 31% nuclear generation, 29.5% plant infrastructure, 28.8% uranium mining, with the remainder in uranium storage, nuclear conglomerates, uranium enrichment and nuclear fuel transport.  NUCL’s top exposure is in utilities (54.2%).  Their remaining catergory names are relatively generic like “energy”, “industrials” and “financials” (in that order, actually) and so part of their flaw is not doing a better job educating investors on the real uranium sub-sector breakdowns.  Hey, isn’t BGI the experts in ETF education?  You know I just like pickin’ on the big guy.

So, bottom line, this might be a decent time to get in to nuclear/uranium as an alternative energy and emerging market play.  The holdings list does not give enough information on its own so a bit of homework is required to see how much of each name is actually going out to places where energy infrastructure for the longer term is a concern.  Because the uranium producer space is limited to a few big names and many microcaps, it’s a tough call.  Pick a few of the big producers and you’ll do fine but if you’re from the industry or are a commodity freak, hopefully you’ve got some talent in picking the future successful producer (who will likely get acquired by one of the big guys).  Since that’s a tough sport, I think the focus should be on the uranium price for the longer term.  With limited instruments available, the challenge now is to decide between Uranium Participation Corp and uranium futures.  Until, that is, an ETF or ETN for this commodity gets launched.

News today from the Associated Press about an early start to this year’s storm season. It’s a subtropical storm, not even a tropical storm never mind a hurricane, but with all the craziness in weather patterns in recent years, you can never be too cautious or prepared. On the investing side, this gives us (investors keen enough to read this blog!) some lead time before the official start of hurricane season which is June 1st.

First, some background reading on weather derivatives:

This article from Canadian Investment Review is from back in 2002 so you can see that weather derivatives are really not that new as an asset class. The article was written by Jason Wei, a professor of finance at the University of Toronto. This is a powerpoint presentation from Wei and Melanie Cao of York University. It’s even older but gives some deeper understanding of how the weather derivatives markets evolved to that time, the types of instruments available and the basic strategies for use.

One of the big problems cited from that time was the lack of investor interest and the resulting issue of liquidity. With hedge funds actively participating in the weather derivative markets especially over the past few years (along with re-insurance/catastrophe bonds due to the spike in extreme hurricane activity), this is not as big an issue. The purpose of these documents is simply to give an idea of where this quite esoteric area of investing came from. I mean, if you tell your friends that your recently established investment is dependent on the heat in Baltimore, you won’t get that funny look?

Now, let’s focus on where we are today. Here’s the link to the Chicago Mercantile Exchange’s weather derivatives website. In the opening paragraph near the top, I found the last sentence quite interesting:

This sector of hedging and risk management products represents today’s fastest growing derivative market.

Fastest growing derivative market. Well, I suppose the other broad areas of equities, interest rates, currencies, commodities and real estate have built well established markets in this space so weather derivatives, despite being around since 1999 (at least on the Merc), are still the new kids on the block. But perhaps it’s also the added focus from the press on the global warming issue and personalities like Al Gore that have moved environmental finance forward as part of a broader solution to what is clearly a massive problem.

Once you arrive here to this site, you’ll see a list of weather contracts, many of them related to temperature but some that I think are quite interesting like the ones for frost and snowfall. Here in Toronto, we’ve been experiencing summer-like weather for the past week and a half. We have no spring or fall here, just a long winter and about four months of summer. I exaggerate but unless you live up here, you just won’t get it. The idea of profiting over the cold months sounds appealing. The idea of profiting from times of heavy snowfall can somewhat compensate any northerner’s aching back after shoveling their driveway. A snowblower would make sense but I’ve just discussed the massive environmental problem, right?

But, of course the reality is that there are many industries who rely on these derivative instruments for serious hedging needs. Think of a utility whose electricity usage spikes up during a heat wave. And, of course, there are the hedge funds on the other side willing to take their bet. Again, one of the popular areas in this field is in hurricane futures which is one of the instruments listed on the CME website. According to this section of the website:

The CME Weather Product group has added CME Hurricane futures and options on five U.S. defined areas - Gulf Coast, Florida, the Southern Atlantic Coast, the Northern Atlantic Coast and the Eastern U.S. The underlying indexes will be calculated by Carvill, a leading independent reinsurance intermediary in specialty reinsurance that tracks and calculates hurricane activity. These contracts will begin trading March 12, 2007 for the 2007 hurricane season that begins June 1.

You would think that this type of recent product development would be getting a lot of press, but I just don’t see it. Good for me and my little blog but if this was an ETF? Sheeesh! There’d be coverage left-right-and-center. Probably most of it would talk about how the industry was yet again finding another thin slice of the market to exploit with an ETF product offering.

But hey, weather is an attractively uncorrelated asset class and I’ve discussed at length and in too many occasions about the fact that this investing world is troubled by highly correlated asset classes leading to synchronized, and due to the multiple compounded herd mentality, sharp down markets.

There’s a lot on the CME website and from the previously cited CME Weather Products main page, the tabs for Education and Resources should provide more than enough background before you begin to implement. Just don’t think that you’re ahead of the curve by exploring of actually entering into this market. Take a look at this chart showing, no surprise, another market with recent explosive growth:

This global liquidity thing … it’s really something. If there’s a market for something out there that isn’t getting a ton of attention and money, it’s a rarity. Domestic automobiles and not much else, I think. This chart cites its source but I found it from this good article from Financial Engineering News. The article is interesting as it gives a nice story as to who is interested in these instruments and why.

For me, someone interested in the asset allocation problem, I’m interested in understanding how plugging something like a weather derivative will affect the overall performance of a globally diversified asset allocation program. As someone also interested in underlying beta risks in multi-strategy and fund-of-hedge fund mandates, I’m keen on knowing if these instruments are useful ingredients in a recipe to provide the appropriate short overlay to offset unwanted long market exposures.

Many different reasons to consider these new products. For many who are simply fascinated by the strength of recent hurricane seasons, perhaps a visit to the National Hurricane Center website might provide evidence to entice them into the new hurricane futures market. To each their own, but I can’t stress enough the need for uncorrelated investments and this area is one of the few that requires investor attention.

With recent news of uranium futures contracts available through NYMEX beginning yesterday (May 7th), I was looking for a price chart for the spot price just to get my bearings on its rise which has been well publicized. It really is funny … go to Google, above the text box, choose “Images” and enter “Uranium price” for your search. You’ll get a LOT of uranium price charts all going from the bottom left to the top right. No surprise. But you’ll open one chart, say this one and you’ll think that the price is somewhere around 85.

The heading says that the data is up to February 2007, so your first guess is that this is a fairly up-to-date chart to start with. But then, through the same list of findings from your Google search, you also will find this chart:

Basically, this second chart only covers the rightmost section (roughly 1/5th) of the first graph. More importantly, this chart adds another couple of months which end up being significant as the uranium spot price has spiked even higher from around $85 to $113. That’s a 33% return in two months. That’s amazing but having this occur after a doubling of its price every calendar year for the past several years is actually quite scary. Kudos to anyone who jumped on uranium early (pre-2004) but a bigger and surely envious “congrats” to anyone who’s held on up till now.

From early April to early May, the price has remained quite flat around $113 and the second chart above (as with most short-term charts of uranium) shows that there are several instances where uranium prices will remain quite level for a period of weeks, if not months.

My point is that uranium has been rising (and rising and rising) over the past several years and to even have a 2-month old chart (geez, even a 2-week old chart in many instances) is playing with stale data.

Of all the news and commentary on this new futures contract, I found this article to be most insightful. It covers a lot of ground in a short read but similar to many of my posts, it goes into potential problems with this new derivative … just some things to think about before you dive in.

Also of note, NYMEX has teamed up with UX Consulting (provider of the 2nd chart above) on this derivative instrument and UX’s website is a great source of information for uranium in general as well as latest price charts … so you won’t have to go Googling for the latest chart.

With the way the ETF industry is moving, you’ve got to imagine that there are a lot of eyes on the launch of the uranium futures. The UPI article above discusses the issue of holding the underlying commodity. There are more than a few hurdles to deal with for an ETF launch for direct exposure to uranium prices. I’ve mentioned this in a few posts in the past but up here in Canada, the Toronto Stock Exchange lists Uranium Participation Corp (U) which might be the easiest way to gain exposure.

I titled this posting “Uranium Mania” simply because of the incredible parabolic curve of the price chart. The move to derivatives can, and likely will, help provide greater access to this market as would an ETF. I’m guessing that quite a few ETF manufacturers (and it’s not at all difficult to guess who they are) are watching developments with the new futures contracts and already have their business development people sniffing around to get a sense of demand for an ETF. News of an ETF would definitely bring us closer to a mania and it’s not difficult to forecast the final stages of the climb if this were to happen.

I’m thinking of an instrument (or instruments) that allow for upside and downside exposure to uranium prices that would best be accepted by the marketplace. Again, if you’ve been following this industry, a very short list of ETF developers come to mind.

But until then, for uranium plays it’s either:

1. Stock selection with big producers like Cameco and a small number of relatively large competitors but a large number of very small producers.

2. Uranium Participation Corp (and the added FX risk for non-Canadians)

3. Uranium futures with more information here

Good luck out there. Don’t get burned (sorry … bad one).

Recent news of more commodity ETFs (actually ETCs trading out of Paris) makes me wonder about some of the truly “high flying” sectors within the commodity complex. For example, here are some recent press releases related to steel:

AMEX STEEL INDEX UP 9.08% IN JANUARY

NEW YORK, February 5, 2007 – The Amex Steel Index [STEEL] rose 9.08 percent in January.* STEEL is a modified market capitalization-weighted index comprised of the common stocks or ADRs of publicly traded companies involved primarily in activities related to steel production. As of January 31, 2006, STEEL included 37 securities. STEEL is rebalanced quarterly. The next rebalancing will occur on March 16, 2007. The Market Vectors – Steel ETF (Amex: SLX) is an exchange-traded fund that seeks to replicate, as closely as possible, before fees and expenses, the price and yield performance of STEEL. SLX generally holds all of the securities that comprise STEEL in proportion to their weighting in STEEL. Options on SLX are listed on the Amex.

AMEX STEEL INDEX UP 40.70% IN 2006

NEW YORK, January 4, 2007 – The Amex Steel Index [STEEL] rose 0.77 percent in December and gained 40.70 percent for the year ending December 31, 2006.* STEEL is a modified market capitalization-weighted index comprised of the common stocks or ADRs of publicly traded companies involved primarily in activities related to steel production. As of December 31, 2006, STEEL included 38 securities. STEEL is rebalanced quarterly. The next rebalancing will occur on March 16, 2006.

The Market Vectors – Steel ETF (Amex: SLX) is an exchange-traded fund that seeks to replicate, as closely as possible, before fees and expenses, the price and yield performance of STEEL. SLX generally holds all of the securities that comprise STEEL in proportion to their weighting in STEEL. Options on SLX are listed on the Amex.

Here’s the chart since SLX’s inception:

Up about 22% over about a three and a half month period. How does this compare with some other related ETFs?

We see from this second chart how the Steel index moves in a fairly close pattern with the Vanguard Materials ETF (VAW), iShares Dow Jones US Basic Materials (IYM) and SPDRs Metals & Mining (XME). I’m surprised that SLX, being less diversified than the other ETFs mentioned here, has not shown more overall volatility over this period although it has shown greater strength in the run up over the past month.

PowerShares DB Base Metals Fund

But the real question is what’s going on with the PowerShares DB Base Metals Fund (DBB)? Based on the above chart, it’s the odd guy out. According to the fund’s site:

Description

The PowerShares DB Base Metals Fund is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Industrial Metals Excess Return™ and managed by DB Commodity Services LLC. The Index is a rules-based index composed of futures contracts on some of the most liquid and widely used base metals – aluminum, zinc and copper (grade A). The index is intended to reflect the performance of the industrial metals sector.

No mention of steel here, just aluminum, zinc and copper. More specifically, according to the fund’s fact sheet the underlying index is reset to have equal weighting to the three metals “annually during the first week or so of November. Throughout the year, the precise weight of each commodity in the Index will change based on price changes.” The current weights are updated each day. A quick scan of that link shows currently an approximate 41% weight in aluminum, 29% weight in zinc and 30% weight in copper.

Further to my blog entry yesterday about the commodities ETF launch by ETF Securities, I refer to some of their funds to see how these specific metals have done recently. A London Stock Exchange site provides a chart for an ETF linked to Aluminum from ETF Securities. They provide a chart for the zinc ETF and the copper ETF. So while most of the lines have been going up in the 2nd chart above, clearly DBB has been moving in the opposite direction due to significant weakness in zinc and copper prices.

Update on my entry from yesterday: As discussed, the new offerings (they’re termed ETCs) from ETF Securities will be launched on Euronext Paris, but they are already listed on Euronext Amsterdam, Deutsche Börse and the London Stock Exchange. For U.S. investors, the LSE is particularly interesting as the ETCs are USD-denominated on that exchange.

Here’s some information on the other ETFs mentioned above:

Vanguard Materials ETF

From the Vanguard ETF site specific to VAW (click to enlarge):

VAW seems quite well diversified (like IYM, it’s a broad materials fund as opposed to the others), including an 11.3% allocation to steel, all with a cost of 25bps … not bad at all. However, as a general materials fund, there’s significant chemical exposure.

iShares Dow Jones US Basic Materials

Information on the iShares Dow Jones US Basic Materials (IYM) can be found on the iShares site. Also note that BGI also has a global ETF called the iShares S&P Global Materials Index Fund (MXI). Like VAW, IYM has its biggest exposures (roughly 53%) in chemicals. Just over 12% of the fund is allocated to steel. No surprise then from my 2nd chart that VAM and IYM track very closely.

MXI only has a track record going back to September 12th of last year but as you can see, as a global version of IYM, it also tracks it closely (3-month chart):

SPDRs Metals & Mining (XME)

This ETF from SSGA is more focused than those from Vanguard and iShares. According to the fund’s site, and in particular it’s holdings list, there’s a lot of exposure to steel. So, here’s the chart comparing XME and SLX:

Fairly close, as expected.

So, what does this all mean? There are a lot of products that appear to be covering the same space. But in fact, the overlap is not as great as one might think. If you want exposure to steel in its purest form, it’s got to be SLX — though you’re getting exposure to an index of companies in the steel industry. For exposure to other industrial base metals (though in this case the exposure is directly to certain commodities markets), there is the PowerShares DB Base Metals Fund (DBB) as well as a similar fund from ETF Securities. For even broader exposure, and back to a basket of underlying stocks, there’s XME, IYM, MXI and VAW.

So despite a significant push of new offerings in the commodity space, and in this case specific to base metals, we can see that investors now have the opportunity to more adequately fine tune their exposures and be more precise with their opportunistic calls.

I see an opportunity here also for infrastructure and alternative energy (especially wind farm) fund managers to use an instrument related to steel for hedging purposes, although considering size, they may already be implementing hedges through the futures markets. Certain manufacturers in the computer hardware sector may be more interested in something like DBB. One can go on and on with examples of how certain investors would want (or need) instruments specific to a certain commodity.

Whether the relevant ETF instrument is redundant considering the availability of its counterpart in the futures market is an interesting thought — it all depends on the type of users that are out there and the demand from each segment.

I don’t believe I’ve ever written about ETF Securities out of the UK, which is a shame because I’m all for the little guy getting into the market and making a name for themselves… well, I wouldn’t actually call them small as according to their site they have just over $1 billion in assets under management.If you’ve never heard of them before, this might interest you. They’re best known for Exchange Traded Commodities (ETCs) and here’s the list of 31 ETCs (21 individual, 10 indices) to be launched on Euronext Paris:

OK, so this kind of takes the sizzle off of the recent related commodity ETF news from PowerShares but really it just allows for even finer tuning. Your scalpel just got a bit sharper. In reality, most active managers with a certain level of sophistication will know that all of the above is not really knew in terms of exposure due to instruments available in the futures markets. This really comes down to a choice of ETFs versus futures, assuming you’ve decided to play the commodity complex in a manner that warrants the use of such instruments.

The question now is whether the masses will see recent price strength over the past months (see 6-month chart below) as a buying opportunity, a shorting opportunity, or don’t know what the %&#@ is going on:

This recent article from Reuters seems to address what’s behind the increased pace of ETF development in the commodity space:

Investors are now more nervous of taking up long-only positions in the indexes, which traditionally have been the most straightforward way for pension funds, insurance companies and high net worth individuals to access commodities.

Analysts say much of the institutional money already invested in indexes is unlikely to exit in a hurry, but new money is expected to take more active approaches, which involve taking short as well as long positions.

If the commodity complex is an area where you don’t want to be “long only” because of its inherent volatility (I think this is so true), it only makes sense that ETFs and derivatives be the natural choice for investors who wish to manage the asset class actively. After the run up of the past few years, they might just have to.

Sidenote: There will come a day, hopefully soon, where we have something similar to Globex (Chicago Merc) so that investors can trade ETFs electronically, 24 hours a day, all over the globe in the same manner as derivatives are traded today. Perhaps with increased mergers between the large stock exchanges on both sides of the Atlantic, and with a couple from east Asia hopefully thrown in, this will happen sooner rather than later.

There was a lot of press coverage this past week on City University London’s Professor of Risk Management and Director of the Alternative Investment Research Centre at the Cass Business School Harry Kat and his recently published papers on replicating hedge fund performance by way of trading futures contracts.I first mentioned this new area of hedge fund replication programs, referring to Kat’s site, from which you can download all his papers, on Seeking Alpha earlier this month. Although there are not very many participants in this area, we are seeing quite a bit of scholarly research, and, like with Kat, we should be seeing the evolution from academic papers to actual investment products/services based on this research. MIT professor Andrew Lo, another researcher in this field, is covered in a separate article, and the concept has even gained broad media exposure from The Economist.

So what is this all about? We are in a world where there are many hedge fund products managed by many hedge fund managers. It’s possible that the hedge fund universe is getting so crowded that there is just not enough good performance to go around. With relatively low barriers to enter into the hedge fund industry, just how much “alpha” is out there, on average, considering the large number of participants? And will the trend of more assets going into a larger number of hedge funds continue? Consider Hedge Funds For Dummies, now online, available to any soon-to-be hedge fund investor. I’m just happy to see that How to Create and Manage a Hedge Fund: A Professional’s Guide is not ranking as high.

Playing the piano, mastering a martial art, starting and running a hedge fund … clearly there are many activities where a book may be helpful, but is not the way to go. In such cases proficiency is nice, but what you really value is an expert.

Getting back to replication strategies. Like I said, you can’t just rely on what’s written on paper. Kat’s papers, as well as those from other researchers [Lo, Jaeger, etc.], provide various statistics as part of the argument to validate their work. But the proof is in the pudding so what we’ll need to see is some form of real, live performance. In the case of Kat and his associate, Helder Palaro, they have developed a software program called “FundCreator” which, according to the recent articles, is now being used by a small number of institutional investors. It is with this program that investors have the means to build portfolios based on Kat’s research. According to Kat:

“In most cases, managers aren’t good enough to make up for the massive fees that they charge. The combination of excessive fees and minimal opportunity in the market makes alternative investments really doubtful in terms of their value for portfolios.”

Kat might not be expecting many greeting cards from the hedge fund community in December. His FundCreator program costs 3 basis points per month for what he calls “the ideal diversifier”. Essentially, through broad beta exposures chosen from a list of 78 different futures contracts managed on a highly active basis, the program makes any number of allocation decisions so as to achieve the desired amount of statistical characteristics [correlation, volatility, etc.]. Clearly, hedge fund managers and especially fund-of-funds will argue that their methods are more proven to provide truly exceptional return characteristics. Like mutual funds, however, the argument always leads to the effect on performance due to high fees. Will replication strategies provide significantly improved performance numbers versus actual hedge fund investing because of its actual investment process or its lower fees or a combination of both?

Reading the various articles above gives you the broadest ideas of what these replication strategies are all about and what I have written here is too short and broad. The academic papers on the internet are generally full of math, except for those from Kat. However, to get a better and more complete understanding of this new concept and how it can be implemented in a real portfolio, I think you need to hear it straight from the source. For those able to get to London on February 12-14, 2007, this HF conference may be of interest. Harry Kat, as well as pretty much everyone [it’s a very small, very niche field at its very earliest stages] in this space, will be speaking at this event.

I have referred to the following blog in the past but I highly recommend, again, AllAboutAlpha, where AlphaMale covers a lot of this new research on replication strategies.

We’ve seen the S&P 500 go up in a strong linear fashion since mid July. A bit extended perhaps? Here’s the 3 month chart:

  We’ve seen some fairly low values in VIX over the past few months as Here’s the 2 month chart for the VIX:

  Incredible to see a few days under $11. It’s been down at $11 before (even as low as $10) as seen in this 3-year chart:

  What’s interesting is the behavior of the S&P 500 relative to the VIX. Here is a chart showing the two:

  An obvious pattern shown clearly in the chart above is that the S&P 500 is climbing well when VIX is falling. This is usually over a 2-3 month period:

· May-June 2004

· mid August-early October 2004

· late October-Christmas 2004

· mid April-late July 2005

· mid October-Christmas 2005

· July-current 2006

If the current trend (upward S&P 500 and downward VIX) continues, then this would be a significantly larger and longer decline period of the VIX (going into 4 months). We’re currently just past the 3 month mark.

Looking at the 3rd chart above, $10 seems to be a fairly firm floor, although it seems like VIX doesn’t like staying down there. There’s almost a propensity for the VIX to bounce off $10-$11 and within a month reach $14-$15.

Bottom line: This looks like a good time to buy VIX call options. If the S&P futures look weak Wednesday morning, a quick entry may be in order … I started off this piece with the question if this rally may be a bit extended. Patient watchers may want to “wait and see” in the hopes of entering when VIX is closer to $11.

There’s got to be something to be said about the timing of fund offerings. We all saw the incredible push of Nasdaq linked products around the peak of 1999-2000. I remember Guaranteed Investment Certificate [GIC] linked notes offered at my local bank, and many of the other Canadian banks, that were linked to the Nasdaq 100 Index being launched near the end of our Canadian RRSP season - this is synonymous to the IRA in the US. The deadline for yearly contributions is the end of February (for the previous tax year). No need to remind you of how the Nasdaq moved after February 2000 but just in case, here’s a chart:

So I wonder now about real estate. It’s a topic that has been discussed at great length by many market observers. Like high-tech, investors can’t say later that they didn’t see it coming. I know many people in the Far East who have everything in real estate. After what happened in Japan, I wonder if they expect it to happen in their home country at some point in time … but just not now. Maybe, but there continue to be new fund offerings allowing global investors to add more fuel to the fire (Note that after each fund’s name below, I include both their ticker symbol as well as its inception date.) They include:1. US domiciled real estate ETFs: Many of these are a fund of REITs such as:

a. iShares Cohen & Steers Realty Majors Index Fund (ICF) 1/29/2001

b. iShares Dow Jones U.S. Real Estate Index Fund (IYR) 6/12/2000

c. streetTracks Wilshire REIT (RWR) 4/23/2001

d. Vanguard REIT (VNQ) 9/23/2004

For group #1, the ETFs with REIT exposure, the growth has obviously been great. Here’s the 2 year chart:

Like the equity markets, you basically have a nice rate of growth since early 2003. Since these ETFs have been around for well over five years (except for Vanguard which was late into ETFs anyway), investors have had a good chance to participate in the rise.2. US domiciled real estate ETFs not focused on REITs but on home builders:

a. SPDR Homebuilders (XHB) 1/31/2006

b. PowerShares Dynamic Building (PKB) 10/26/2005

c. iShares Dow Jones US Home Construction Index Fund (ITB) 5/1/2006

Group 2 is a different story. Homebuilding was the second wave of real estate investing via ETFs with fund launches in late 2005 and early 2006. How have they done this year?

3. European domiciled real estate ETFs: I’ve seen recent news that a European ETF provider called Indexchange Investments has just launched three new real estate equities based ETFs on the Frankfurt and Stuttgart exchanges. They cover three geographic regions with these specific indices:

a. The Dow Jones Stoxx 600 Real Estate index – this index tracks 22 European real estate equities

b. The DJ Stoxx Americas 600 Real Estate index – this index holds Canadian and American real estate equities

c. The DJ Stoxx Asia/Pacific 600 Real Estate index. This index is composed of real estate stocks in Japan, Hong Kong, Singapore, Australia and New Zealand

Group #3 represents recent fund offerings in the real estate space geared for European investors. I’m sure similar funds either exist or are in the works for Asian and other international investors. I think about the timing of these and wonder.

There are other means for investors to get into real estate investing via capital markets (on top of your primary home, winter cottage, investment property for rental income, timeshare in the warmer regions, etc.) and these include:

Housing futures and options traded on the Chicago Mercantile Exchange. Based on S&P/Case-Shiller Home Price Indices, these cash-settled derivative contracts cover 10 major US cities individually as well as in aggregate through a weighted composite index. These actually look like a great hedging vehicle for residents in any of these large metropolitan areas with significant and highly appreciated home values. Of course, someone has to be on the other side to speculate. Goldman Sachs has recently entered into a licensing agreement with S&P for the development of financial products based on the S&P/ Case-Shiller Home Price Indices. Perhaps investors will soon be able to participate in this specialty market without direct involvement in derivative instruments.

Property derivatives have been in existence for about a decade in the UK albeit in limited use. The market for this type of instrument has grown in the past few years however these are instruments, often custom made, for real estate developers and perhaps institutional investors (pension funds) who are building hedging programs to overlay on top of their real estate portfolio. Again, speculators (hedge funds and others) would likely be on the other side.

I wouldn’t be surprised to see increased derivative and ETF development for real estate, just like we have seen recently for commodities (GLD, SLV, USO, DBC) the other asset class with plenty of press regarding its recent climb in prices. These are two of the most common alternative investment asset classes but I wonder if investors today have weightings in these two asset classes that are as large, or larger, than their holdings in traditional stock and bond positions.

Bottom line: Be aware of new investment products in the real estate space. Perhaps some areas (emerging markets, east Asia) may be worthwhile for further analysis, but I’d be careful. No one can know if it will be as bad as the Japanese real estate market in the 1990’s or the Nasdaq crash but it’s the timing of new product development that’s the issue.

Watching Tuesday’s launch of the space shuttle live on CNN got me thinking about risk management, since a lot of the commentary was about the threat of foam falling off the shuttle’s exterior, just as had been in the case during the Columbia disaster when the shuttle was destroyed upon re-entry from space.They also discussed other possible mishaps. The comment was made that at one point all the astronauts as well as technicians down on the ground were thinking the same thing: “Hope I didn’t forget something” or “Hope I don’t mess it up.” Though only discussed for a relatively short period of time, it was a rather uncomfortable tone for what was a very nice July 4 day in Cape Canaveral.

So, the question I have is what risk management process did NASA go through after Columbia? NASA is the home of the real “rocket scientist”. I recall from the movie Armageddon, one of the NASA guys trying to figure out how to save the world from a giant meteor’s impact was supposedly “the smartest guy in the world.” Really now? Well, if there’s a book on the subject, I’d be interested in reading it.

Should be good for investors to consider that “black swan event” (term from Nassim Taleb’s book Fooled By Randomness), how best to plan for it, and how to deal with it when it eventually happens.

Just a thought. Are there little things that can happen (consider something as insignificant as a piece of tile falling of the underbelly of the shuttle) that could cause so much trouble that it causes massive damage to an entire entity? That tile is clearly no longer considered insignificant. Of course there are many potential causes for the markets, and thus your portfolio, to have a serious disaster. There are numerous scenarios starting with countless initial events that could cause a cascading effect resulting in a major market meltdown.

Now, we really don’t have to consider a complete “total destruction situation” where a diversified portfolio falls to zero. However, we can all think of scenarios which lead to a 50% loss or more. I’m not sure that the actual number is important. I’m not even sure if the causes are important because, frankly, can we do anything about it? What is important is to remember that in times of complete distress in the markets, correlations spike close to 1. This means that the benefits of diversification fail investors when they’re needed the most. There’s a similarity where distress to a certain component of the shuttle may lead to its total destruction.

So what should be of high importance to investors is what can be done on relatively short notice to cushion the blow of a quick and major market downturn?

First, before trying to trade your way out of trouble, make sure the basics are in place: diversify your portfolio well with various uncorrelated and even negatively correlated positions. Strategic asset allocation is key including the importance at times for high safety positions (cash/gold). Diversification fails, but not often.

When it does fail, not everything fails completely. VIX options and futures are good examples of instruments which are very negatively correlated with general market trends, although truly effective as a short-term play. Broad market equity index derivatives (buying put options, shorting index futures) are a cheap and easy method. But with the recent inverse ETFs, there’s a choice for investors who are accustomed to holding only long positions in funds. These funds have been discussed numerous times before, but here’s the list again:

* Short QQQ ProShares (Amex: PSQ)
* Short S&P 500 ProShares (Amex: SH)
* Short Dow 30 ProShares (Amex: DOG)
* Short MidCap S&P 400 ProShares (Amex: MYY)

In all cases, when you start to consider these as potential positions, you have to switch from your “strategic asset allocation hat” to “tactical asset allocation”. It just doesn’t make sense holding these positions for very long unless you are in a serious decline like in 2000-2002 or those of the early and mid 70’s. On the other hand, all of these potential choices have a cost if you’re wrong about the direction of the market. Clearly that’s what hedging is all about.

You buy insurance for your home, car and body. Assuming you keep up your home, change your car’s oil and are disciplined about daily vitamins and exercise, doesn’t your diversified portfolio require insurance as well?

My argument is that it’s slightly different for a portfolio. I don’t think you need continued exposure to a hedged position (long put, inverse ETF position or otherwise) as you do with daily vitamins. But with TAA, it’s all about the timing. Yeah, it’s tough. But it’s not rocket science.