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October 03, 2008

Index Summary

• The major market indices were lower this week. The Dow Jones Industrial Index (1) fell 7.34 percent. The S&P 500 Stock Index (2) lost 9.38 percent, while the Nasdaq Composite (3) finished 10.81 percent lower.
  
• Barra Growth (4) underperformed Barra Value (5) as Barra Value finished 9.08 percent lower while Barra Growth declined 9.68 percent. The Russell 2000 (6) closed the week with a loss of 12.12 percent.
  
• For the week, the Hang Seng Composite (7) finished lower by 4.83 percent; Taiwan (8) lost 3.16 percent, and the Kospi (9) fell 3.84 percent.
  
• The 10-year Treasury bond yield closed at 3.61 percent, down 25 basis points for the week.

Regulations, baseball and the law of unintended consequences

By Frank Holmes, CEO and chief investment officer

With the World Series coming up soon, it seems timely to apply some key financial regulations to a baseball game.

Say the visiting team scores on an error in the top of the first and the home team fails to score in the bottom of the inning. Under the current mark-to-market rule for securities, known as FAS 157, there would be no chance to play the other eight innings -- the game would be over.

Say runners are on first and second and the batter fouls off a pitch into the grandstand. Under the no-uptick rule for short sales, the runners would be allowed to freely advance around the bases.

Say the visiting team scores a go-ahead run in the top of the ninth, then its players refuse to take the field for the bottom half. Under the weak rules governing naked short-selling, the umpires not only couldn’t order them out of the dugout, they also couldn’t declare a forfeit.

If any of these scenarios occurred in an actual game, there would be immediate protests and calls for change. And that’s what we’re now seeing with some of the major financial rules.

The current regulatory regime governing the financial sector appears to be seriously flawed, and those flaws have played a major role in the crisis that required the large-scale rescue that was finally approved by Congress following a week of political theatre during which 9.3 percent of the S&P 500’s value was wiped out.

Also playing a major role were the greedy residents of both Wall Street and Main Street that loaded up on debt, apparently without giving much thought to how it would ever be paid back.

This extreme leverage loaded the bases with danger, and the regulations triggered a grand slam against the economy. All of the players involved should be held accountable for the mess.

The rescue plan for troubled assets is important, but it’s only a partial solution. I think the prominent economist Nouriel Roubini is on the right track when he suggested recently that the government use a Depression-era approach to recapitalize banks with public money and take preferred shares in exchange.

It’s a good sign when you see Warren Buffett spending Berkshire Hathaway’s money on what he sees as bargains in the financial sector. In our analysis of Mr. Buffett, he appears to make major investments when a sector is down two standard deviations, and that’s where the market is today.

We agree with BCA Research when it says “opportunistic, selective buying remains the cornerstone of our investment strategy.” The price correction should lose downward momentum as politicians create policies that reflect current conditions.

Accelerating central bank liquidity is traditionally bullish for commodities, but given how far things have fallen, the transition to a renewed bull market in emerging economies and commodities could take months.

The Leaders and Laggards table has been moved to the bottom of the page, click here to jump to it.

Domestic Equity Market

Strength

• The specialty consumer services group was the best-performing group for the week, up 3 percent, led by its single-member, H & R Block Inc. In a press release this week the company stated that it expects an additional 31,000 taxpayers will receive “soft notice” letters from the IRS, starting in October. These notices will likely be sent in situations where the IRS received an informative document showing income that appears to be underreported on the tax return. H & R Block’s audit services program helps taxpayers navigate an audit.
  
• The household products group was the second-best performer, rising 2 percent on the strength of its largest member, Procter & Gamble Co. This group is in the consumer staples sector which typically outperforms in a period of weakening or uncertain economic times.

Weakness

• The real estate services group was the worst-performing group, declining 32 percent. Its single-member, CB Richard Ellis Group Inc, operates in the commercial real estate leasing & sales business, an area which has been weakening as a result of disruption in the credit markets. Also, short selling likely played a part in its decline since it is a financially-related stock, but not on the SEC’s “no-short” list.
  
• Six of the ten worst-performing groups were commodity-related groups, as commodity prices continued to decline in expectation of a slowing global economy. The six groups were down in the range of 29 percent to 22 percent, and included diversified metals & mining, coal & consumable fuel, oil & gas refining & marketing, steel, fertilizer & agricultural chemicals and construction & farm machinery.

Opportunity

• Although the level of merger & acquisition activity has slowed when compared to the 2007, there may still be an opportunity for gain in M&A transactions in 2008.
  
• The government “rescue” plan passed by Congress this week could possibly help ease the credit crunch.

Threat

• A continuation of the credit crunch presents a threat to the economy.
  
• Slowing economic growth in the U.S. presents a threat to the domestic component of corporate earnings.

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The Economy and Bond Market

Bonds rallied sharply this week as the credit crisis continued, even as Congress passes a $700 billion financial rescue plan. Economic data was negative which at this point just confirms the onset of recession in the U.S. The ISM manufacturing composite index (10) fell to its lowest levels since October 2001 and the economy lost 159,000 jobs last month.

Strength

• The rescue plan was passed by Congress, potentially setting the stage for stabilization in the financial markets.
  
• Euro zone inflation fell to 3.6 percent while unemployment rose to 7.5 percent, putting pressure on the European Central Bank to ease monetary policy.
  
• Fed fund futures are now pricing in a 50 basis point rate cut from the Fed.
  
  
  

Weakness

• The credit crisis is impacting virtually all areas of the economy as commercial paper issuance has dropped by more than $200 billion in the past three weeks.
  
• France and Germany disagreed on a rescue package which will eventually delay much needed assistance.
  
• The magnitude of the bailout raises concerns of currency debasement and the potential inflationary ramifications.
  

Opportunity

• The Fed is likely to take a cautious approach and may cut interest rates in the near future to bolster confidence.
  
  

Threat

• Inflation is likely to slow with global economic growth, but with central banks around the world pushing money supply higher, inflationary pressures in 2009 can’t be ruled out.

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Gold Market

For the week, spot gold closed at $835.50 per ounce down $43.25 or 4.92 percent. Gold equities, as measured by the XAU Gold & Silver Index (11) fell 18.95 percent for the week. The U.S. Trade-Weighted Dollar Index (12) surged 4.37 percent.

How does gold perform in a deflationary environment? David Rosenberg, Chief U.S. Economist at Merrill Lynch, noted "Gold will not only serve as a refuge in its role as a store of value, but is a useful hedge against both inflation as well as deflation since deflation is inherently destabilizing for financial assets (in that deflationary period form 2001 to mid- 2003, gold managed to rally more than 30 percent), not to mention the prospect of a return to a dollar bear market. Moreover, the price of gold is still just half of its prior peak in ‘real’ terms, even after the rally of the past eight years. So, we see much more upside than downside risk to bullion." The chart shows the price performance of gold in “real” terms 1975 to present.

Strength

• The deepening global financial crisis has led to an enormous increase in investment demand for gold.
  
• News of gold bar and coin shortages are a continuing theme in this market. Vault staffs are reportedly working overtime in London while a Rand Refinery in South African is running at full capacity seven days a week to supply the market with Krugerrands. The Austrian mint, which produces the Vienna Philharmonic coin for the European market, has extended its work shifts into the weekends to accommodate demand.
  
• Premiums to buy gold have soared to over $20 an ounce recently. A normal premium in recent memory has typically ranged only a few dollars.

Weakness

• Commodities have fallen 10.4 percent this week, the most since 1956 as poor U.S., EU and Chinese data show economic conditions slowing much more than forecast. Copper had its biggest weekly loss in two decades and platinum suffered its worst quarterly fall in 21 years on weak auto demand.
  
• The dollar rallied 4.37 percent this week as globally there was intense scramble to acquire dollars by institutions while the pending $700 billion liquidity plan remained an open issue.
  
• Despite upcoming festival seasons, gold imports into India fell 36 percent in September to 64 metric tonnes from 100 metric tonnes during the same month last year.

Opportunity

• An official from Barclays Capital called current times a “perfect storm” in the gold market that could propel the price of gold to record highs in the next six months citing renewed interest by hedge funds to get into gold as a safe haven.
  
• Merrill Lynch Chief U.S. Economist David Rosenberg said that gold will be a safe haven and a “useful hedge against inflation as well as deflation.” He reiterated also that gold is far off its inflation adjusted peak from 1980. His team sees “more upside than downside risk to bullion.”
  
• Notable investor Marc Faber dismisses the idea that any bailout of the financial system will help the U.S. avert a recession. Any rally on the news he said will be temporary and “an opportunity” to sell. Dr. Faber also recommended that investors should have physical gold as part of their portfolio.

Threat

• Gold lease rates were up sharply this week. Coupled with rapidly declining gold prices there is some speculation that gold was being borrowed to short sell into the market to raise U.S. dollar liquidity.
  
• In an effort to cut costs, UBS will stop over-the-counter trading of some commodities such as natural gas, crude oil, power, agricultural products and industrial metals. They will, however, continue trading precious metals.
  
• Further demands for liquidity could still keep the dollar moving higher in the short term.
  

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Energy and Natural Resources Market

Strength

• Despite falling benchmark steel sheet prices, tubular steel (OCTG) used in the oil and gas industry continue to rise. The average OCTG price increased to $3,107 per ton, up from $3,065 in August and well above the January price of $1,376 per ton.

Weakness

• The Reuters/Jefferies CRB Index (13) of 19 raw materials, declined by 10 percent to a new 52-week low of 328.70 through Thursday, on further concerns over economic growth and a potential global recession.
  
• Consol Energy, Foundation Coal, and Patriot Coal each separately announced production shortfalls or cuts yesterday due to a variety of issues such as labor shortages, geological issues and regulatory inspections. On average, the cuts totaled approximately 800,000 tons of production per month.
  
• India’s biggest alumina producer said a coal shortage led to a production cut of as much as 20 percent this month, which will more than likely erode exports of the metal used to make aluminum.
  
• Spot prices for Australian thermal coal have fallen from a peak of $200 per ton in July to roughly $121 this week. This is just below the primary fiscal year contract price of $125 a ton.
  
• Indian iron ore exporters warned this week that demand from steel mills in China had fallen sharply over the past month and that Chinese buyers were defaulting on contracts with suppliers.

Opportunity

• The U.S. Department of Energy said Oct. 2 it has received 19 applications from 17 electric power companies for federal loan guarantees totalling $122 billion to support the construction of 14 nuclear power plants.
  
• Supportive of natural gas prices, Barclays Capital expects U.S. liquefied natural gas (LNG) imports to stay around 1.0 billion cubic feet per day for the remainder of the year given the continued wide divergence between regional gas prices.
  
• Belarus has imposed export duties on potash in the amount of 200 euros per metric ton, effective from September 1, 2008 until December 31, 2008. Belaruskali is the second largest global potash producer, accounting for 16 percent of global output and 17 percent of global exports.

Threat

• The purchasing manager’s indices (PMIs) of the major Western world economies fell sharply in September, giving a strong indication that developed world manufacturing may continue to see severe downward pressure.
  
  

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Emerging Markets: China Region

 

Strength

• Asian central banks appear to be ahead of the curve relative to Europe and the U.S. They have reduced interest rates in an effort to counter the impact of the U.S. financial crisis on their economies. China, Taiwan, Australia and New Zealand have all cut interest rates in the last few weeks.
  
• Given the sell-off in Chinese shares, some value had to be created somewhere, and it’s no surprise investors like Warren Buffett are taking advantage of this. Buffett is buying up to 10 percent of BYD Co., China’s largest maker of rechargeable batteries.
  

Weakness

• Due to slowing car sales in China as of late, Toyota Motor Corporation of Japan plans to reduce the daily production of cars at its plant in the Guangdong province.
  
• Manufacturing activity as measured by the CLSA-sponsored Purchasing Managers’ Index (PMI) showed a sharper than expected slowdown in September. Any reading below 50 indicates a contraction in activity; September’s came in at 47.7.
  

Opportunity

• China’s government is aware of the slowdown taking place in the economy and has a strong current account and trade surplus to use towards spending if needed to prop up the economy. Several steps have already been taken and additional measures are expected during the fourth quarter. The government will most likely continue to reduce reserve ratios and interest rates.

Threat

• The current U.S. financial crisis has caused a recoupling of the world’s economies as the issues impacting U.S. financial services firms have spread around the world. This may cause a slowdown in global economic activity.
  
• Consensus estimates for the Chinese stocks in the H-share index continue to be revised downwards. This makes forming a bottom difficult if estimates continue to be revised down.
  

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Leaders and Laggards

The tables show the performance of major equity and commodity market benchmarks of our family of funds.

Weekly Performance
Index	Close	Weekly Change($)	Weekly Change(%)
Gold Futures	840.10	-48.40	-5.45 %
Oil Futures	92.89	-14.00	-13.10 %
Korean KOSPI Index	1,419.65	-56.68	-3.84 %
10-Yr Treasury Bond	3.61	-0.25	-6.36 %
Natural Gas Futures	7.37	-0.10	-1.37 %
XAU	112.09	-26.20	-18.95 %
S&P/TSX Canadian Gold Index	236.25	-33.79	-12.51 %
DJIA	10,325.38	-817.75	-7.34 %
S&P BARRA Growth	533.35	-57.17	-9.68 %
S&P Energy	451.78	-67.51	-13.00 %
S&P 500	1,099.23	-113.78	-9.38 %
Nasdaq	1,947.39	-235.95	-10.81 %
S&P BARRA Value	561.34	-56.08	-9.08 %
Hang Seng Composite Index	2,366.06	-120.01	-4.83 %
Russell 2000	619.40	-85.39	-12.12 %
S&P Basic Materials	181.28	-31.80	-14.92 %

Monthly Performance
Index	Close	Monthly Change($)	Monthly Change(%)
Gold Futures	840.10	+31.90	+3.95 %
10-Yr Treasury Bond	3.61	-0.09	-2.49 %
Korean KOSPI Index	1,419.65	-7.24	-0.51 %
S&P BARRA Value	561.34	-84.59	-13.10 %
DJIA	10,325.38	-1,207.50	-10.47 %
Russell 2000	619.40	-122.51	-16.51 %
S&P/TSX Canadian Gold Index	236.25	-17.13	-6.76 %
S&P 500	1,099.23	-175.75	-13.78 %
S&P BARRA Growth	533.35	-89.68	-14.39 %
Nasdaq	1,947.39	-386.34	-16.55 %
S&P Energy	451.78	-76.77	-14.52 %
XAU	112.09	-22.37	-16.64 %
Oil Futures	92.89	-16.46	-15.05 %
Natural Gas Futures	7.37	+0.11	+1.46 %
S&P Basic Materials	181.28	-53.34	-22.73 %
Hang Seng Composite Index	2,366.06	-460.39	-16.29 %

Quarterly Performance
Index	Close	Quarterly Change($)	Quarterly Change(%)
Russell 2000	619.40	-46.38	-6.97 %
DJIA	10,325.38	-963.16	-8.53 %
S&P BARRA Value	561.34	-60.02	-9.66 %
10-Yr Treasury Bond	3.61	-0.37	-9.25 %
S&P 500	1,099.23	-163.67	-12.96 %
Gold Futures	840.10	-103.20	-10.94 %
Nasdaq	1,947.39	-297.99	-13.27 %
S&P BARRA Growth	533.35	-99.70	-15.75 %
Korean KOSPI Index	1,419.65	-186.89	-11.63 %
S&P Basic Materials	181.28	-64.77	-26.32 %
S&P Energy	451.78	-180.15	-28.51 %
Hang Seng Composite Index	2,366.06	-612.85	-20.57 %
S&P/TSX Canadian Gold Index	236.25	-111.67	-32.10 %
Oil Futures	92.89	-52.40	-36.07 %
XAU	112.09	-76.64	-40.61 %
Natural Gas Futures	7.37	-6.21	-45.72 %

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Please consider carefully the fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

An investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. Gold funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The price of gold is subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5 percent to 10 percent of your portfolio in gold or gold stocks. Investing in small- and mid-cap stocks may be more risky and more volatile than investing in large-cap stocks. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio. Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries. Tax-exempt Income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. Bond funds are subject to interest-rate risk; their value declines as interest rates rise. The Eastern European Fund invests more than 25% of its investments in companies principally engaged in the oil & gas and banking industries.  In particular, the fund will invest at least 25% of its net assets in the following industries: energy equipment and services; oil, gas and consumable fuels; and commercial banking.  However, the fund will not invest more than 50% of its net assets in any one of those industries.  The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile. These market comments were compiled using Bloomberg and Reuters financial news.

Holdings as a percentage of net assets as of 6/30/08:
Berkshire Hathaway - Global Megatrends Fund (1.43%)
H & R Block – 0.00%
Proctor & Gamble Co. – 0.00%
Richard Ellis Group Inc – 0.00%
Merrill Lynch – 0.00 %
Barclays Capital - 0.00%
UBS - 0.00%
Consol Energy – Global Resources Fund (0.24%)
Foundation Coal – 0.00%
Patriot Coal – Global Resources Fund (0.76%)
BYD Co. – 0.00%
Toyota Motor Corporation – 0.00%

*The above-mentioned indexes are not total returns. These returns reflect simple appreciation only and do not reflect dividend reinvestment.

(1) The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry.
(2) The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.
(3) The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.
(4) The S&P BARRA Growth Index is a capitalization-weighted index of all stocks in the S&P 500 that have high price-to-book ratios.
(5) The S&P BARRA Value Index is a capitalization-weighted index of all stocks in the S&P 500 that have low price-to-book ratios.
(6) The Russell 2000 Index® is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000®, a widely recognized small-cap
index.
(7) The Hang Seng Composite Index is a market capitalization-weighted index that comprises the top 200 companies listed on Stock Exchange of Hong Kong, based
on average market cap for the 12 months.
(8) The Taiwan Stock Exchange Index is a capitalization-weighted index of all listed common shares traded on the Taiwan Stock Exchange.
(9) The Korea Stock Price Index is a capitalization-weighted index of all common shares and preferred shares on the Korean Stock Exchanges.
(10) The ISM manufacturing composite index is a diffusion index calculated from five of the eight sub-components of a monthly survey of purchasing managers at roughly 300 manufacturing firms from 21 industries in all 50 states.
(11) The Philadelphia Stock Exchange Gold and Silver Index is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver.
(12) The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.
(13) The Reuters/Jefferies CRB Index is an unweighted geometric average of commodity price levels relative to the base year average price.

The S&P/TSX Canadian Gold Capped Sector Index is a modified capitalization-weighted index, whose equity weights are capped 25 percent and index constituents are derived from a subset stock pool of S&P/TSX Composite Index stocks.
The S&P 500 Energy Index is a capitalization-weighted index that tracks the companies in the energy sector as a subset of the S&P 500.
The S&P 500 Materials Index is a capitalization-weighted index that tracks the companies in the material sector as a subset of the S&P 500.

The Hang Seng China Enterprises Index is a capitalization-weighted index comprised of state-owned Chinese companies (H-Shares) listed on the Hong Kong Stock Exchange and included in HSMLCI index (Hang Seng Mainland Composite Index).

The Consumer Price Index (CPI) is one of the most widely recognized price measures for tracking the price of a market basket of goods and services purchased by individuals. The weights of components are based on consumer spending patterns.

The Purchasing Manager’s Index is an indicator of the economic health of the manufacturing sector. The PMI index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and the employment environment.

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