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.

A couple of weeks ago I was invited by the guys at “The Market Traders” to join in on their weekly roundtable podcast as one of three guest panelists.  If you check out their site, you’ll see that they’re big on commodities.  Possibly a bit more of a speculative bent to their site with ads that make me think that it’s a place where stock pickers come to congregate.  However, I was surprised to find that I wasn’t the only one commenting on ETFs and my fellow panelists didn’t really spend a lot of time discussing specific stocks although a few ETFs were mentioned (not just by me).

We basically comment three times:  Once on energy, the second time on the US dollar and finally with thoughts on areas of the market that we like.  Some who have followed my writings and have become accustomed to the way I do things might be a bit surprised by my final comments.  I basically state in explicit terms how I don’t believe now is a time to think like a traditional asset allocator.  I don’t think now is the time to stick to the “60%-equity/40%-fixed income” strategic asset allocation model.  Frankly, to have a “buy-hold” mentality all of the time requires a stomach of immense fortitude.  (What you are hearing now are people from Vanguard and DFA squirming in their chairs.)  Does that mean I’m leaning towards market timing?  On the spectrum, I don’t think I’m at the far end which is market timing, but I’m certainly not at the buy-hold end.  I’d like to think that the “strategic asset allocation” process which I think is so important (cool with that Vanguard/DFA?) should, in this environment as well as others, be allowed to deviate in two ways:

1.  Allow for some tactical asset allocation.  That may mean allowing min/max constraints for asset classes to deviate even more from “home” or what may be defined as the policy allocation.  That may also mean allowing the asset allocation shifts (rebalancing, delaying implementation of cash equitization, etc.) to happen a little more frequently than normal.  This allowance for tactical decisions could actually mean several things but generally I’m saying that I believe some allowance for deviation from standard asset allocation protocols is warranted.

2.  Allow for exposure beyond the traditional asset mix.  This means to make sure that alternative investment exposures are in place.  Is it too late today for gold, oil, agriculture and other commodities that seem to be getting all the attention these days?  They’re volatile (and I believe, getting more volatile) but their diversification properties are undeniable.  Caveat:  I’m talking about exposure to the commodities via ETFs, ETNs or derivatives, not indirect exposure via equities (like gold producers).  I don’t think it’s too late to get into infrastructure and other inflation hedging asset classes and the only question is how much of these alternative asset classes is warranted as a buffer to the core of traditional asset classes (stocks/bonds/cash)?

Buy-hold philosophies for multi-asset class exposures made a lot of sense for anyone from the period of 1980 to now.  The only major hit was 2000-2002.  The big question I ask myself is whether we are still in this secular up market or did that end one year ago.  In other words, are we in a sideways or down market that has the potential to be anything as bad as the 2000-2002 bear market?  My sense is that for broad regional market exposures like the S&P 500 the answer is likely to be yes.  However, for various sectors and foreign exposures, I feel confident the answer will be no.  We’ve come out of an environment where nearly everything did well fueled by a world of cheap money.  That doesn’t mean that the pendulum will swing causing nearly everything to plummet.

A very important consideration is also the role of private equity and hedge funds given my comments above on the importance of alternative investments.  I can’t stress this enough:  As much as I am a fan of passive instruments, I’ve never said that one should completely disregard active management.  Is it hard to pick the successful managers ahead of time?  Yup.  Do they cost a lot.  More than ETFs and mutual funds but if you’re finding non-correlated returns, they should cost more.  The key question in today environment is what proportion of your portfolio do you want to allocate to market risk and how much to manager risk?

That one takes a bit of time to sink in once you really think about it.

Then you have to ask yourself, is it possible that regardless of which way I choose, it’s likely that the result will be very similar?  In other words, you put all your money in one of two possible portfolios:  All ETFs or all hedge funds … and the result is both go up or both go down!  Of course it’s possible that these portfolios go in opposite directions but that’s what we would expect and that’s why we assume the active-passive proportion decision is important.  But if they go the same way, then we’re likely to lose faith in what we were promised by someone.  The passive route promises very little.  The returns are what the markets provide.  It’s the active route that promises quite a bit more … sometime more than what was provided.  The real bummer is allocating significantly to private equity and hedge funds hoping that they will provide a buffer to the traditional core portfolio of more liquid positions but not reaching that result.  In other words over-promising and under-delivering.

Today’s deleveraged environment provides opportunities but an ever changing landscape for investors travelling the PE/HF path, some good and some bad. We hear of pension funds allocating more and more to many alternative asset classes and strategies.  I wonder if they are pleased or disappointed with their results.  Are the fees worth it?  Are managers providing alpha?  Is the illiquidity constraint more than they bargained for?  Were they too late in making asset mix shifts?  Have they improved their asset/liability situation?

Everyone is talking about credit problems (mortgage, auto, credit card) and the various tentacles of the US economy that are breaking down.  My sense is that it could be as dire as some are stating but the press is likely doing a decent job of sensationalizing the story.  But what about the pension landscape?  Low interest rates plus negative market returns of the past 12 months are bringing us back to the asset/liabiility mismatch situation we first saw during the market slide of 2000-2002.  Are these funds doing so well with their portfolio returns that the relatively low interest rate environment is not causing havoc to their books?  Is this yet another cause for concern for the US financial “infrastructure” landscape?  So many questions and I only wish I could provide simple yes or no answers.  Then asset allocation would be like ordering a pizza.

Despite the volatility we expect to find in international markets and especially in the so-called “developing and frontier markets” (I’m very much not liking those names anymore) there are so many reasons not to have anything but minimal exposure to the US whether it be equities, fixed income or dollars.  Fareed Zakaria’s commonly cited view that one must notice it’s not “the fall of the US” but “the rise of the rest” is important.  It’s important for investors because there’s a parallel to a shift in asset allocation that will surely happen … and it’s already started.  Just how much is an appropriate allocation to the emerging markets?  Defining what is or is not an emerging market or frontier market or even developed market would help in answering this.  But just as important, I believe that the simple move away from “home biased portfolios”, driven by an acknowledgment that intelligent/selective global diversification, is a necessary move in what is likely no longer a simple long-term up market.  Diversification may not be what it used to be, but along with compound interest, it’s one of the very few free lunches we investors have.

Put another way, imagine you are one of the sovereign wealth funds that the press and politicians seem to enjoy commenting on these days.  Recent allocations of these funds to western financial conglomerates (investment banks in need of capital and quickly) is a move to use some of their US dollars to buy relatively cheap assets that will provide some yield (surely negotiated to be better than what others are getting) as well as a buffer to their home grown commodity exposures.  I spend a lot of time thinking about what else is on their shopping list to diversify themselves away from existing commodity and US dollar related risks.  It’s the same exercise any investor should have with their portfolio and the positions held within it.

Just got back from yet another conference and no surprise it covered the current hot topic: commodities.

Speaking of hot, this event was in Dubai. I’ve experienced some hot and humid conditions in my life in places like Manila, Seoul, Singapore and Hong Kong. But this was by far the hottest climate I’ve ever experienced. It was a dry, baking heat. When outdoors, finding shade helped and certainly the buildings had great air conditioning. But, for example, I had my cousin who lives in the city take me around the gold (souk) market. Getting out of the car into the sun was incredible. It felt just like a dry sauna. And they say it’s just the beginning of the hot season! Luckily, the hotels, office buildings and shopping centres are all so luxurious that climate does not have to be a concern. With most taxis I rode in being a Lexus, you get a sense of what this city is about. Never mind the Burj Al Arab hotel, indoor skiing and other obvious signs of excess.

A quick comment on the souk. It’s all about gold there. Prices are quoted daily and there are people buying. I wish I was in Dubai six months ago and a year ago to get a handle on the number of people transacting. A good sign was at the retail section of the Dubai airport (departure section). They had a gold merchant right at the centre when you pass through the last security checkpoint (I think my carry on luggage was scanned only twice which is hopefully enough). Unlike the real souk market which was not empty but certainly not busy, this place was packed! And people were really buying. They didn’t look like momentum traders nor supermodels but everyday travelers. Maybe they know that gold is back to where it was near the beginning of the year:

Or more likely, maybe they new better than me than to take the heat and walk the outdoor souk.

From the moment you cruise into Dubai International or drive into downtown, you can’t help but notice the construction. It beats Las Vegas, Miami and other real estate bubble regions of the US. It kind of reminds me of Seoul when I first went there as a youngster in 1979. My bet is that Dubai will want to host an Olympics … but they’re held in August and if that’s still the hot season I just don’t know who could survive the marathons, triathlons and other outdoor events. Still, you can’t help but sense the feeling of ambition in Dubai. For some reason, a lot of the new buildings going up have the number of floors in the triple digits. Excess is a relative term when you’re in Dubai. The sense on the ground is that the construction boom is in full throttle but not anywhere close to the bubbly stage. But I can’t get my mind off the fact that a lot of the construction is done at night when the temperatures are simply cooler. It’s the endurance of the migrant workers who have the day shift that I find quite astonishing. Think of the pyramids in Egypt and the Yucatan, the Taj Mahal and other larger-than-life structures and the same can be said for the city of Dubai. The super-skyscraper “Burj Dubai” was front and centre from my hotel room window. I can’t remember and certainly could not even count the number of cranes working throughout the day and night when viewing the skyline. Part of the view is filled with very unique and certainly luxurious looking buildings, but among them were cranes working on competing structures. The success story that is the UAE is of course based on the decision of its leaders to diversify beyond oil. But the structures we see being built today, like the pyramids of the past are built from the labors of a massive force that are too often left forgotten. I think that in today’s world when we think about gold and oil, the supply/demand imbalances are often cited as being driven based on what’s happening in the emerging world. That’s certainly true, but the commodity that is labor is certainly a key factor as well and you can see that when driving by any construction site in Dubai. Of course, think of the factories in coastal China and the low cost IT worker in Bangalore and you quickly get the story of the emerging markets.

An important point to make on this is the importance of the success of the emerging markets in aggregate. It simply has to happen. Jeremy Siegel at Wharton wrote a paper in the September 2007 Financial Analysts Journal titled “Impact of an Aging Population on the Global Economy”. To summarize one of its key conclusions I begin with a simple fact: The western world is aging and it can’t eat its financial assets during its retirement stage. Much has been said of an equity market depression should the boomers sell their equity investments as a whole even if it’s spread out over several decades. Siegel’s paper articulates the fact that the growing middle class of the emerging world can be a very significant group that buys these financial assets. As individuals, they may not have much residual assets left for savings and investment, but in aggregate the numbers can and likely will be in their favor. This logic makes sense and our only hope is that the typical worker from the emerging markets does not go berserk with their discretionary spending and adopt a savings rate similar to many in the west. Furthermore, we have to hope that the western world does not adopt a protectionist stand. We see the beginning of potential trouble already. How do most Americans (never mind their government) feel about some sovereign wealth funds buying significant parts of major Wall Street financial conglomerates? What about if the same happens to media firms, utility companies and certain defence/high tech firms? Much of Western Europe isn’t happy with the rising growth of mosques versus churches across the continent. Will religious as well as racial discrimination hamper the transfer of wealth, and as important, capital investment? I think that the factors driven by demographics are so strong that any reasonable person or society will figure out what measures are required in order to survive. Unfortunately, the short-term horizon of politicians often conflict with this simple assumption.

Getting back to this commodities conference, the overall turnout was a bit of a disappointment but what was especially poor was the level of institutional investors in attendance. I couldn’t find one. Luckily I had meetings set up for me prior to traveling or this would have been a rather uneventful trip. One observation that I made was the fact that despite this being a commodities event in a growing part of the emerging markets, on day one of this conference all sessions except for one made some reference to indexing, passive investing or the use of ETFs. I did not attend day two and so I can only wonder if this fact remained true. Now I know that most of the discussion revolved around the active use of ETFs and/or derivatives but this still strengthens my case that the ETF story is not only strong but expanding globally. I think that the saturation we see today in the US will grow to many other regions. However, it’s still early. Today, there are no ETFs domiciled in Dubai. Great fanfare has been made about Dubai as the financial centre bridging the time gaps between the financial centres of Europe and East Asia. It will only be a matter of time before Dubai becomes a hub for derivatives and ETFs. From my travels, I see a parallel between ETFs (or financial services products in general) and airports. The US and Europe are full of busy yet aging airports. The emerging world is now making waves about their fancy new and relative large airports, albeit in much smaller numbers. I think the ETF industry will expand to these same regions with a few but relatively large (by asset levels) offerings in the not too distant future. Who knows what the expansion will be like thereafter. I don’t see a duplication of what has happened in the US but perhaps something fairly close in a few markets. We’ll see how the BGI’s, SSGA’s and other ETF providers do in entering these markets to compete with the local providers.

By the way, I’ve mentioned that the ETF industry within the region is still sparse. However, we’re not much better here in North America. The SPDR S&P Emerging Middle East & Africa ETF (GAF) is all we have now.

Not exactly the greatest diversifier but the high correlation story is one you’ve heard from me enough times I’m sure.

An interesting tone I sensed at this conference and confirmed at my meetings was some urgency in terms of dealing with the commodity complex. The need for active management was clear. Most would agree that a “buy-hold” mentality just doesn’t make sense for this highly volatile asset class. This would be true not just for a diversified (index-like) exposure but also positions in specific sub-indices (agriculture, metals, energy) or direct single commodity exposures. Despite the fact that so many commodity tracker funds have been launched in recent months and years, it looks like the need for them is very high indeed.

If you were to ask an investor what was their main reason for commodities exposure, you’d get a variety of answers. This may be true for any stock, hedge fund or asset class but I’m very interested in those given for commodities: inflation hedge, low correlation to other major asset classes, macroeconomic rationale given growth of emerging markets and relative dormancy in 1980’s and 90’s, demise of US dollar. These are all risk based rationale but for whatever reason, it seems like there’s a vast array of investors jumping on the Jim Rogers bandwagon. This includes the many ETFs, ETCs and ETNs that have hit the market over the past few years with exponential growth both in terms of numbers and assets. Should there be cause for concern that these new assets are helping fuel the fire? I think so as it will likely lead to greater volatility both up and down. Don’t get me wrong, even without all these new commodity tracker funds, I’m still in the camp that we’re in a long secular bull market albeit with the strong possibility of down markets (drops of 20% easily) with the possibly of not regaining new highs until at least six to twelve months if not longer. The question is whether the magnitude of drops and time to recovery are magnified due to ETFs and related instruments. I can’t help but think so.

And the main reason why I think this is so is just from considering who would be using these commodity trackers. The big user has to be the hedge funds which for me includes managed futures/CTAs. Don’t have anything against them. My first job in the industry was basically in this space although the focus was squarely on equity indices. Just like quant funds that were quite synchronous (unfortunately to the down side) in the late summer of 2007, I could see CTAs herding in and out of the broad commodities complex to capture the major up and down markets … I’m not saying they’ll all move in line to day-to-day volatility.

This excess momentum due to mass herding is what angers the emerging countries when they consider the foreign “speculators” (not “investors”) getting in and out of their market. That’s one of the prices of capitalism. The key, like we see in Dubai, is to find the long-term story. Dubai and other countries in the GCC region and beyond will not only survive but evolve into a longer term success story based on their ability to reap the rewards of this high oil price period (or “era” depending on how long this lasts). My hope is, just as South Korea copied the Japanese model through a well educated workforce and strongly industrialized infrastructure, the neighboring countries in the gulf and the broader MENA region can duplicate some of the success of Dubai. We can see some of this already in Bahrain and Qatar but there needs to be more.

Final thought on Dubai. I had dinner with a gentleman in the industry and asked what model Dubai used for its success to diversify beyond its core asset. My guess was Hong Kong but he said it was Singapore. Makes sense since Singapore is a bit more diversified in terms of having had greater labor requirements in the past (not so much today) from abroad to help build its infrastructure whether it be engineering, financial or otherwise. Singapore definitely has a more culturally diverse population than Hong Kong or any other Asian city I can think of. In this regard, I can’t help but think that the commodity that is often left unconsidered or, at best, overlooked is labor. Where will the migrant worker move to next? Where can one find skilled or at least partially skilled labor? I heard of the incredible housing and food inflation in the UAE and I wonder how that effects the laborer at the very bottom of the ladder. Probably not well but it’s certainly better than their prospects at home. Still, on one of my comfortable taxi rides, I saw a bus packed full of workers … something I’ve seen in countless other cities but I could see that conditions for them were not good. Not to pick on Dubai, but I wonder how fair their labor laws are for immigrant workers. This question is easily applicable to other booming economies that have significant immigrant populations and the debate in the US on this subject is an appropriate example even though their economy, nor its outlook in my opinion, could not be described as booming. This trip was certainly an eye opener for me. The chance to see and feel the luxury was nice but I’m glad I was able to observe a bit of the other side although from far away. Cliche as it it may be, I think it’s Pierre Trudeau who first said something to the effect that you really don’t appreciate the value of Canada until you’ve traveled the world. It’s certainly not meant to be an insult to Dubai - clearly one of the great success stories of the emerging world and especially within a volatile region - but I find it interesting that after this trip I realized just how great Canada is. Maybe it’s also the fact that we get roughly ten days at most of 40 degrees Celsius heat or worse a year.

I spent some time today with my wife and daughters at the park with warm sun and a cool breeze. Perfect weather.

Lehman Brothers have now entered the ETF fray (actually, their product line up contains exchange traded notes) and they’re branded as Opta ETNs. Well this is an interesting development and one that I don’t find very surprising.

Let’s think about the ETF industry for a minute (I am aggregating ETNs and any other derivative of this type of instrument … no not that derivative … into the term “ETF”). Are we moving more and more towards alternative asset classes? Are we adding sexier functionality to products? Are actively managed ETFs on the horizon? The answer to these questions is not just “yes” but we’re basically there. If the ETF industry is less about beta and more towards something else … some alternative or exotic or “non-standard” beta and even possibly (wow!) alpha then watch out. Investment banks are going to jump in and then some.

Why wouldn’t they? Once you move away from the more traditional views of passive management, you’re moving closer to the I-banks sweet spot. The higher fees (margins) don’t hurt either.

One of the Opta ETNs covers commodities in general with a fantastic ticker symbol (”RAW”). Another covers the hot topic of the day, agriculture. And the last one brings some competition to PSP in the private equity space. Note how Lehman uses the word “Beta” in the commodity ETNs but not the private equity ETN. I agree … private equity is no asset class.

Regardless of classification, Lehman is entering the ETF/ETN space focused on alternative investments. It would not surprise me one bit if other I-banks enter in a similar fashion. Many, like Merrill Lynch have publicly spoken on their hedge fund replication products … they could be turned to ETFs. There are many ETFs that are in the middle of regulatory approval manufactured by existing ETF providers both large and small (firms that is) that, when launched in the market, would have no competition. These would be rather esoteric asset classes or strategies such as carbon credits or 130/30. Again, I-banks live and breath these markets and strategies and unlike startup ETF providers have the cash (some, thanks to their new friends, the Sovereign Wealth Funds) to make a real go at it.

If the I-banks do jump in to the ETF marketplace in a big way, there could be significant fallout. More products and more competition would make it harder for the many new entrants in the field (that are not I-banks or backed by them) to not only establish themselves but grow in a significant manner. Like mutual funds, hedge funds and other financial products, ETFs are sold not bought … just find out who makes the big money at these firms. I don’t see how the little guys could go up against a marketing machine heavyweight like a Lehman, Goldman, Merrill or Bear.

Worse still, I wouldn’t want to be a mutual fund right about now. Not only do they have to keep up with their lobby against the favorable tax treatment of ETNs but they must also be thinking about how to stop this whole active management ETF train from leaving the station. Too late … I think that was the whistle and last call.

Well, if you welcome competition (and you should), hopefully the average ETF management fee will at least go down … wait, we’re talking Wall Street I-bank heavyweights right? Check that. Don’t hold your breath.

Interesting finding in the Globe and Mail’s Streetwise blog where Andrew Willis provides news of an upcoming IPO for GHG Emission Credit Participation Corp. on the Toronto Stock Exchange. Willis mentions that this is a pure play into the carbon emissions market similar to other funds on the TSX that provide pure play exposure to gold, molybdenum and uranium. I’ve mentioned Uranium Participation Corp. (U) as a unique and easy means to uranium price exposure however there are now futures for this commodity as well.

This press release give a bit more on the IPO.

Technically neither of these “Participation Corp.” (uranium and now emission) instruments are ETFs but they are traded on an exchange like a stock and for the vast majority of investors do the job of providing indirect commodity exposure as GLD and SLV do for gold and silver respectively.

I’ve discussed carbon markets in the past and some googling will provide more background information … more than you need, of course. I find Wikipedia may not be the most reliable source of information for a particular subject, but it usually provides a decent set of links and this is true when you look here and here.

Not surprisingly, there’s also news of problems in this new space. Fertile ground for active managers.

Another interesting angle is to explore getting a piece of the infrastructure by purchasing shares in Climate Exchange PLC (CLE) which is covered in the topmost link as well as in this National Post article.

For the large institutional investors, I’d speculate that they would gain exposure to emission markets through hedge funds. Frankly, I would be surprised if internal managers in even the largest pension funds included direct carbon instrument exposures within their GTAA programs. For most investors, this market is still in its infancy and therefore getting in quick and easy may be the best approach simply for practical reasons. Alternative energy will be hot for a long while and emissions may be the next uranium. Perhaps exposure to the market itself through GHG Emission Credit Participation Corp. as well as to the exchanges through Climate Exchange PLC should provide more than enough of an allocation replacement should uranium investors decide to take their profits and move on.

Many observers of the ETF industry have commented on the thinner slices to sector exposures provided by fund manufacturers in recent years. My take is different. Although there are some “sectors” that are indeed quite narrow, many new fund offerings are more “thematic” in nature. These include water, alternative energy and infrastructure and are more broad that they are, in my opinion to be considered asset classes themselves. Of course, some would consider this issue semantics but that’s for the final user to decide within their own investment process. Certainly, many institutional investors look at infrastructure as an asset class. I don’t know if I would consider water to be an asset class … actually, I don’t … but it certainly is broader than a sector and can be considered thematic in nature.

At the end of the day, I am interested in finding things (call it a sector, call it a theme, I really don’t care) that help in the overall risk-adjusted return potential for any given portfolio. I think Van Eck is a firm that thinks the same way. Steel company exposures (through their Steel ETF, SLX) may not be a diversifier for many, but I could see it as one for many unique types of investors. The same could be said for their Environmental Services ETF (EVX), their Gold Miners ETF (GDX), their Global Alternative Energy ETF (GEX) and their new Russia ETF (RSX).

To take RSX as another example, for an investor with a need for emerging market exposure outside of what they likely already hold (China, India, EEM) and with a strong commodity bias, this fund makes sense. For someone like a Canadian or Australian, it likely doesn’t make so much sense.

But now I’m getting word of some new ETF product development in the Van Eck pipe as seen from this recent SEC filing.

What have we here? (Think Lando when he first met Leia for all the fellow Star Wars geeks out there.) Here are some of the more interesting excerpts:

Market Vectors—Global Agribusiness ETF and Market Vectors—Global Nuclear Energy ETF (the “Funds”) are distributed by Van Eck Securities Corporation and seek to track the DAXglobal^® Agribusiness Index and DAXglobal^® Nuclear Energy Index, respectively, each of which is published by Deutsche Börse AG (“Deutsche Börse”).

More specifically on the Agribusiness ETF:

MARKET VECTORS-GLOBAL AGRIBUSINESS ETF

Principal Investment Objective and Strategies

Investment Objective. The Fund’s investment objective is to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal^®® Agribusiness Index.” Agribusiness Index (the “Agribusiness Index”). For a further description of the Agribusiness Index, see “The DAXglobal^® Agribusiness Index.”

Principal Investment Policy. The Fund will normally invest at least 80% of its total assets in equity securities of U.S. and foreign companies primarily engaged in the business of agriculture. Companies primarily engaged in the agriculture business include those engaged in agriproduct operations, livestock operations, agricultural chemicals, providing or transporting agricultural equipment, and providing or transporting ethanol/biodiesel, and which derive at least 50% of their total revenues from such activities. This 80% investment policy is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.

Indexing Investment Approach. The Fund is not managed according to traditional methods of “active” investment management, which involve the buying and selling of securities based upon economic, financial and market analysis and investment judgment. Instead, the Fund, utilizing a “passive” or indexing investment approach, attempts to approximate the investment performance of the Agribusiness Index by investing in a portfolio of securities that generally replicate the Agribusiness Index.

The Adviser anticipates that, generally, the Fund will hold all of the securities which comprise the Agribusiness Index in proportion to their weightings in the Agribusiness Index. However, under various circumstances, it may not be possible or practicable to purchase all of those securities in these weightings. In these circumstances, the Fund may purchase a sample of securities in the Agribusiness Index. There also may be instances in which the Adviser may choose to overweight another security in the Agribusiness Index, purchase securities not in the Agribusiness Index which the Adviser believes are appropriate to substitute for certain securities in the Agribusiness Index or utilize various combinations of other available investment techniques in seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the Agribusiness Index. The Fund may sell securities that are represented in the Agribusiness Index in anticipation of their removal from the Agribusiness Index or purchase securities not represented in the Agribusiness Index in anticipation of their addition to the Agribusiness Index. The Adviser expects that, over time, the correlation between the Fund’s performance and that of the Agribusiness Index before fees and expenses will be 95% or better. A figure of 100% would indicate perfect correlation.

The Fund will normally invest at least 95% of its total assets in securities that comprise the Agribusiness Index. A lesser percentage may be so invested to the extent that the Adviser needs additional flexibility to comply with the requirements of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), and other regulatory requirements.

Because of the passive investment management approach of the Fund, the portfolio turnover rate is expected to be under 30%, generally a lower turnover rate than for many other investment companies. Sales as a result of Agribusiness Index changes could result in the realization of short or long-term capital gains in the Fund resulting in tax liability for shareholders subject to U.S. federal income tax. See “Shareholder Information—Tax Matters.”

Market Capitalization>. The Agribusiness Index is comprised of companies with market capitalizations greater than $150 million that have a worldwide average daily trading volume of at least $1 million and have maintained a monthly trading volume of 250,000 shares over the past six months. The total market capitalization of the Agribusiness Index as of [ • ], 2007 was in excess of $[ • ] billion.

So we now have a competitor to the up to the PowerShares-Deutsche Bank agriculture ETF (DBA). A quick review from its website gives us this description:

The PowerShares DB Agriculture Fund is based on the Deutsche Bank Liquid Commodity Index – Optimum Yield Agriculture 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 traded agricultural commodities – corn, wheat, soy beans and sugar. The index is intended to reflect the performance of the agricultural sector.

With all the focus on metals and energy, diversifying into agriculture is a reasonable move for investors with the size to spread their allocations out even further. Those who lean more towards a Jim Rogers philosophy will look to DBA and/or this new Van Eck offering as more of a strategic (I would say tactical) bet.

And like applying a GLD/GDX combo for exposures to both the gold bullion price and gold miners, a similar DBA/new Van Eck combo makes sense here. For those implementing a position to a specific commodity, I think this dual positioning is ideal and the tilting between the two positions can be a significant source of alpha in the long-term (in my opinion). If only this were also available to the commodity I’ve been commenting on recently and for quite some time: uranium.

More specific to the upcoming Nuclear Energy ETF from Van Eck:

MARKET VECTORS-GLOBAL NUCLEAR ENERGY ETF

Principal Investment Objective and Strategies

Investment Objective. The Fund’s investment objective is to replicate as closely as possible, before fees and expenses, the price and yield performance of the DAXglobal^®® Nuclear Energy Index.” Nuclear Energy Index (the “Nuclear Energy Index”). For a further description of the Nuclear Energy Index, see “The DAXglobal

Principal Investment Policy. The Fund will normally invest at least 80% of its total assets in equity securities of U.S. and foreign companies primarily engaged in various aspects of the nuclear energy business. Companies primarily engaged in the nuclear business include those engaged in uranium mining, uranium enrichment, uranium storage, providing equipment for use in the provision of nuclear energy, nuclear plant infrastructure, nuclear fuel transportation and nuclear energy generation, and which derive at least 50% of their total revenues from such activities. This 80% investment policy is non-fundamental and requires 60 days’ prior written notice to shareholders before it can be changed.

Indexing Investment Approach. The Fund is not managed according to traditional methods of “active” investment management, which involve the buying and selling of securities based upon economic, financial and market analysis and investment judgment. Instead, the Fund, utilizing a “passive” or indexing investment approach, attempts to approximate the investment performance of the Nuclear Energy Index by investing in a portfolio of securities that generally replicate the Nuclear Energy Index.

The Adviser anticipates that, generally, the Fund will hold all of the securities which comprise the Nuclear Energy Index in proportion to their weightings in the Nuclear Energy Index. However, under various circumstances, it may not be possible or practicable to purchase all of those securities in these weightings. In these circumstances, the Fund may purchase a sample of securities in the Nuclear Energy Index. There also may be instances in which the Adviser may choose to overweight another security in the Nuclear Energy Index, purchase securities not in the Nuclear Energy Index which the Adviser believes are appropriate to substitute for certain securities in the Nuclear Energy Index or utilize various combinations of other available investment techniques in seeking to replicate as closely as possible, before fees and expenses, the price and yield performance of the Nuclear Energy Index. The Fund may sell securities that are represented in the Nuclear Energy Index in anticipation of their removal from the Nuclear Energy Index or purchase securities not represented in the Nuclear Energy Index in anticipation of their addition to the Nuclear Energy Index. The Adviser expects that, over time, the correlation between the Fund’s performance and that of the Nuclear Energy Index before fees and expenses will be 95% or better. A figure of 100% would indicate perfect correlation.

The Fund will normally invest at least 95% of its total assets in securities that comprise the Nuclear Energy Index. A lesser percentage may be so invested to the extent that the Adviser needs additional flexibility to comply with the requirements of the Internal Revenue Code and other regulatory requirements.

Because of the passive investment management approach of the Fund, the portfolio turnover rate is expected to be under 30%, generally a lower turnover rate than for many other investment companies. Sales as a result of Nuclear Energy Index changes could result in the realization of short or long-term capital gains in the Fund resulting in tax liability for shareholders subject to U.S. federal income tax. See “Shareholder Information—Tax Matters.”

Market Capitalization. The Nuclear Energy Index is comprised of companies with market capitalizations greater than $150 million that have a worldwide average daily trading volume of at least $1 million and have maintained a monthly trading volume of 250,000 shares over the past six months. The total market capitalization of the Nuclear Energy Index as of [ • ], 2007 was in excess of $[ • ] billion.

Perhaps the whole green ETF thing has gone a bit far in the past year but, a bit surprisingly, this would be the first pure play on the nuclear energy story. I have commented recently on uranium as have so many other industry watchers in recent months after having seen the commodity double in price in the past four calendar years … it’s up roughly 70% so far this year according to the chart found here.

I just said “pure play”, but it’s important for prospective investors to consider the 50% and 80% values quoted in the above descriptions. That’s 50% of the revenue of an underlying holding must fit the required parameters and 80% of the fund’s assets is to be invested in companies whose primary business operations are in the field of agriculture or nuclear energy respectively.

I don’t want to comment too much on this nuclear energy ETF as I don’t have enough information at this time. But here’s the problem I foresee: There’s just not an even spread of companies involved in the nuclear energy business. Let’s take uranium mining for example. It’s Cameco (CCJ), a very small number of competitors who are close in terms of size and a large number of small cap, if not micro cap, producers. Having an ETF based just on uranium miners would be a logistical nightmare and investors would have to accept a few stocks dominating the fund. An equal weighted ETF for this sector would make sense except for the fact that the thinly traded smallcaps/microcaps would provide an interesting (to say the least) situation for the market makers of the fund. I could see hedge funds getting into that game on the other side. We can only hope that there is a more robust mix in other related businesses mentioned in the prospectus namely uranium enrichment, uranium storage, providing equipment for use in the provision of nuclear energy, nuclear plant infrastructure, nuclear fuel transportation and nuclear energy generation.

In the past I’ve mentioned both Cameco and Uranium Participation Corp (U) as appropriate uranium plays. This new nuclear energy ETF would be an even more appropriate holding in the place of Cameco and with recent uranium derivatives on the market, exposure to the price of uranium itself allows for more complete exposure (and inverse through shorting) than in the past.

No word yet on fees as well as other details on these upcoming Van Eck ETFs.

I’d say that of all the ETF providers, it’s the news out of Van Eck that gets me the most interested and I always look forward to finding out what’s next from them.  Nothing too fancy … just new exposures, but I like it!

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).

Just received this mass e-mailing from ETF Securities out of the UK:

ETF Securities creates world’s first exchange-traded precious metals platform backed by physical metal

• 5 new physically backed exchange traded commodities (ETCs) to be listed on the London Stock Exchange (LSE)
  
• Platinum, palladium and a precious metal basket ETC to be made available to ordinary investors for the first time ever
  
• Silver offered for the first time outside of the USA
  

The global pioneer in exchange traded commodities, ETF Securities, is set to bring another world first to the London Stock Exchange with the listing of a range of physically backed, precious metal, exchange traded commodities (ETCs). See the attachments above to review the full press release and fact sheets. For our full product list follow this link: http://www.etfsecurities.com/en/document/etfs_document.asp#product

For more information please visit our website: www.etfsecurities.com

Note that instead of providing attachments as stated above, I simply refer you to the ETF Securities website and in particular this page. With all the chatter of a platinum ETF and palladium ETF … well for those interested, these are exchange traded commodities and they’re traded on the London Stock Exchange.

I didn’t find the description of the precious metals basket clear until I read this on one of the pages of their website:

For the first time ever, investors can now trade all four major precious metals (platinum, palladium, silver, gold) individually or as a basket, on the London Stock Exchange.

Another interesting innovation.

Let me start by saying that I received three calls today from the press. On the one hand, I’m happy that the blog is getting some attention and with further coverage in the mainstream press, I am very eager to see how my readership at “The Beta Brief” grows (fingers crossed). However, everybody wants to talk about the greater focus on “active management” in the ETF industry. Is it that surprising?! It’s neither bad or good. The industry is simply evolving based on its inner economic conditions, changes in the overall market environment and the resulting changes in the behavior of investors. There will be a continued push away from the classical passive form of index investing but, on the other hand, we will likely continue to see a very high proportion of ETF assets remain in the traditional, relatively lower cost funds like SPY, QQQ and the offerings from Vanguard.

With the recent downside market action and resulting spike up in VIX, I like many market participants am eager to see if this will be a relatively short “V” pattern with new highs being quickly re-established. Here’s a 10-year chart of the S&P 500:

As you can see, since early 2003, there has not been any serious drawdown and down markets were quickly erased with new highs in a matter of months. The growth versus inflation story both in the US and globally seems to have many investors feeling not too worried but not entirely care free. It’s the incredible resilience of the global markets to a continuous assault of significant events that has me wondering what does it really take to shock this bull market? Mideast turmoil and its effect on the energy markets hasn’t done it. An all out war (albeit short) in Lebanon in addition to conflict in Iraq and Afghanistan seems almost like a non-issue now. The UK subway bombing is an example of an even more “focused” event that shocked the market but in such a meaningless way in terms of severity and length. Closer to home in the US, despite a White House adminstration that seems destined to be the ultimate case study for grad school management programs (G.W. Bush was the first US president to have earned an MBA, right?) with a chain of foul ups too long to mention, the markets have shown a nearly straight line upwards. However, G.W. Bush assumed office in early 2001 when the S&P 500 was at around 1350. Just a simple observation, but if you include distributions (as opposed to just a price based calculation using the above chart), the US market has provided close to cash equivalent returns over the Bush presidency. Somehow I think if Gore won the election back in 2000, there wouldn’t have been too significant a difference in market performance although that’s certainly highly debatable. Well, I think there’d certainly be less laughs on the late night shows … I doubt Lieberman (or Edwards if Kerry won in 2004) would have done anything like shot someone in the face, but the Democrats are also damn good at screwing themselves with ease. The market was already on its way down and no matter who won the election back in 2000 nothing would have stopped the bear market. September 11th brought a quicker drop but spiked back up only to continue the downward trend until we hit bottom somewhere in the later half of 2002.

But now we’re at a completely different time. We’re near (S&P 500) or past (Dow 30) previous highs. And what interests me now is what remains highly resilient during the moments - even if they’re relatively short - when the market seems to release some steam. Hopefully, this kind of analysis not only finds good defensive performers in mini-corrections but in serious market declines as well. First, let’s take a shorter term look at the S&P 500:

We can see last summer’s market decline as well as the turmoil over the past month. In between is one of the smoothest bull markets I’ve seen. I think it’s too short to be considered a cyclical bull but at seven months, it was a fairly nice long run of about as straight a line as a market could have, and with a rate of ascent that makes it that much more incredible.

However, you plot some sectors over this chart and you see that there are areas that are even more incredible over the past year. With all the press related to commodities, one might guess that the oil & gas sector would have been a good place to put assets over the past year but all it’s brought is its usual high level of volatility:

At least it looks relatively uncorrelated to the S&P 500 so for asset allocators with an eye for diversification (not for Canadians, Russians and other oil producers of course) there looks like an argument to hold a certain portion of one’s portfolio here. What about gold & silver?

Pretty much the same story. Low correlation. With bigger drawdowns than in the oil & gas sector over this period, again the idea is to add some of this but not too much. It’s somewhat uncorrelated so it can dial down a portfolio’s overall volatility, but add too much commodities and watch your volatility skyrocket!

Obviously, something less gut wrenching is utilities:

No surprise, utilities are one of the classic defensive sectors. Compared to the broader market it often timeis has a lot less volatility and, in fact, over the recent year’s chart looks like a really well run hedge fund. I’m not joking. Look at the behavior of the Dow Jones Utilities Average over the months of May/June 2006 as well as over the past 5 weeks in the chart above. During these times of market stress, the DJUA was relatively flat or slightly upwards (last summer) or strongly up (recent weeks). Otherwise, during other times it looks kind of like the index but on a month-to-month basis you don’t see a high degree of correlation. Unfortunately, the comparison of DJUA with hedge funds only goes so far as you can see in this 10-year chart:

Unlike nearly all hedge fund indices (as bad as they are as benchmarks I use them as the only decent source for comparison), you can see that the DJUA did not protect investors from the bear market of 2000-2002 in any way better than the broader market S&P 500 Index.

Still, my point is that utilities is one of a few areas where it clearly has been going strong even in comparison to the S&P 500 during this bull market. And, of course, as a defensive play it seems to do relatively well even in times of distress. Recent commentary has suggested that the new infrastructure ETF from SSGA, the SPDR FTSE/Macquarie Global Infrastructure 100 ETF (GII) is actually a global utilities fund in disguise. For review, refer to my previous posts covering infrastructure here and here. Some of my comments from those posts seem to suggest that infrastructure, like many areas that have shown new product offerings in the ETF space, have shown too great a rise and that investors might be wise to show restraint and wait for better valuations and a lower point of entry. Price action over the past few months have proven me wrong overall as shown in the following chart which includes several infrastructure oriented ETFs and CEFs:

All of these funds involve Macquarie and although they have different mandates you can see that they generally move in tandem. For example, although the S&P 500 had a modest increase in the month of March, all infrastructure funds in the chart above had a strong month except for the first week. Perhaps I was correct earlier this year when I addressed concerns of the recent strength in infrastructure oriented funds. The sharp declines in late February in line with the overall market seem to agree with this. However, their incredible concerted rebound was frankly unexpected. I would have thought that any rise would be in line with the broad markets, not the sort of out performance shown in the chart above.
Therefore, and perhaps not surprisingly, infrastructure and utilities are quite similar in that they have demonstrated an ability to deliver favorable performance in the good times, but more importantly, when the broad markets are not as strong. And the immediate corollary to this for me is the attention given to fundamental indexation whether through PowerShares or WisdomTree. Like other alternative weighted index methodologies, the focus is on value over growth. No one would argue that utilities are a value play, but so too is infrastructure with the stable income generated from its business operations (airport, highway, port, water service, etc.).

Lastly, I have seen some very brief commentary on the transports. Here’s a 3-year chart comparing the Dow Jones Transportation Average to the S&P 500:

Over 1 year, the S&P beats the DJTA. Over 2, 3, 4 or 5 years, the DJTA wins. Regardless of commentary relating to transports as a leading indicator, I can’t see this an anything more than a high beta version of the broader market. And in today’s environment, for the defensive oriented investor, this or an ETF in this space is likely one to avoid. Look how it behaved last summer, over the past month and in other times of market declines. But perhaps technology or in the chart below, internet stocks, are an even better example of a purely cyclical play … the perfect opposite of the defensive sector play:

This example goes too far to the other extreme but it clearly makes the point to differentiate how far apart a defensive sector like utilities looks compared to a cyclical sector and versus the broader market. Some may think of transports as a possible defensive play but in times of market distress, if you felt nervous about the S&P, transports would make you manic! Speaking of transports, I’d like to write about freight derivatives at some point. I continually neglect the derivatives market as there’s just so much happening in the ETF space but it’s just so interesting to see the continued innovation in the derivatives markets (property derivatives, housing derivatives, economic derivatives, weather derivatives). Some more for the “to do” list.

Bottom line: For investors concerned about providing an adequate level of defense for their portfolios, some sector tilts may provide greater diversification benefits than geographically based asset allocation. Rather than allocating more towards EAFE or even emerging markets, investors may look to areas like utilities, infrastructure and other sectors that may have a better chance of sustaining past earnings levels or at least have minimal downside effects to general operations when the overall global economy softens. With concerns of greater correlations among asset classes and asset strategies, sector “bets” (yeah, it’s an active decision that may be right or wrong) are one of the more tried and true methods available to any level of investor. Clearly, some sectors are better than others for defensive maneuvering. If sector rotation is to be fully explored as a viable strategy, thank goodness for the recent delivery of sector oriented ETFs brought to the market by ETF manufacturers and especially the relatively younger providers who have brought some very interesting niche funds to the marketplace.

In the past, I’ve commented on how a Canadian investor should not consider emerging market investments, in general, as a diversifier to their total portfolio. If in fact they do have a home bias, as most investors do, the results during times of distress can be quite agonizing. Not only are the correlation in returns high between Canada (EWC) and the emerging markets, but they are the perfect anti-diversifiers:

The same is true for other resource heavy economies such as Australia (EWA):

And South Africa (EZA):

Interesting that in this last case we see that the South African ETF is actually more volatile than EEM but that isn’t surprising when you see that nearly 25% of the fund is in the metals and mining sector.

Based on the above, it’s fair to assume that this correlation risk can be applied to any investor with a relatively large exposure to the commodity complex, no matter where they are located. However, you don’t simply want to avoid the greater macro story coming out of the developing world, do you? We need to think about what other possible choices there are beyond broad EM exposures such as EEM and VWO.

Latin America

Let’s take a look at these ETFs for the Latin America region:

Again, I use the same 3-year timeframe as the charts above. Probably not surprisingly, we see that the broad Latin American ETF (ILF) zigs and zags in tandem with the Mexican ETF (EWW) and Brazilian ETF (EWZ). Suddenly, EEM looks conservative in comparison to these but follows the same upwards and downward oscillations. The correlations are to be carefully considered if you hold some (or all!) of these.

East Asia

Here we finally see some variation in price movement, in this case from the far east:

The Malaysian (EWM) and Taiwanese (EWT) ETFs seem to move closest together. China (FXI) and South Korea (EWY) show great appreciation but at different times. However, what we find again is the synchronized down movements not only in the summer of 2006 but in March and October of 2005. Scroll up to review all the other charts and you’ll see that when I say “synchronized”, it’s global in scope.

Central/Eastern Europe

What about this region? We don’t have an ETF for this region yet although Roger Nusbaum discussed a new index that could be easily tracked by an ETF … but c’mon, 15 stocks! Bogle will go bananas over this.

So, I dig into the closed end fund world to build this chart which has the Central Europe & Russia Fund (CEE), Morgan Stanley Eastern Europe Fund (RNE) and the Templeton Russia & East European Fund (TRF):

Same moments of downward movement as described above, and then some. No doubt investors in this region experienced a “Maalox moment” last summer.

So, we can see that within each region there’s quite a bit of correlation, but especially during times of significant market distress where, in fact, the correlation is not just high within that region but within what looks like all emerging markets. What about the BRICs?

Although we have news of Van Eck soon to launch a Russian ETF, the best I can do for charting Russia is ING Funds’ Russia Fund [LETRX]. Similarly with India, the iPath MSCI India Index Exchange Traded Notes (INP) from Barclays does not have a long track record like The India Fund (IFN) which I use in its place.

The chart only goes back 2 years because of the shorter record for FXI. However, the real problem with this chart is that we have a mix of indexing and active management. For example, someone else may have chosen another proxy for India, such as the Eaton Vance Greater India Fund [EMGIX] and the results would be significantly different from IFN as shown in this 12-month chart:

But I think the point is that if you have regional emerging market exposures as shown with the BRIC exposures from the 2nd chart up, you’re getting about as good an amount of diversification as you can get … still getting the upside boost of these regions’ returns but also with the coordinated downside which it seems you can’t escape without some serious timing abilities.

Whether you call it timing or active management, it seems as if it is required for the emerging market space. And I say this despite the fact that the SPIVA scorecards from Standard and Poor’s show that active managers in even this space have a difficult time beating their relevant benchmark. Nevertheless, you either rely on some timing or else you’ll have to accept some serious drawdowns like we saw last summer as part of the plan.

I specifically chose some funds above from the individual BRIC countries but of them, it’s nice to see that it’s the big newsmakers, China and India, that show somewhat reduced levels of correlated returns:

To me, it’s unfortunate that Brazil’s weighting is so large in BRIC ETFs (nearly half) with China, and especially India, with smaller allocations. Thus, I like the idea of country specific ETFs for China and India as well as the idea of a Chindia ETF. Some news here about an upcoming ETF for this combination.

For the future, emerging markets, but especially China and India, are the real stories. If I were consulting on a hedge fund mandate related to these regions (which I’m currently not), the problem I’d focus on would not be the long exposures but the ability to be opportunistic on the short side. Based on the charts above, the down periods can be short but painful. However, it’s important to note that these are not just emerging economic markets but emerging securities markets. Thus, the regulatory environment does not often allow for easy and opportunistic trading. You will often have a tough time shorting stocks in these new jurisdictions. A combination of stock selection on the long side (bottom up analysis) with shorting of ETFs (top down analysis)? Sounds pretty basic but this may be the real value of emerging market focused ETFs.