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Opportunities in the Bad News?

By Frank Holmes
CEO and Chief Investment Officer

There’s been plenty of bleak news coming out of the equity markets and the U.S. economy as a whole. Are there opportunities hidden within that bad news? Are we now in one of those “blood in the streets” scenarios that Rothschild (and many investors after him) found so appealing?

If you believe in the cyclical nature of markets, the chart below from Stifel Nicolaus may be of interest. This chart shows the 10-year rolling return of the S&P Stock Market Composite going back nearly two centuries—current performance (inside the circled area) is at low levels only seen during the Great Depression.

The negative news flow keeps many investors on the sidelines waiting for sunnier days, while those who believe that what goes down eventually comes back up may see an opportunity to snap up equities at bargain prices.

A similar story line may be created for the next chart, which was produced by Old Mutual insurance company. The MSCI World Index is a measure of stock market performance across the world (including the U.S.).

The chart shows how the growth rate can swing wildly based on global events, but what’s clear is that the negative rolling 10-year growth since 2008 is unmatched in the past four decades. Markets have always bounced back, and as you can see on both charts, the best gains tend to be posted early in the turnaround.

One more data point—over the past decade, Treasury bonds have outperformed U.S. equities by nearly 90 percent. This is the widest margin of such outperformance over a rolling 10-year period in more than a century.

J.P. Morgan points out that history shows equities eventually reversing that trend, and when they do, they on average climb more than 250 percent over 10 years—a compounded annual growth rate of 13.6 percent.

The persistent bad macroeconomic news makes another round of “quantitative easing” (i.e., money injection) by the Federal Reserve increasingly likely. This could be good for equities by lowering long-term interest rates, stimulating the economy and boosting valuations.

It’s often said that hope is not an investment strategy, and that’s certainly true. It’s also true that hopelessness is also not an investment strategy. History and cycles are not perfect predictors, but it’s worthwhile to pay attention to these indicators.

I would also invite you to take our G-20 flag quiz—not only is it fun, it also teaches you a little about one of the most important global economic groups. If you have already done the quiz, try it again—you can always increase your speed and accuracy.

Index Summary

• The major market indices were mixed this week. The Dow Jones Industrial Index fell 0.62 percent. The S&P 500 Stock Index declined 0.66 percent, while the Nasdaq Composite finished 1.20 percent lower.
• Barra Growth underperformed Barra Value as Barra Value finished 0.36 percent lower while Barra Growth fell 0.96 percent. The Russell 2000 closed the week with a gain of 0.98 percent.
• The Hang Seng Composite finished lower by 2.19 percent; Taiwan declined by 2.58 percent and the Kospi fell 2.59 percent.
• The 10-year Treasury bond yield closed at 2.64 percent, up 7 basis points for the week.

Domestic Equity Market

The figure below shows the performance of each sector in the S&P 500 Index for the week. Three sectors gained and seven declined. The best-performing sector was utilities, up 2 percent. Other better-performing sectors included telecom services & energy. The three worst-performing sectors were technology, industrials and consumer discretion.

Within the utilities sector the best-performing stock was NiSource Inc., up 6 percent. Other top performers in the sector were CMS Energy Corp., Ameren Corp., TECO Energy Inc. and PG&E Corp

Strengths

• The industrial real estate investment trust (REIT) group was the top-performing group, up 8 percent on the strength of its single member, ProLogis. A research report by the owner/developer of industrial warehouse facilities stated that the nation’s distribution property leasing markets were showing signs of recovery at midyear 2010.
• The consumer electronics group outperformed, rising 5 percent, led by its single member, Harman International Industries Inc. The maker of high-quality consumer electronics gear was mentioned favorably in an investment blog.
• The education services group outperformed, advancing 4 percent, led by member Apollo Group Inc. The for-profit education firm published a white paper that provided some incremental data points on its students’ loan default rates.

Weaknesses

• The specialty stores group was the worst performer, down 5 percent, led by its largest member, Tiffany & Co. The retail jeweler reported second-quarter earnings above consensus and raised earnings guidance for the fiscal year, but second-quarter revenue was below consensus.
• The investment bank & brokerage group underperformed, falling 5 percent. All four members of the group were down, with Charles Schwab Corp. having the largest percentage decline after a major brokerage firm lowered its rating and target price.
• The coal & consumable fuel group underperformed, losing 5 percent. The price of natural gas, a rival fuel for coal in power plants, declined this week, making it somewhat easier for power companies to switch from coal to natural gas for fuel.

Opportunities

• There may be an opportunity for gain in merger & acquisition transactions in 2010. Corporate liquidity is high, thereby providing the means to pursue acquisitions.

Threats

• Should investors’ expectations for an improving economy not come to fruition on a reasonable time frame, it could be a threat to stock prices.
• As governments around the world begin to wind-down the monetary and fiscal stimulus programs put in place during the economic crisis, it will likely present a headwind for stocks.

The Economy and Bond Market

Treasury bonds sold off sharply on Friday, sending yields higher as the market was disappointed by Federal Reserve Chairman Bernanke’s comments regarding the prospect for additional unconventional monetary policy. The market wanted a more definitive commitment and apparently was priced accordingly.

The chart below shows the 10-year Treasury bond, which experienced the sharpest one-day sell off since May. For the week, however, yields were only modestly higher.

Strengths

• Mortgage rates hit a fresh new low of 4.36 percent, the lowest level since records began 39 years ago.
• Credit-card debt fell to the lowest levels in eight years as consumers continue to pare down debt and repair personal balance sheets. While this is negative for near-term spending, it is ultimately what must be done and the process is moving forward relatively rapidly.
• The Fed reiterated its commitment to do what it takes to prevent deflation through additional monetary policy.

Weaknesses

• Second-quarter GDP was revised lower to 1.6 percent from the originally reported 2.4 percent. This was in line with expectations, but does highlight the tentative nature of the economic recovery.
• Housing remains very weak, new home sales fell 12.4 percent and reached a new record low while existing home sales fell by more than 27 percent.
• Ireland’s long-term debt was downgraded this week and credit default swap spreads for the sovereign-debt-burdened “PIIGS” countries (Portugal, Ireland, Italy, Greece and Spain) have reached levels at or near all-time highs. After a lull, investors appear to have refocused on the long-term negative prospects for many of these countries.

Opportunities

• Inflation is unlikely to be a problem for some time and this gives central bankers and other policymakers around the world room for expansive policies.

Threats

• Next week’s economic calendar is full of potential market-moving reports. The most important of these will be next Friday’s job report and Wednesday’s ISM Manufacturing Index.

World Precious Minerals Fund - UNWPX • Gold and Precious Metals Fund - USERX

Gold Market

For the week, spot gold closed at $1,238.01 per ounce, up $10.13, or 0.83 percent, for the week. Gold equities, as measured by the Philadelphia Gold & Silver Index, rose 3.4 percent. The U.S. Trade-Weighted Dollar Index was essentially flat.

Strengths

• The World Gold Council released it Gold Demand Trends publication for the second quarter of 2010 and highlighted the massive growth in investment demand, including a 414 percent jump in gold ETFs compared to the same period last year. Gold demand also rose 36 percent higher than the same period as last year.
• The gold price was propelled to a seven-week high due to a U.S. government report that showed weaker-than-expected data in orders for durable goods and a record low pace sales of new homes.
• India’s consumption of gold rose 94 percent in the first half of 2010 compared to the same period last year. The total demand for gold jewelry in the country in the first half of 2010 increased 67 percent compared to the same period last year.

Weaknesses

• “The world may well have lost its optimism over the global economic outlook, but the two key drivers for the price of gold—anticipation of higher inflation and lack of risk appetite—are little more than shifting sands,” according to Renaissance Asset Management.
• Investors withdrew $33 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute. If that pace continues, more money will be pulled out of mutual funds in 2010 than any year since the 1980s, with the exception of 2008, when the global crisis peaked.
• It was hoped the numerous festivals in India at the end of August would revive gold buying in India, but the high price appears to have trimmed volumes and caused consumers to opt for cheaper imitation gold.

Opportunities

• Van Eck Associates forecasts a new record gold price as of $1,400 as we move through the fall of 2010 and into 2011.
• Amid the likelihood of a hung Parliament, Australia’s Association of Mining and Exploration Companies is pushing for the government to remove all uncertainty and scrap a planned mining tax. The AMEC points out that Australia’s reputation has been damaged, and that dropping the tax would “announce to the world that Australia’s doors are open for business again.”
• An analyst at the Gold Forecaster stated that “gold will not enter a bear market by falling as equity markets are to do today. It is not an item whose demand will fall away.”

Threats

• U.S. Representative Ron Paul plans to introduce a new bill next year that would allow for an audit of U.S. gold reserves.
• Many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century.
• Dean Baker, co-director of the Center for Economic and Policy Research, estimates that it will take two decades to recover the $6 trillion of the housing wealth lost since 2005.

Energy and Natural Resources Market

Strengths

• Despite concerns over global growth, the price of copper gained 1.7 percent on the week and has consistently traded above the key $3 per pound level during the month.
• The 4-week moving average of chemical railcar loadings increased 5.1 percent in the week ended August 21 following a 5.8 percent increase the prior week.
• Chicago corn futures continued to rise late in the week, extending the previous session’s biggest one-day rally in nearly a month as strong global demand and concerns over the size of the U.S. crop supported the market.
• Ferrous scrap prices into Rotterdam rose 3.4 percent to $365 per metric ton, according to Platts.

Weaknesses

• The price of natural gas fell nearly 10 percent this week, below $4 per million BTU, on amply supply and waning consumption entering the shoulder months for demand.
• Power rationing in China’s Zhejiang province is expected to cut demand from copper fabricators for at least several months, with some fabricators indicating production levels down 30 percent. Zhejiang province accounts for approximately 20 percent of China’s total production of copper-fabricated products.
• China’s coking coal imports fell in July to 3.1 metric tons from 4.9 metric tons in July 2009 and 3.6 metric tons in June this year.

Opportunities

• The Wall Street Journal reported that China's second largest utility is aiming to increase coal self-sufficiency. The executive director of Datang International Power Generation said that the company aims to boost its coal self-sufficiency ratio to 40 percent by 2015 from 20 percent now by seeking to buy mine projects in Inner Mongolia to secure supplies.
• China called for further mergers and consolidation in its massive coal industry to eliminate outdated capacity and improve efficiency, the State Council said on its website.
• According to media reports, state-owned Oil India has $2.5 billion available in cash and is looking to purchase shale-gas assets in the U.S. and Australia. The government has asked Oil India and Oil & Natural Gas Corp. to each make at least one acquisition this year to meet demand in Asia’s second-fastest growing major economy.

Threats

• The combination of slowing Chinese economic growth and expanding refineries means this year’s 51 percent decline in profit margins from turning crude into gasoline, diesel and kerosene is poised to worsen.

Emerging Markets

Strengths

• Thailand’s GDP expanded by a higher-than-expected 9.1 percent in the second quarter from a year earlier, as surging exports helped offset the impact of political turmoil.
• Second-quarter GDP rose 7.9 percent year over year in The Philippines, exceeding consensus estimates. Growth was driven by higher fixed-asset investment, especially in construction, and government spending.
• GDP and consumption levels in dollar terms place Russia on par with Brazil and India, according to Troika Dialog research. Data from the Brookings Institution imply that Russia actually has the largest middle-class consumption among the BRIC nations, which supports the consumer sector investment theme.
• The Brazilian corporate and retail investors still continue to borrow—the data from July show 18 percent growth of outstanding loans year over year.
• •The unemployment rate in Brazil in July declined to 6.9 percent from 7 percent in June. With the latest inflation data at 4.4 percent, below the official target of 4.5 percent, the market expectations are that the current interest rates of 10.75 percent are unlikely to change by year-end
• Investors continue to be attracted by the prospects of Brazil. Shell and Cosan set up a joint venture to produce sugar and ethanol and to consolidate the fuel distribution in the country. The combined entity will have an 18 percent market share in the fuel distribution, behind Petrobras (34 percent) and Ultrapar (21 percent)
• Retail sales in the greater Santiago area in July increased by 25 percent year over year. The Central Bank of Chile updated a previously forecast GDP growth of 4 percent to 5 percent, saying it is more likely to reach 6.5 percent

Weaknesses

• Hong Kong’s July exports increased by a slower-than-expected 23.3 percent year over year, while imports grew a less-than-estimated 24.9 percent year over year, reflecting a slowdown in China.
• According to WINDS database, out of 90 Chinese property developers listed in Shanghai and Shenzhen that have reported first-half results, close to two-thirds show negative operating cash flows. A similar ratio was last seen in the middle of 2008.
• Russia’s ministry of economy estimated that the drought will shave off at least 0.4 percent to 0.5 percent from GDP growth this year. According to Reuters, potential total effect on the economy could be 0.7 percent to 0.8 percent being slashed from GDP growth.
• An appreciating Chilean peso (up 3.3 percent against the U.S. dollar last month) is causing strain for many Chilean exporters. The Central Bank rejected an intervention call at this stage, saying the currency strength is a reflection of the strength of the Chilean economy

Opportunities

• The 60-mile traffic jam in Northern China since August 14 is attributable to coal transportation to meet higher demand for power generation because of unusually hot weather. The provinces of Inner Mongolia, Shanxi and Shaanxi account for half of China’s coal production. Truck transportation to coastal regions has added tremendous pressure on highway infrastructure. These bottlenecks highlight the longer-term need for more infrastructure construction in the hinterlands and shorter-term opportunity for higher coal prices.

• Russian car deliveries increased 9 percent in the first seven months of the year and jumped 48 percent in July, compared to first-half year sales growth of 0.6 percent in the rest of Europe.
• The Venezuelan government will cancel $200 million in outstanding debt of Colombian exporters. Although the two countries represent very divergent political systems, their trade relations remain strong
• HSBC is reported to be bidding for a controlling stake in Nedbank, the fourth-largest bank in South Africa. It remains to be seen whether the South African authorities will authorize such a transaction after holding ICBC (of China) to a 20-percent stake in Standard Bank
• Time Warner bought a stake in Chilevision, the local free-to-air TV network, for around $150 million. It remains to be seen how Time Warner, which already operates in Chile through CNN, will reposition its strategy in the country

Threats

• Deteriorating U.S. economic data, including housing sales and unemployment, might weigh on investor sentiment toward Asian countries that have largely relied on exports for the current recovery.
• The constitutional referendum on September 12 could limit potential upside in Turkish equities until the outcome is known. Historically, market performance was hindered by the prospect of a coalition government.
• Mexico continues to battle to restore stability while conducting its war on drugs.

Leaders and Laggards

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

Please consider carefully a 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. 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.
The Eastern European Fund invests more than 25 percent of its investments in companies principally engaged in the oil & gas or banking 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.
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.
Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are 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 these sectors. Investing in real estate securities involves risks including the potential loss of principal resulting from changes in property value, interest rates, taxes and changes in regulatory requirements.
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. Each tax free fund may invest up to 20 percent of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes. Bond funds are subject to interest-rate risk; their value declines as interest rates rise. The tax free funds may be exposed to risks related to a concentration of investments in a particular state or geographic area. These investments present risks resulting from changes in economic conditions of the region or issuer.
Past performance does not guarantee future results.
Investing in real estate securities involves risks including the potential loss of principal resulting from changes in property value, interest rates, taxes and changes in regulatory requirements.
These market comments were compiled using Bloomberg and Reuters financial news.

Holdings as a percentage of net assets as of 6/30/10:
NiSource Inc: All American Equity Fund 0.95%
CMS Energy Corp: 0.00%
Ameren Corp: 0.00%
TECO Energy Inc: 0.00%
PG&E Corp: 0.00%
ProLogis: 0.00%
Harman International Industries Inc: 0.00%
Apollo Group Inc: 0.00%
Tiffany & Co: 0.00%
Charles Schwab Corp: 0.00%
Datang International Power Generation: 0.00%
Oil India: 0.00%
Oil & Natural Gas Corp: 0.00%
Royal Dutch Shell: 0.00%
Cosan: 0.00%
Petrobras: 0.00%
Ultrapar: 0.00%
HSBC: 0.00%
Nedbank: 0.00%
ICBC: 0.00%
Standard Bank: 0.00%
Time Warner: All American Equity Fund 0.95%
Chilevision: 0.00%

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

The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry.
The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.
The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.
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.
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.
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.
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.
The Taiwan Stock Exchange Index is a capitalization-weighted index of all listed common shares traded on the Taiwan Stock Exchange.
The Korea Stock Price Index is a capitalization-weighted index of all common shares and preferred shares on the Korean Stock Exchanges.
The Philadelphia Stock Exchange Gold and Silver Index (XAU) is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver.
The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.
The MSCI Russia Index is a free-float weighted equity index developed in 1994 to track major equities traded in the Russian market.
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 500 Financials Index is a capitalization-weighted index. The index was developed with a base level of 10 for the 1941-43 base period.
The S&P 500 Industrials Index is a Materials Index is a capitalization-weighted index that tracks the companies in the industrial sector as a subset of the S&P 500.
The S&P 500 Consumer Discretionary Index is a capitalization-weighted index that tracks the companies in the consumer discretionary sector as a subset of the S&P 500.
The S&P 500 Information Technology Index is a capitalization-weighted index that tracks the companies in the information technology sector as a subset of the S&P 500.
The S&P 500 Consumer Staples Index is a Materials Index is a capitalization-weighted index that tracks the companies in the consumer staples sector as a subset of the S&P 500.
The S&P 500 Utilities Index is a capitalization-weighted index that tracks the companies in the utilities sector as a subset of the S&P 500.
The S&P 500 Healthcare Index is a capitalization-weighted index that tracks the companies in the healthcare sector as a subset of the S&P 500.
The S&P 500 Telecom Index is a Materials Index is a capitalization-weighted index that tracks the companies in the telecom sector as a subset of the S&P 500.
The MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world.
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.
The S&P/TSX Capped Metals and Mining Index is a capitalization-weighted 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 S&P Stock Market Composite is a combination of major market indices used to gauge overall equity performance dating back to the earliest days of the market.