There is an interesting BusinessWeek article that is worth the read if you invest, or are planning to invest, in a commodity fund. Since most commodity funds invest directly in futures, how those funds are managed can have an effect on returns.
One area of difference is how the fund manages margin. Since the fund is purchasing futures, margin must be set aside, but it is up to the fund to determine how those funds are invested. Some of the more conservative funds will purchase Treasuries, while others will invest in higher yielding bonds. Over the long haul this can have a noticeable effect on overall returns (and risk) for the fund.
Another area of difference which may have an even bigger impact is the effect of "roll yield." Roll yield is the positive or negative return you get when you sell one futures contract and/or roll an expiring contract into a new one. How often this is performed depends on both the duration of the contracts (how often they have to be rolled over), and any strategy employed by the commodity fund to try and manage the duration exposure. Depending on duration and strategy, having prices go into either contango and backwardation can have either a positive or negative effect on the commodity portfolio.
Some funds will only invest in short duration futures, essentially trying to mimic the commodity spot prices as close as possible. Other managers believe the fund is a long-term investment, and should be managed as such. These funds will buy contracts with durations from 3 months to 3 years. Various strategies and back-testing are performed to find the best contract durations based on whether the market is in contango (longer-duration contract prices are higher) or backwardation (longer-duration contract prices are lower).
Initial results are somewhat inconclusive as to which strategy is the best - i.e., managing the duration works sometimes, and sometimes it does not, especially if the dynamics of the market have recently changed. This is especially true of crude oil futures which seem to be affected on a daily basis by new variables in somewhat unpredictable ways.
Nonetheless, when purchasing a commodity fund it is worth thinking about what type of management you are comfortable with. Do you want relatively passive management with a fund that mimics the spot price dynamics - both good and bad? Or do you want a fund that tries to more actively manage the contract durations, allowing the fund to respond better when the market is either in contango or backwardation - even if fundamental and technical changes can put the fund on the wrong side of the market? As usual, it is often a matter of personal preference and current exposure. Unfortunately, while investing in commodity funds is certainly easier than trading futures for most, you still need to do your homework.
It looks as though the price of European emission permits are increasing at a fast enough rate that German companies are threatening to leave the country. As reported in the Spiegel article, in the last 12 months the price for the right to pump a ton of carbon into the atmosphere has increased from €23 ($36.5) to nearly €30 ($47.6). The approximately 30% hike over the last year is having a direct effect on the electricity production of power companies. Based on past studies, it is expected that the marginal price for electricity generated from a coal-fired plant would increase by the entire price of the carbon credit. For modern natural gas plants, the marginal price would increase by approximately 33%. Of course, the tough measures of the emission trading program have not yet been implemented, with a proposed trading period starting in 2013. At that time every company will need to acquire the permits from the trading exchange. It is expected at that point that both prices and volatility will increase further.
If companies are being negatively impacted, then who is doing well? Apparently, the German state. The German Finance Minister Peer Steinbrück expects tax revenues from the climate protection program to exceed earlier estimates, raising €525 million ($832 million) in the first six months. If the trend continues, the German government may need this money to make up for the job losses that are being threatened to be lost to relocation. Of course, all of this says nothing as to whether or not the credits will even have any benefit, regardless of their impact on economic growth (see lessons learned).
As is now well known, this week the SEC announced that it plans to tightened short-selling rules on Monday for 19 financial companies, essentially limiting naked short selling by now requiring short-sellers to actually borrow the shares they plan to sell before shorting. The new restrictions were loosen a little on Friday when the SEC said market makers wouldn't have to pre-borrow the stock, but would still need to deliver them within three days. Market makers had complained that the new rules would prevent them from providing the necessary liquidity for making an efficient market.
Upon first hearing of the rule change (or enforcement), in particular the listing of the gang of 19, I wondered in a post whether some companies on the list would prefer to not be included, given the attached stigma of needing Government intervention to prop up their shares. After all, the rule is effectively an SEC induced short-squeeze. Of course, that was 3 days and +20% ago. Now other companies are wondering why they were not included. After all, they like +20% moves as well.
As mentioned in a recent WSJ article, the Financial Services Roundtable, who represents 100 of the largest U.S. financial companies, wants the SEC to extend the order to include companies they represent as well. Companies like Wachovia, reporting next week, are not currently included. Apparently they are either not big enough to fail, or are not yet in poor enough shape to fail. Given the recent investigation of Wachovia, and speculation about poor numbers next week, that may soon change.
If history is any indication, and it usually is - it is rarely different this time - then companies may want to be careful what they wish for. Research by Professor Charles Jones at Columbia Business School has found that similar moves by the SEC have some unhappy precedents. As mentioned in the WSJ article: "In 1932, the New York Stock Exchange announced that, effective April 1, brokers would need written authorization before lending an investor's shares. "This wreaked havoc on the securities lending market, but the effect was completely temporary," he [Jones] said, because the move only added extra hoops, and didn't prevent people from taking bearish positions if they wanted."
More regulation, and temporary results. Not necessarily what we need long-term, but what we will probably get regardless. Maybe with less next quarter, short-term, results-generated management, by both investors and the government, we would not need additional layers of regulation.
Today I got a chance to watch a little more of CNBC and other financial news shows and noticed a few things. First, there is a growing chorus about whether or not we have reached a bottom in the financial companies, and the market in general. There is a lot of talk about how "just think, if you had bought Fannie or Feddie or JPM or LEH last week, you would be up x%." It is common to do "what if" scenarios, but the coverage seems to be a little more intense today.
There was also a comment today on CNBC from Bill Seidman that was interesting. When asked about the recent actions of the Treasury Secretary, he mention that while current moves could positively affect the market near-term, even over the next year, the proposed actions are a longer-term disaster. He gave the analogy of how Secretary Paulson was running the Treasury like he ran Goldman Sachs, making sure he makes his numbers next year. Great stuff. While not mentioned by Seidman, you might also be able to make the same argument regarding the Fed, which seems to be managing quarterly GDP numbers and not focusing on controlling inflation and supporting the dollar for fear of occasional lower growth.
There was a nice, shall we say really nice rally in the financial stocks yesterday, with the XLF surging up 12%. Fannie and Freddie also had big days. Down volume in the XLF has also recently spiked to record levels (twice), potentially indicating capitulation (see a nice article by Bill Luby at greenfaucet.com). Yet, I have to wonder how much of Wednesday's movement is based on the recent SEC changes in the short selling of financial companies, and how much is due to capitulation and a potential market bottom. Have all the problems with Fannie, Freddie, banking, housing, and credit been cured since we can no longer short without (heaven forbid) actually borrowing the shares we want to sell?
A WSJ article discusses the changes in the short selling requirements. In short, the SEC has created a temporary protected list of 19 financial companies that prevents naked short selling of their shares. The extra protection of the 19 companies will continue until July 29, but can be extend for 30 days beyond the original July 15 date, and could be extended to more companies. Now, instead of allowing brokers to sell a stock short as long as they have a "reasonable" belief they can locate the needed shares and actually deliver them, they will now need to make formal arrangements to borrow the shares before shorting. The new rules will prevent multiple brokerage firms from looking at the same available stocks from the same custodial banks, assuming they would be able to deliver these shares if necessary. While the stock prices of the listed companies reacted positively to the added restrictions, it is unclear that the companies themselves will appreciate the added stigma of appearing to need government and SEC protection. The effects of the new shorting rules on hedge funds - who actively engage in short selling - is also unclear, but certainly not positive as each will now need to secure shares first before shorting. Hedge funds do have the ability to use puts and swaps, yet those on the other side of these derivative trades may need to find other ways to hedge their exposure.
But is this the real problem, and will the current SEC changes really fix the underlying issues in the market? It is mentioned that short interest has risen sharply for financial stocks and the NYSE and Nasdaq markets since the last market correction eight years ago. But is this really any surprise? Financials have been one of the largest, if not the largest sectors in the market. Given that they are now suspect due to the recent credit and housing issues, and have been for some time, would you not expect both the financials and the market to see increased levels of shorting?
The recently increase in down volume experienced late last week and early this week may be the capitulation that the market is looking for. Regardless of whether it is or not, I am still not convinced that an SEC induced short sale restricted rally is the making of a recovery. If it is, what does this really say about our markets?
The Chicago Board Options Exchange has introduced a Crude Oil Volatility Index (OVX), similar to the CBOE VIX which tracks volatility and fear in the stock market. The contracts have 30 day contract durations and allow traders to profit from oil trading in both directions. The OVX holds near-term futures contracts and cash to compute the level of volatility in the West Texas Intermediate crude markets. Should you trade it? As John Carter from Trade the Markets was recently quoted in a CNBC article: "I wouldn't see a lot of applications for the retail investor unless they're a little more sophisticated." Good advice indeed. It is also interesting how these types of vehicles seem to come out just as the markets they are taping into are topping or rolling over. Makes you wonder - but that is a discussion for another day. Adam Warner over at the Daily Options Report also had a nice post a few months back about using the VIX, but not trading it, since it is a derivative of a derivative. Furthermore, with retail VIX trading the guy on the other side of the trade probably knows more than you do. The post is still worth a read. Check it out.
James Altucher has written about two potential wind power plays in a recent Financial Times article. The two stocks are AeroVironment (AVAV) and Otter Tail (OTTR). Yes, strange names, but Altucher mentions that these stocks interest him in part because his ".... general approach when dealing with “hot topic of the day” type stocks is to look for back doors. Find stocks that have legitimate cash generating businesses, trade at cheap multiples and happen to be making serious moves in whatever the hot field is." AeroVironment and Otter Tail certainly fit this description since they both have other primary businesses that do something other than support the wind power industry. Therefore, if wind power ends up being a passing fad (not likely, but scale could be less or slower than expected), you still have something else to fall back on. Probably not a bad strategy given the recent introduction of numerous companies claiming to be in the wind industry, as well as the number of wind power-based companies that still trade over the counter and on the pink sheets.
AeroVironment was founded in 1971 and headquartered in California. Its primary business is making unmanned aircraft systems and energy technologies for military and weather uses, among others. The company also offers a fast charge system for recharging industrial vehicle batteries while they remain in the vehicle. The market cap of the company is around $600 million. It has a trailing P/E of 29.8, and forward P/E of 22.1. The PEG Ratio is 1.18, with a quarterly revenue growth rate year-over-year of 26.8%.
AVAV has moved up recently after announcing that it secured a contract to produce its new Puma AE small UAV for the U.S. Special Operations Command. The indefinite delivery, indefinite quantity contract begins with an initial delivery of $6 million. If the initial one-year contract delivers at 100%, and the four single year follow-on options are exercised, the contract could go as high as $200 million. Management is expecting to grow sales and earnings at 20% to 25% per year. Of course, this says nothing of the wind business, which is currently a very small, shall we say insignificant part of their business. In a sense you are getting the wind business for free, and are buying into to a company that is doing well in the UAV market with the stock reflecting the defense earnings. But there is potential for profits from wind investment. Their Architectural Wind segment builds small modular wind turbines that connect to existing skyscrapers and other tall buildings and structures that are most likely to catch the wind. This allows a company to begin generating energy from the turbines without building a new structure, which is not only expensive and time consuming, but could require permitting and other hassles. Nonetheless, keep in mind that right now the near-term earnings are reflecting the defense business - which is looking pretty good.
The other company mentioned is the Otter Tail Corporation, a utility founded in 1907 and serving 129,000 customers in the U.S. and internationally. In addition to exposure to the utility industry, the company invests its excess cash in other subsidiary business, including those with specialties with polyvinyl chloride and polyethylene pipes, waterfront equipment, material and handling trays, horticultural containers, metal parts stamping and fabrication, diagnostic medical equipment, diagnostic imaging services, food ingredient processing, waste water and HVAC system construction, fiber optics, and electric distribution systems, among others. Yes, I know what you are thinking - kind of like a mini-conglomerate, Berkshire Hathaway-type of stock. The market has not recently been kind to such stocks, but OTTR appears to be an exception. The market cap of the company is around $1.3 billion. It has a trailing P/E of 25.7, and forward P/E of 19.6. The PEG Ratio is 2.82, with a quarterly revenue growth rate year-over-year of 26.8%. Bill Gates is the second largest shareholder in Otter Tail.
As for wind exposure, one of OTTR's businesses of interests is DMI Industries, a large maker of wind towers. Demand for wind towers has been strong, with orders stretching into 2012, causing DMI to open new plants. The new plants are expected to give the company the ability to produce and deliver off-shore wind towers, as well as more easily ship to expanding European and South American markets. Company management continues to express how demand is increasing rapidly, and the new plants will allow them to meet existing demand and expand as demand continues to increase, which is expected.
For those interested, other wind plays with varying levels of pure-play exposure also exist. Some common names that appear from time-to-time include Trinity Industries (TRN), making tank containers and tank heads for structural wind towers, Thomas & Betts Corporation (TNB) for electrical and steel structures, Owens Corning (OC) for building materials, Clipper Windpower (CRPWF.PK) for wind turbine manufacturing, Kaydon Corporation (KDN) for custom engineering products, Broadwind Energy (BWEN.OB) for wind farm construction and infrastructure, Woodward Governor (WGOV) for the design and manufacture of energy control and optimization of industrial turbines, and MasTec (MTZ) for building and installation of utility infrastructure.
In addition to the already mention names, the Danish-based Vestas Wind Systems (VWDRY.PK) is a major pure-play company offering wind power solutions for building wind farms, both towers and turbines. The Chinese energy infrastructure specialist company A-Power Energy Generation Systems (APWR) is also expanding into wind turbine manufacturing, providing both wind and China exposure. Other turbine manufacturers include Gamesa Corp Teca SA (GCTAF.PK) and Suzlon Energy Limited (SUZLON.NS). Ameron International Corporation (AMN) is a maker of water pipeline systems, but also is involved in wind-tower manufacturing. General Electric (GE) recently received an order for 667 wind turbines from T. Boone Picken's Mesa Power LLP. In addition to GE, Siemens AG (SI) also manufactures wind turbines. Finally, American Superconductor (AMSC) has a power systems division that supplies electrical systems used in wind turbines, a necessary but often forgotten piece of the wind power industry.
As mention before, many pure plays, and not-so-pure-plays are small caps that trade OTC and on the pink sheets, and subsequently include the risk and rewards of such investments. A number are also international companies. Confused on what to buy? Don't worry. First Trust recently launched the First Trust ISE Global Wind Energy Fund (FAN) for those that don't want to try and pick the winners in the group, but simply want to increase their exposure to wind energy. Good luck in your choices. Hopefully the wind is at your back.
The old Chinese proverb (with English translation) of "May You Live In Interesting Times" certainly seems to be the case for financial companies and those affected by the credit crisis (which is just about all of us). Even just a quick review and read of the financial/investment news sites gives the following:
International Herald Tribune discussing problems with Citigroup and the financial industry in general. Meredith Whitney is also quoted as staying "There is no place to hide for them." It is felt that Citigroup is so big that they are exposed to nearly everything.
New York Times article continuing to discuss how gas and food prices are pushing up inflation.
London Times Online discussing how share prices fell on the London markets after news of historic drops in home prices, and inaction by the Bank of England, are striking fears that Britain is in or near a recession.
London Telegraph article on how the Bank of England is essentially sitting on the side lines with regard to interest rates while they try to determine if a potential recession or out-of-control inflation is their worst problem.
WSJ article reporting an 18% drop in Q2 net income at U.S. Bancorp as it triples it provisions for credit losses.
Chicago Tribune article on how investors are fleeing suspect banks as fear mounts regarding a more widespread crisis in the banking sector.
Reuters article about how George Soros is once again predicting that this is the worst financial crisis of our lifetimes, and that Fannie and Freddie are just the beginning. Soros goes on to say that it may not get better any time soon given that the Fed Chairman is in a box with limited options.
Financial Times article about how the credit crisis is causing Australian companies to sell assets in an effort to improve their balance sheets.
Bloomberg article regarding the dollar hitting new lows versus the Euro, just as Bernanke and Paulson discuss issues with Fannie and Freddie, and the markets in general.
MarketWatch article discussing how Lehman Brothers, while not in danger of failing, may need an alliance, need to go private, or even need to be taken-over to prosper, yet it is unclear who might actually be in a position to purchase them. European companies, such as Deutsche Bank, Barclays, and HSBC as possible candidates since most U.S. companies will not be interested.
Forbes reporting how German investor confidence is at a 16 year low.
Fortune article discussing how the SEC, if it did not already have enough to worry about, now has to spend more time and effort chasing down rumors and the spreading of false information given its ability to damage financial companies, and even the entire financial system with greater ease than ever before.
Investors Business Daily article regarding inflation in the developing world, and how 2/3 of global inflation increases are coming from emerging markets - the very same markets that are hoped to out-perform other markets in the future.
..... and on and on and on.
Of course, is it enough to have bad news reported again and again, or do we need to really feel the bad news? Even a recent BusinessWeek article highlights how we still do not seem to have enough fear in the markets. While the recent sell-off has been consistent, the slope of the sell-off has not been very steep, nor displaying the types of spikes that often indicate fear and panic.
As of last week, the put/call ratios were not at the panic levels of the last year. The recent high for the 10 day CBOE total put/call ratio was 1.1, off from the recent peaks of 1.28 in March. The 30 day CBOE put/call ratio had a recent high of 1.0, compared to 1.17 in March. The 10 day equity only put/call reached 0.82, below the 1.00 level in March. The VIX is showing a little more fear, moving above 30% today for a short time, but falling back below 28% mid-day. Stronger, but not really the mid-30s spike that many traders are looking for.
Some indicators are beginning to show more fear. The latest Investor’s Intelligence poll had the bulls declining to 27.4% and bears rising to 47.3%. The bullish sentiment has not been this low since 1994. The bearish sentiment has not been this high since 1998. This gives a difference of 19.9 percentage points, the biggest bearish spread since 1994. The recent AAII poll shows 22% bulls and 55% bears, a number that is similar to March levels.
Overall, still a mixed bag, but looking better. Given the recent events and news, it does make you a little fearful (pardon the pun) about what it is going to take to get the capitulation the market is looking for. Interesting times indeed.
A few months ago BullBearTrader highlighted a U.S. News and World Report interview with Jon Auerback, in which he discussed potential new BRIC-type countries (see the original article, or initial post). In the article Auerback mentions Nigeria, Zimbabwe, and Kenya as potential regional opportunities. Other analysts and investors have also begun to talk about Africa as being one of the next regions for achieving above average growth and investment opportunities, even given some of the political, economic, and inflationary risks that still exists.
To take advantage of current and future redistribution of capital into Africa, Van Eck Global is offering a new frontier market exchange traded fund called the Market Vectors Africa Index ETF (AFK). For more information, see the IndexUniverse article, or read the prospectus. The AFK is not the first vehicle to begin tracking the performance of companies domiciled or operating in Africa. In a recent post we discussed the newly offered PowerShares MENA Frontier Countries Portfolio (PMNA). The PMNA tracks the Nasdaq OMX Middle East North Africa Index, which includes the countries of Bahrain, Egypt, Jordan, Kuwait, Lebanon, Morocco, Nigeria, Oman, Qatar, and the United Arab Emirates.
The AFK is unique in that it follows the Dow Jones Africa Titans 50 Index, covering 50 stocks from 11 different African markets, including Nigeria (32.5% weight total, 25.2% onshore, 7.3% offshore), South Africa (26.2% total, 24.7% onshore, 1.5% offshore), Egypt (13.1%), Morocco (11.4%), Equatorial Guinea (6.2% offshore), Zambia (3.4% offshore), Angola (2% offshore), Mali (1.7% offshore), DR Congo (1.5% offshore), Kenya (1.2%), and Ghana (0.7% offshore).
A few points are worth noting about the index. For one, not all of the companies in the index are domiciled in Africa but are nonetheless included since they derive a majority of their revenues from African markets - thus the classification of "offshore." Also, the index is not constructed totally of frontier markets. Both South Africa and Egypt are typically classified as emerging (see previous post for a discussion of the distinction between emerging and frontier markets). This classification is important given that the emerging markets represent nearly 40% of the index. This actually gives the index both the higher growth and return potential of the higher-risk frontier markets, but also some of the liquidity of slightly less risky investable emerging markets.
The index is market cap weighted and sets maximum holdings at 25% for countries and 8% for any individual companies. Of interest is that Nigeria is already overweight at 32.5% total weight, with 25.2% onshore. It is not clear if the offshore percentages are included in the 25% country limits. Banks currently make up 33.7% of the index, with basic resources at 18.2%, oil and natural gas at 13.5%, telecommunications at 10.2%, and technology at 7.3%. As for components, the fund states that it "..will normally invest at least 80% of its total assets in securities that comprise the Africa Titans 50 Index." Companies must have market capitalizations greater than $200 million. The fund's prospectus also mentions that it may utilize derivatives. The expense ratio for the fund is 1.2%, which can be waived down to a net expense ratio of 0.83%, but is still expensive compared to some of its peers.
While not a pure frontier market ETF (there currently are none), the index does give concentrated exposure to the African region, allowing investors to follow their belief that growth in Africa may be the next big thing. Given capital flows into Africa, and the benefits of higher commodity prices for some of natural resource rich countries in the region, a small exposure to Africa within your portfolio may be worth considering.
The SEC is looking to expand investigations into the spread of false rumors that may affect the financial system. Articles at Reuters and Bloomberg mention the recent slide in Freddie Mac and Fannie Mae, as well as Lehman Brothers, for the increased SEC attention. No word in either article whether a member of Congress will be investigated after the recent collapse of IndyMac, although an LA Times article does mentioned that some federal regulators are looking into the issue.
This all comes just as the International Herald Tribune is reporting how banking analysts are predicting that as many as 150 of the 7,500 banks nationwide (mainly small and mid-size) could fail over the next 12 to 18 months. Others disagree and state that while there will be liquidity issues, many lenders are likely to first either shut branches or seek mergers with stronger banks. The article also notes that the nation's banks are in less danger now than in the late 1980s and early 1990s when over 1,000 institutions failed during the savings-and-loan crisis. Unfortunately, even with less bank failures, the $125 billion government bailout that resulted at the time may seem like a good deal if things were to get as messy this time around. Hopefully we can avoid reaching the same levels, but some analysts are not optimistic.
Some perspective is in order. In 1994, the FDIC listed 575 banks that it considered to be troubled, while earlier this year only around 90 banks were listed - but the list is probably growing. Yet given recently developments, more failures are likely beyond the six already reported given that bank failures are a lagging indicator. Of interest is that IndyMac was not on the troubled bank list earlier this year, highlighting the fluidity of the problem. Also, of the $53 billion the FDIC has to reimburse consumers of failed banks, IndyMac is estimated to need between $4-8 billion, putting more pressure on existing banks, and possibly forcing the government to get more involved as it has recently with Freddie and Fannie.
Not unexpectedly, short sellers are jumping into the waters as various regional banks, such as BankUnited Financial Corporation (BKUNA), now trading under a dollar, and the Downey Financial Corporation (DSL), trading between $1-2 after reaching a 52 week high of $65.67, have been highlighted as having potential problems. In order to spot banks in danger, two popular ratios are used. First, when you divide non-performing assets by all outstanding loans, you find that a ratio over 5% signals danger (see CNBC article). Using this ratio you find that other banks, in addition to BankUnited and Downey (BankUnited's ratio is 5.36%, while Downey is at 13.86%) are suspect, including Corus Bankshares (CORS) at a 13.18% ratio, Doral Financial (DRL) at 12.82%, and FirstFed Financial (FED) at 6.73%. A second commonly used ratio that compares non-performing assets divided by reserves plus common equity causes Washington Mutual (WM), with a ratio of 40.6%, to also become suspect. Any value around 40% is thought to be in the danger zone.
As expected after the news leaked out Friday morning, the WSJ is reporting Sunday evening that Anheuser-Busch has agreed to be acquired by InBev for $70 per share, or nearly $52 billion. Hopefully you had less connection than myself and made an options purchase. Even with the tenuous credit and equity markets, I am sure there are some investment bankers happy to make the deal happen. Given the lack of stock activity in BUD over the last six years, I suspect shareholders will also have no problem approving the deal. (I guess now I am glad that BUD sold the Cardinals a few years back. At least St. Louis still has baseball).
