www.usfunds.com

August 01, 2008

Index Summary

• The major market indices were mixed once again this week. The Dow Jones Industrial Index (1) lost 0.39 percent. The S&P 500 Stock Index (2) gained 0.20 percent, while the Nasdaq Composite (3) barely budged but finished 0.02 percent higher.
  
• Barra Growth (4) underperformed Barra Value (5) as Barra Value finished 0.90 percent higher while Barra Growth lost 0.40 percent. The Russell 2000 (6) closed the week with a gain of 0.82 percent.
  
• For the week, the Hang Seng Composite (7) finished higher by 0.42 percent; Taiwan (8) lost 3.19 percent, and the Kospi (9) declined 1.51 percent.
  
• The 10-year Treasury bond yield closed at 3.94 percent, down 16 basis points for the week.
  
  

 

July’s Commodities Purge Offers Long-Term Opportunity

By Frank Holmes CEO and Chief Investment Officer

Are we at the end of the commodity bull market or does this battered sector offer an attractive buying opportunity?

That’s the question on the minds of everyone trying to navigate one of the most complex and volatile markets we’ve seen in years. The continuing economic slowdown (particularly at home and in other G-7 countries), combined with more than a year of bleak news from the financial sector, has left investors dazed and desperate.

The liquidity crisis has forced leveraged investors and companies to unload assets across the board to comply with new accounting rules like FAS 157 and FAS 140, and this has created a domino effect as investors panic. An estimated $15 billion was pulled out of U.S. stock funds in July, about four times more than in June. For the first seven months of 2008, those outflows totaled $52.4 billion, an all-time high.

July was also a very tough month for commodities and commodity stocks. The S&P Natural Resources Index fell off 15 percent, the worst monthly sell-off in the sector since August 1998, when the Russian currency crisis triggered the implosion of the hedge fund Long-Term Capital Management. Prices for the underlying commodities also suffered in July, with the Jefferies/CRB Index down 10.1 percent.  This was just short of the worst monthly performance for this index since 1970.

The fundamentals for gold have not changed, and with negative real interest rates in the U.S., this is a good time to maintain exposure to gold investments. As you can clearly see from the chart below, July and August generally mark a low time for gold before prices climb with the arrival of the fall buying season, which is another reason to consider gold now.

The world is different from a decade ago. Back then, the world was experiencing a global currency crisis that started in Asia in 1997 and peaked in 1998 with Russia defaulting on its sovereign debt. This was the final blow that doomed Long-Term Capital Management.

China and other emerging economies have massive U.S. dollar surpluses, and these countries are committed to infrastructure spending. This week China’s government announced that it will focus more on sustainable growth than worry about inflation. This is significant.

Last month’s tumble for resources can be traced back to the latest troubles in the financial sector that started more than a year ago with the subprime mortgage collapse and were accelerated by the new accounting rules in late 2007. The intermarket relationship of assets get bundled together with a liquidity event, and the icing on the cake was the March 2008 collapse of the auction-rate securities market, which basically froze $300 billion in retail investor cash. This issue has yet to be resolved, and lawsuits are flying everywhere.

The market is now seeking liquidity in response to the recent moves by Merrill Lynch and others to sell mortgage-related assets at huge losses and the persistent rumors that more Bear Stearns-like failures are yet to come.

The regulatory actions in July to stop shorting of 19 financial stocks, including Merrill Lynch, was well-timed. These stocks have rallied 50 percent off their lows, and more importantly for Merrill, it was able to refinance its losses. Had the SEC not stepped in, packs of illegal short-sellers could have crushed Merrill’s stock, just as they did Bear Stearns.

While energy and resources felt the impact of July’s turmoil, it’s important to keep in mind that this performance did not reflect the sector’s solid fundamentals. Historically, oil dips in July before rallying from August through October, as illustrated in the seasonal chart below.

As the chart above illustrates, in July energy stocks (represented by the S&P 500 Energy Index) moved from two standard deviations above the mean to two standard deviations below the mean in just 20 trading days. We think this extreme pullback offers patient investors a window of opportunity.

Many market pundits have predicted the demise of high crude oil prices after a peak near $150 a barrel, but with numerous energy stocks already trading at levels not seen since crude was under $100, we maintain that much of this forecasted price adjustment is already reflected in energy stock valuations.  It appears, based on valuation metrics, that oil stocks are priced as if oil were selling at $70 a barrel.

Moreover, unlike other bull markets where equities traded at challenging valuations, energy and resource stocks are historically cheap. Price-to-earnings ratios are well below the broader market, and these companies have tangible assets that are unaffected by mortgage write-downs.

 

Looking at crude oil fundamentals, we remain constructive given that despite very high prices for oil, OPEC production has been unable to eclipse peak production levels and spare capacity remains critically low relative to prior decades.  Outside the OPEC cartel, countries such as Russia and Mexico have struggled to keep up with demand and are experiencing significant production declines.  Meanwhile, costs continue to escalate as marginal supply is typically located in geopolitically sensitive areas or extracted from expensive unconventional resources.

A similar fundamental story holds for the metals and mining sector, where new discoveries and production are not adequate to keep up with strong global demand.

Lehman Brothers published an interesting research piece today on resource sector corrections between mid-2006 and early 2008. During that time, there were five significant corrections in the Dow Jones STOXX Basic Resource Index (SXPP) averaging 22 percent, and these corrections were followed by rallies averaging 29 percent. That trend appears to be holding for last month’s correction as well – after bottoming out on July 23, the SXPP rose 10 percent by month-end.

Going forward, we have recalibrated our models in order to capture this environment of heightened volatility and will look to capitalize on this period of market inefficiency.

 

 

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 paper products group was the best performer for the week, up by 18 percent. Both members of the group, International Paper Co. and MeadWestvaco Corp., rose after posting earnings reports handily in excess of the analyst consensus estimates. International Paper spoke of its earnings being helped by improved pricing, strong operating performance, cost management and good results in businesses outside of the U.S. It did state, however, that higher-than-expected input costs continue to negatively impact its real earnings potential.
  
• The personal products group was the second-best-performing group, rising by 14 percent, led by Avon Products Inc., which reported earnings in excess of the analyst consensus estimate. Results were driven by sales growth in emerging markets, with sales up over 30 percent in Brazil and Russia and up 20 percent in China. The CEO stated that the quarter’s performance was the best that the company has delivered since launching the turnaround plan in late 2005.
  

Weakness

• The real estate management and development group was the worst performer, off by 26 percent, led down by its single member, CB Richard Ellis Group Inc., which reported earnings substantially below the analyst consensus estimate. The earnings release stated the results were primarily driven by significantly lower sales activity brought about by continued deterioration of global credit markets, which initially began in the U.S. and has now spread worldwide. The company added that softer leasing activity due to weakened economic conditions, primarily in the Americas and the U.K., contributed to the decline in results.
  
• The specialized finance group was among the underperformers, losing 7 percent. Stock exchange operator NYSE Euronext reported earnings that were slightly below the consensus estimate. The earnings miss was primarily expense-related due to continued investment spending initiatives and costs related to the installation of recent acquisitions. Also, net revenue was somewhat lighter than expected. CME Group Inc., operator of the Chicago Mercantile Exchange and the Chicago Board of Trade, reported that volume on its exchanges declined 1 percent in July due to a drop in the trading volume of interest-rate products.

Opportunity

• Although the level of merger and acquisition activity has slowed when compared with the first half of 2007, there may still be an opportunity for gain in M&A transactions in 2008.
  

Threat

• The high costs of energy and raw materials pose a challenge to corporate profitability.
  
• 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

Bond yields were predominantly flat this week. Inflation remains a concern, and the economy and equity markets demonstrated continued signs of weakness. Yield spreads between the two-year and 10-year notes widened this week, which normally precedes a slowing economy.

Strength

• The CRB Commodity Index was down over 10 percent in July, its worst monthly loss in 28 years. The sell-off in commodities will ease some inflation concerns.
  
• Second-quarter GDP came in lower than expected (1.1 percent actual vs. 2.4 percent estimated), reducing the chance for a rate hike.
  
• While many market participants believe the Fed will raise interest rates in the near future, others believe the precarious state of the financial sector will keep the Fed on hold or even elicit a cut in interest rates. In fact, central bankers communicated to the public this week that financial markets continue to be “fragile”.

Weakness

• The change in non-farm payrolls came in better than expected on Friday (-51K actual vs. -75K estimated), which was a strong data point for the economy.
  
• The United States government reiterated plans to rescue Freddie Mac and Fannie Mae as well as disclosing an estimated record budget deficit of $490 billion next year.

Opportunity

• The markets are struggling with unusually high levels of uncertainty, including the financial crisis that persists, housing and mortgage difficulties, a possible global economic slowdown, inflation and a presidential election that could significantly change the tax landscape for investors. These are all well-known risks, but cumulatively they have become very difficult for the market to digest as many market participants have contrasting views of the ramifications. Ultimately, this degree of uncertainty in so many segments of the market increases the demand for “safe haven” securities.

Threat

• The threat of global inflation continues to be an important theme as commodity prices remain relatively strong despite the correction in July. Central banks around the world may have to raise rates to combat higher prices even in a sluggish economic environment.
  

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Gold Market

For the week, spot gold closed at $910.80, down $19.05 or 2.05 percent. Gold equities, as measured by the Philadelphia Stock Exchange Gold and Silver Index (XAU) fell 6.33 percent for the week. The U.S. Trade-Weighted Dollar Index (DXY) rose 0.77 percent.

Strength

• Hong Kong’s first gold exchange-traded fund was launched on Thursday and turned over $18.8 million its first day of trading. This amount corresponds to over 208,000 shares, each representing 0.1 ounces of gold. The ETF was introduced to meet increased demand for gold, which more than doubled in 2007.
  
• Data released on July 31 by the Commerce Department showed that real GDP in the second quarter of 2008 fell by 0.2 percent. The report stated further that the U.S. experienced negative growth in the last quarter of 2007 for the first time since 2001. Harvard professor Martin Feldstein warns that if that is considered the staring point, the U.S. might be in for a very long recession.

Weakness

• Due to deteriorating economic conditions, JP Morgan has lowered its price targets for platinum for 2008 and 2009. The price forecast is now $1,885 an ounce for this year and $1,650 an ounce for next year.
  
• Yet another institution, Standard Chartered, cut its forecast for platinum for the rest of 2008 and all of 2009. Analysts now expect prices to be $1,750 for the remainder of 2008 and $1,675 for 2009, down from $2,050 and $2,105, respectively. The main reason for the lowering is the decreased probability of power outages in South Africa.
  
• Gold buying in India has been modest this year. It is expected that only prices below $900 an ounce would lead to heavy buying. Sales are expected to take off again in September when the wedding season starts.

Opportunity

• Gold exchange-traded funds (ETF) have outperformed all listed gold stocks but were outperformed by silver ETFs at the same time. Analysts at RBC Capital Markets expect increased demand for physical gold over the next few months as the summer season comes to an end.
  
• The European Central Bank (ECB) is contemplating raising interest rates once again if inflation keeps rising. The ECB just raised rates the beginning of July to 4.25 percent, up 0.25 percent. This could help underpin the euro relative to the dollar.
  
• According to James Turk, founder and chairman of GoldMoney.com, investors should not only think of gold in terms of its price but rather as money without the risk. Gold generally moves with oil and commodity prices and therefore, retains most of its purchasing power even if prices fall.
  

Threat

• The Russian government has decided to ease taxes on oil companies to encourage oilfield production and is considering shifting some of the burden on mining companies. In related news, the largest shareholder of the world’s biggest nickel and palladium miner proposed having an ally of Prime Minister Vladimir Putin as the new leader of the company. Although the candidate has no formal mining experience, this would secure the state’s support.
  
• Merrill Lynch made a daring move by selling its collaterized debt obligations for 22 cents on the dollar. Other financial institutions will likely be forced by their auditors to mark-to-market their distressed debt, and this could lead to a clearing of the market by quarter-end. In conjunction with this move, new housing-relief legislation has now been passed into law, which will facilitate homeowners attempts to refinance their obligations, now possible with the losses crystallized on the books of Merrill and others to follow.
  
• As the presidential election cycle plays out, there is a strong motivation to address the concerns of the consumer and thus secure the votes needed to retain power. Bailing out the consumers' debts and finding new ways to weaken or subsidize high food and energy prices are in the cards.

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Energy and Natural Resources Market

Strength

• Crude oil and natural gas futures posted their first weekly gains in the past three weeks.
  
• The two sub-funds in which Russia collects its windfall oil revenues totaled a combined $162.4 billion, the Finance Ministry said this week.
  
• Teck Cominco announced on Tuesday that it would buy metallurgical coal mining company Fording Canadian Coal Trust for $14.1 billion.

Weakness

• The CRB Index of 19 commodities has slumped 10 percent since June 30, the biggest decline since a 10.5 percent drop in March 1980, when the U.S. economy was in a recession. Natural gas plunged 31 percent, making it July's biggest losing commodity, while corn was down 18 percent and nickel sank 16 percent.
  
• Zinc futures in Shanghai fell the most in two weeks after China, the world's largest producer and consumer of the metal, removed export rebates from today. The government will end a 5 percent tax rebate on zinc with a minimum purity of 99.995 percent, the State Administration of Taxation said in a statement.
  
• Platinum fell 14.9 percent in July, sharply underperforming gold through the month as investors exited long platinum trades due to demand concerns and a lack of acute supply disruptions.
  

Opportunity

• China, the world's second-biggest energy consumer, is facing a deepening summer power crisis that may persist into the winter months, the nation's dominant electricity distributor said. State Grid Corp. of China, which supplies power to more than 1 billion people, said electricity shortages have worsened because of inadequate coal supplies. Forty-six percent of the power stations connected to the distributor's grid have coal stockpiles below the "caution line," or seven days of consumption, data from the company showed today.
  
• Indonesia's oil watchdog, BPMIGAS, warned that the country's dwindling oil reserves could be exhausted in 10 years' time if no new reserves are found. Indonesia has struggled to develop its rich energy resources, turning into a net importer of crude oil in recent years.

Threat

• Goldman Sachs said on Wednesday that it is cutting its 2008 platinum price forecast by $200 an ounce and its 2009 price outlook by 14 percent amid fears over weakening demand. The bank said it has sliced its 2008 price forecast to $1,907 an ounce from $2,107, and its 2009 forecast to $1,963 from $2,300, in response to "a weakening macro environment". The bank said the revision was due in part to Anglo Platinum's confirmation of significantly weaker jewelry demand this year.
  
• Falling premiums for primary metal and aluminum alloy are scaring away buyers in Asia on fears that regional demand is deteriorating. "The bearish mood is intensifying, and premiums appear to be dropping at a faster pace," a trader at a Japanese trading house said.
  
• Thailand's National Energy Board has approved an end to a diesel subsidy scheme introduced in March to combat the effect of soaring fuel prices, the Energy Minister said.

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Emerging Markets: China Region

Strength

• Due to the Olympics, China added 91 million Internet subscribers in the 12 months ending June 30, more than the total addition in the previous three years. With a total of 253 million Internet users, China surpassed the U.S. as the largest Internet market in the world.
  
• Standard & Poor’s upgraded China’s long-term debt rating by one level to A+ in recognition of the big improvement in the government’s balance sheet, which has $1.8 trillion in foreign exchange reserves.

Weakness

• Asia-Northern Europe container shipping traffic dropped 0.5 percent in June, the first decline since 2001, as European countries headed toward recession, according to Lloyd's List.
  
• South Korea’s consumer price inflation accelerated to 5.9 percent in July from 5.5 percent in June, faster than expected and the highest in almost 10 years.
  

Opportunity

• China’s official Purchasing Managers’ Index dropped below 50 for the first time since 2005, suggesting a contraction in manufacturing that is hurt by both slower exports and higher input costs. While a negative data point, this may reinforce China’s new policy focus on GDP growth and reduce the risk of overtightening.

 

Threat

• The liquidity crunch for developers and wealth evaporation for potential homebuyers due to the stock market meltdown should continue to weigh on the property sector in China.
  

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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(%)
Natural Gas Price	9.40	+0.32	+3.48 %
Oil Futures	125.20	+1.94	+1.57 %
S&P Barra Value*	634.24	+5.64	+0.90 %
Russell 2000*	716.14	+5.80	+0.82 %
Hang Seng Composite*	3,174.33	+13.12	+0.42 %
S&P Energy*	558.64	+1.76	+0.32 %
S&P 500*	1,260.31	+2.55	+0.20 %
S&P Materials*	243.14	+0.49	+0.20 %
Nasdaq Comp.*	2,310.96	+0.43	+0.02 %
DJIA	11,326.32	-44.37	-0.39 %
S&P Barra Growth*	619.50	-2.49	-0.40 %
Korean KOSPI Index*	1,573.77	-24.16	-1.51 %
Gold Futures	917.50	-19.40	-2.07 %
10Yr Treasury Bond	3.94	-0.16	-3.93 %
Toronto Gold Index*	303.24	-17.46	-5.44 %
XAU*	162.54	-10.98	-6.33 %

Monthly Performance
Index	Close	Monthly Change($)	Monthly Change(%)
Russell 2000*	716.14	+43.80	+6.51 %
Hang Seng Composite*	3,174.33	+120.75	+3.95 %
Nasdaq Comp.*	2,310.96	+59.50	+2.64 %
S&P Barra Value*	634.24	+13.33	+2.15 %
DJIA	11,326.32	+110.81	+0.99 %
S&P 500*	1,260.31	-1.21	-0.10 %
S&P Materials*	243.14	-0.95	-0.39 %
10Yr Treasury Bond	3.94	-0.02	-0.53 %
S&P Barra Growth*	619.50	-12.66	-2.00 %
Korean KOSPI Index*	1,573.77	-49.83	-3.07 %
Gold Futures	917.50	-38.70	-4.05 %
S&P Energy*	558.64	-76.24	-12.01 %
Oil Futures	125.20	-18.37	-12.80 %
Toronto Gold Index*	303.24	-46.16	-13.21 %
XAU*	162.54	-27.81	-14.61 %
Natural Gas Price	9.40	-3.99	-29.79 %

Quarterly Performance
Index	Close	Quarterly Change($)	Quarterly Change(%)
Oil Futures	125.20	+8.88	+7.63 %
Gold Futures	917.50	+47.60	+5.47 %
10Yr Treasury Bond	3.94	+0.08	+2.10 %
Toronto Gold Index*	303.24	+0.80	+0.26 %
Russell 2000*	716.14	-9.60	-1.32 %
XAU*	162.54	-6.51	-3.85 %
Nasdaq Comp.*	2,310.96	-166.03	-6.70 %
S&P Materials*	243.14	-22.43	-8.45 %
S&P Barra Growth*	619.50	-57.94	-8.55 %
S&P Energy*	558.64	-53.41	-8.73 %
S&P 500*	1,260.31	-153.59	-10.86 %
Natural Gas Price	9.40	-1.38	-12.78 %
DJIA	11,326.32	-1,731.88	-13.26 %
S&P Barra Value*	634.24	-97.50	-13.32 %
Hang Seng Composite*	3,174.33	-514.54	-13.95 %
Korean KOSPI Index*	1,573.77	-274.50	-14.85 %

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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.
These market comments were compiled using Bloomberg and Reuters financial news.

Holdings as a percentage of net assets as of 6/30/2008:
Merrill Lynch: 0.00%
Lehman Brothers: 0.00%
International Paper Co.: 0.00%
MeadWestvaco Corp.: 0.00%
Avon Products: 0.00%
CB Richard Ellis Group Inc.: 0.00%
NYSE Euronext Inc.: 0.00%
CME Group Inc.: 0.00%
Freddie Mac: 0.00%
Fannie Mae: 0.00%
JP Morgan: 0.00%
Standard Chartered: 0.00%
Royal Bank of Canada: 0.00%
Teck Cominco: 0.00%
Fording Canadian Coal Trust: Global Resources Fund (1.57%); All American Equity Fund (1.80%); Global MegaTrends Fund (0.90%)
Goldman Sachs: 0.00%
Anglo Platinum: 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 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.
(11) The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.

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 S&P GSSI Natural Resources Index is an equity benchmark for U.S. traded securities. The natural resource sector is classified according to the Global Industry Classification Standard. The index is a modified-capitalization weighted index, the constituents of which are selected according to objective screening criteria.

The Reuters/Jefferies CRB Index is an unweighted geometric average of commodity price levels relative to the base year average price.

The Dow Jones STOXX Basic Resource Index is a capitalization-weighted index representing companies in the Europe region involved in the basic resources sector.

The China Purchasing Managers’ Index measures business conditions by surveying 20 sectors and is jointly compiled by the National Bureau of Statistics and the China Federation of Logistics and Purchasing.

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