Strength Building in Emerging Markets

The fundamental truth is that Emerging markets now account for half the world’s economic output, and 80% of the world population. However, emerging market stock capitalization only accounts for less than 15% of the world capitalization. In economics it is called market disequilibrium. In finance, I call it an investment opportunity.
I have inserted a chart from a recent BCA Research report that shows emerging markets have recently been gaining strength. Historically, emerging markets gaining strength is a signal for a bottom in world economic downturns. The substantial relative strength shown in opposition to the U.S. indexes should be closely watched in the upcoming weeks. Continued strength and momentum could signal a fundamental bottom and growth around the corner.

China Stimulus Measures:
"Just as Britain was the country of the 19th century, the U.S. the country of the 20th century, China will emerge the country of the 21st century." These words from Warren Buffet are strong enough to stand in front of May turn out to be notorious enough for us to overlook Berkshire Hathaway’s recent 96% decline in Q4 FY08 profit. At China’s National People’s Congress, Premier Wen Jiabao promised GDP growth of 8% for the year. Although this percentage does not amount to the past decade of Chinese rate of growth, it will most definitely shine 8% greater than any developed economies for the year. I have confidence in this affirmation as Wen is on the brink of introducing China’s second stimulus plan in the past year.
A stimulus plan will be the key to bringing the world out of a global recession, however; it will not come from the United States government. This past Wednesday China’s benchmark stock index rose 6% on talks of another China stimulus plan in the creation stage. This news also sent the U.S. broader market higher, which gives indication that growth in Asia will lead to growth around the world. Other bullish indicators within Emerging Asia as of late is the strong rally in manufacturing commodities such as copper and iron ore. The copper futures market has been on a rally as an indicator that China’s economy and stimulus bill will spark production and growth.
After the Asia Crisis in 1997/98, many countries implemented structural changes to macro- and micro-economic improvements leading to stronger, conservative balance sheets. As investors have been leaving U.S. equities, they will look for investments that have not been dismantled by credit and leverage. The U.S., Euro-Zone, and Britain had the easiest access to credit, and they are hitting the ground the hardest. Countries without easy access to credit will turn into investment opportunities for the new financial environment. With a healthier macro-economic environment, Asia will be able to implement a stronger fiscal policy than developed regions.
Further looking into commodities, which across the board are currently at depressed levels, China and its net importers tend to benefit over other countries from this type of commodity environment, especially with lower energy prices. This will free up businesses and promote investment.

Emerging Markets Leading the Recovery:
The fundamental truth is that Emerging markets now account for half the world’s economic output, and 80% of the world population. However, emerging market stock capitalization only accounts for less than 15% of the world capitalization. In economics it is called market disequilibrium. In finance, I call it an investment opportunity.
I have inserted a chart from a recent BCA Research report that shows emerging markets have recently been gaining strength. Historically, emerging markets gaining strength is a signal for a bottom in world economic downturns. The substantial relative strength shown in opposition to the U.S. indexes should be closely watched in the upcoming weeks. Continued strength and momentum could signal a fundamental bottom and growth around the corner.

Strength behind the Great Wall:
I have highlighted China as the emerging economy to lead the turnaround for many reasons. With a population greater than 1.3 billion, the middle class continues to grow and become financially competitive. Wen Jiaboa stated the importance of “significantly increasing investment to simulate economic growth, improve people’s lives and deepen reform.” As I stressed earlier the conservative economic environment has ensured China’s financial freedom from toxic assets. It is also important to look at the export market as it was once a vital part of China’s economy. Today, China has allowed the Yuan to appreciate, and thus deviating from its prior export competitiveness. China will seek future growth in part by foreign investment and will not be leaning on the coattails of the developed world to purchase Chinese goods. These factors, along with the additive that the Chinese government lowered the corporate tax rate to 25% (from 35%) will ensure that China will be the boom that relieves the current bust.

Investment Opportunity:
To take advantage of this investment opportunity, my colleague, Addison Schroeder, believes the best way to gain diversified exposure to China is through the FTSE/Xinhua 25 Index ETF, FXI. Even though a few companies in this index are partially state-owned, the growth of China will still be reflected in the returns generated by the index. Addison is optimistic in the possibility that one day capitalism will take over socialism, and the state-owned companies will be able to take advantage of the free market system. For a more developed play on China Schroeder likes the MSCI Hong Kong Index ETF, EWH.

Emerging markets are still a high risk investment, however, from the decline in the emerging indexes over the past year, it may be the right time to jump in and participate in some bargain shopping. Emerging markets are a great fit in the wider portfolio as they offer a rare combination of value and growth.

• In respect to Addison's opinion on state-owned companies, I have a little more positive outlook. A recent article from the Economist describes that "the more "capitalist" an economy, the deeper the downturn. And the more the country is still in command, the better chance for recovery in 2009." State-controlled firms account for nearly 1/3 of the industrial production. These firms have been demanded not to cut jobs or capital spending. The Economist references that all major Chinese banks are state-owned, and "if they get a phone call telling them to lend more, they are likely to do so."

Investing in Gold for 2009

In March of 2008 gold spot hit 1,030/ounce (all-time high), partly due to rampant inflation of oil and food prices. In December, gold hit a 21-month low of 681/ounce, a 34% drop. Currently gold has been steadily rising to where it stands today at 957/ounce.
I see gold rising as the necessary flight to safety, and speculative trading pushes Gold past the $1,000 price level. Gold is a safe play in any economic downturn as it provides broad safety against economic uncertainty and an inflationary environment.

Gearing up for inflation:
Inflation, by economic definition, is in store for the future of our economy. Historic events and spending packages that have resulted in inflation do not amount to the government spending and increase in the money supply (M1 and M2) that the Federal Reserve has currently undertaken. The current bailout over the past year has added to $8.5 trillion (S.F. Chronicle). This unprecedented ocean of artificial liquidity may soften the recession, but must have lasting affects in respect to inflation.
• The Fed is expanding our monetary base by more than $11 billion a day since September, to nearly $1.5 trillion. That’s an increase of 79.02% since October of 2007.
• On an annualized basis, the “run rate” – the increase of dollars in circulation – is soaring by 369.92% per year

An Overvalued U.S. Dollar
Through history, gold has shown a strong negative correlation to that of the U.S. dollar. As the dollar has been extremely overvalued from foreign investment, the future holds depreciation in the dollar and thus a rise in the demand for gold. The reasoning behind this is that as the 8.5 trillion begins to flood the global economy; this liquidity will torpedo the dollar to the floor. In other words, it is time to start moving our assets out of the dollar, and into gold.

Bull Market set for Commodities:
Another strong fundamental basis for gold is the predicted bullish commodities market in store for 2009. Commodities are currently undervalued as: 1) gas prices have fallen 47% from July highs, 2) corn prices have fallen 50% from their summer high, and 3) wheat hit a 16-month low at the end of 2008. The crop production report has shown acreage decreases of the following:
• Corn acreage fell 1.2%.
• Soybean acreage dropped 1.4%.
• Canola acreage dropped 1.9%.
• Sunflower acreage shrank 0.8%.
• And acreage of dry edible beans fell 0.7%.
This cut in supply will naturally increase demand causing an increase in prices, and overall inflation. As gold hit its all-time high during similar inflation, gold will rise above 1000/ounce to reflect the commodity price increase that will tighten household and corporate budgets. In such inflationary environments, households and businesses will look to save in safe investments, gold being the ultimate selection.

Is Gold Currently Overvalued?
During the Great Depression, the Dow dropped to $36, and simultaneously gold rose to $36/ounce, a 1-to-1 ratio. In 1980, after the 1970’s bear market, the Dow fell to $850 as gold appreciated to $850/ounce, once again reflecting the 1-to-1 ratio during economic downturns. Peter Schiff believes that the 1-to-1 ratio will once again work its way back into the market as the Dow has room to fall, and gold has room to rise. The current valuation may suggest the “running of the [gold] bull” is just beginning.

SPDR Gold Shares ETF (ticker: GLD)
Although their may be other ways to seek high returns and leveraged profits with the rise of gold, the intention of this investment is for a safe haven against economic instability, currency volatility, and for better allocation and diversification within the endowment portfolio. Being said, it would not be beneficial to play gold through the equity market or leveraged ETF’s, as we would merely be increasing our risk. Therefore, the proper investment is within the SPDR Gold Shares ETF (ticker: GLD) (infamously known as “The Trust”). GLD is a fund whose shares are intended to parallel the movement of gold prices. This ETF eliminates any concern over storage and delivery while giving the investor exactly what they want- gold. Traded in the NYSE, each share of the GLD represents one-tenth of an ounce of gold. This investment product is one of the easiest and least expensive ways to access the gold market.

GLD 2/13 close: $92.55

787 Billion Answers to Unemployment

In keeping good hope during this economic meltdown I turn to the quote, “mistakes are a fact of life, it is the response to the error that counts.” With Obama’s recent $787 billion stimulus package we may finally be responding to the errors. Current discussion on Wall Street and Main Street has revolved around the heart of the stimulus plan; tax breaks or spending.
The plan’s focus on infrastructure is the white knight that will restructure this domestic economy to what it once was. Obama, as well as many economic analysts, say we will know the bottom when we start to see the soaring unemployment rate, currently at 7.6%, begin to reverse. In past recessions, America has been attributed as a productive, manufacturing nation that seeks national growth within its borders. During such recessions, tax breaks were all necessary as household spending from the rebate went directly back into the American economy. However, today is a different story. Over the past quarter-century, America has shifted from the producing country we were, to the service country we are today. The service sector currently comprises upwards 70% of our annual Gross Domestic Product. This means that money from tax breaks will simply go two places: 1) pay off outstanding debt 2) automobile, clothing, electronic imports, and thus aiding foreign economies. Also, with the consumer confidence at a low, and the current state of frugality within the American household, the rebate may be saved, which will do nothing to fix the recession. With the ailing problems in our domestic economy, infrastructure is the important focus of the package as it will secure future growth through the restructuring of American jobs, and thus the American economy.
As I am a part of the future generation that will inherit this plan and economy, I understand that to fix the current conditions means the addition of future debt. If this plan will bequeath my generation with piles of debt, at least leave us somewhat better off—with infrastructure, and alternative energy, and improved education and health care.
Another questions comes about as to if $787 billion is enough to stimulate. From my research, this plan is a necessary amount for today; however, we will need more in the future. Alongside the lagged affect of fiscal stimulus, this package will do its job to keep the consumers, markets, and housing from falling much further, but without another plan in the near future, we will see sideways movement for years similar to that in the 1970’s. We have been trying monetary policy; however, the Federal Reserve is running out of bullets. Fiscal policy is next on deck, and although we would rather stay away from the medicine cabinet, we must allow steroids into this game.

Corn market set for rebound

Corn prices are down over 50% from their June 2007 peak of 7.65, but the current dip in corn prices is just a temporary decrease, as higher demand and a potentially smaller-than-estimated total crop are poised to push corn prices higher.
Carryover stocks currently are at decade lows after the Midwest (mainly Iowa and Illinois) experienced the worst floods in 15 years this past July. Floods erode current supply leading to high prices as seen in the summer of 2008. Floods also will have an affect on the 2009 total supply, with the carryover stocks having less cushion. Carryover stocks from the previous year become the current year’s beginning stocks and augment current production in determining supply. I see this effect having a positive affect on the price of corn in respect to the Winter/Spring seasonal trend. As farmer-owned grain has been sold and used domestically or abroad, and farmers begin to dig into carryover inventories, prices tend to rise. Investors advise to take short-term positions at this point in the market as tops in the market tend to occur around February and March. And with carryover stock inventory at drastic lows, the seasonal trend should magnify the price affect.
Another possibility for corns price pop comes from speculation that hot, dry weather will reduce production in Argentina and Brazil, the two biggest exporters of the crops after the U.S. Argentina’s corn harvest may drop as much as 40 percent to 12.5 million metric tons compared with 20.85 million last year, and Argentina’s corn harvest may drop as much as 40 percent to 12.5 million metric tons compared with 20.85 million last year.
On the Demand side of the equation, I see President Obama’s stimulus package having a positive affect on corn prices. He has stated that the plan will have a large focus on infrastructure to create more jobs for an economy currently with 7.2% unemployment. Corn starch plays a major role in infrastructure. Corn starch is used in the paper industry for coating paper, and the construction industry for wallboard construction. I understand that stimulus plans generally have a lagging affect on our economy, but I feel that the futures markets will be first affected as a leading indicator of this increase in the demand for corn.
Another factor of demand is the use of ethanol (produced from corn) as an alternative resource to gasoline. This USDA raised its expected total of corn to be used to make the alternative fuel ethanol in 2009 by 150 million bushels. 33% of corn production is expected to be used for ethanol, which is a 23% increase from last year. Finally, in its favor, legislation from the U.S. energy bill signed by Former President George W. Bush on December 20 requires biofuels to increase to 36 billion gallons in 2022 from 7.5 billion in 2012.
Finally, during times of recession, people substitute heavily into vices, and I see the increased demand for vodka (grain alcohol) having a positive affect on the price of corn.
To invest on these corn fundamentals, the futures market is a great place to seek the highest returns. However, if your capital and risk do not match up to this type of investment, the DBA (PowerShares commodity ETF) is a great way to play the corn boom. The DBA has 63% of its asset holdings in the corn futures market.

Corn Spot Price (close 2/12): 369.25