Best Investment Strategies for Quantitative Easing (QE2)

On November 3, 2010 the US Federal Reserve announced its second round of Quantitative Easing (QE 2), a program through which it intends to buy an additional $600 billion of longer-term treasury securities by mid 2011. This equates to $70 billion per month. In this week’s blog I will be discussing what investments are best for the QE 2 environment, focusing on commodities, precious metals, gold and US companies that export.

The major impact of QE2 is that it will inject $600 billion directly (by printing money) into the economy. Theoretically this will facilitate the Fed’s stated policy to grow the economy and increase job growth. It will have the outcome (if everything goes according to plan) of decreasing interest rates and devaluing the dollar, which will have the following effect on investments:

· Since most commodities are valued in $US QE2 will drive up the cost of commodities.

· QE2 will have the positive effect of making US exports cheaper (it is a positive for companies that export and should help their stock price) for companies or consumers outside the US. It will have the opposite effect with imports which will become more expensive for US companies or consumers to buy.

· Interest rates may decrease which will in theory help to grow the economy. For example, for REIT companies that need to refinance their properties every 5 to 7 years this will lower their interest costs.

As for myself, I don’t tie my whole portfolio to my macroeconomic forecast or the forecasted economic environment. I could be wrong, so I tilt some of my portfolio (10 - 20%) to take advantage of the QE2 economic situation and the rest elsewhere. It helps to hedge so that, if my forecast is wrong, I am not forced to sell assets that have lost value. Today many people are finding themselves in the unfortunate position of needing to sell their houses to raise cash to pay debt and living expenses. You never want to be forced to sell an asset that has lost value. A well-diversified portfolio is key – you never put all your eggs in one basket.

As routine due diligence I will review all of my investments against the current economic conditions to determine whether any are no-no’s for the forecasted economic environment. For example, if I was invested in a company that used commodities for the majority of their products, and it is not possible for the company to raise their prices, I will decrease or eliminate my investment in that company.

Also, always understand the tax consequences of your investments, how the investment works and what your exit strategy will be.

The following are methods for investing in commodities, precious metals, gold and companies that export:

1. Commodity producing companies. Examples of commodity producing companies are coal and Natural Gas (NG) producer Consol Energy Inc. (CNX) and gold, silver and copper producer Goldcorp Inc. (GG). Consol Energy is the biggest coal exporter to China for steel production. Canada Goldcorp is one of the largest gold producers in the world. I own the following commodity producing companies:

Lundin Mining Compnay - LUNMF.PK
Advantage Oil and Gas Ltd. - AAV
Pegrowth Engery - PGH
Penn West Engery - PWE


2. Future Based Commodity ETFs. Before you buy future based commodity ETFs you may want to read the following article “Commodities are a Rock in a Hard Place”: http://www.morningstaradvisor.com/articles/article.asp?docId=17924.
Before buying a future based commodity or commodity index you need to understand the contango and backwardation effects (you should also understand the tax consequences of a taxable account). Two famous future based commodity ETFs are States Oil (USO) and United States Natural Gas (UNG). These funds have been influenced by the contango effect in the future energy market. UNG lost over 50% of its stock value in the last year. A worthwhile article on the contango effect on UNG is “What’s Wrong With UNG?” http: http://etfdb.com/2009/whats-wrong-with-ung/.


3. Exchange Traded Funds (ETFs) or Mutual Funds (MF) index of commodity producing companies. For a very good article on ETFs of commodity producing companies indexes see
http://seekingalpha.com/article/195688-the-benefits-of-equity-commodity-etfs.

You can buy selector based ETFs, for example metals and mining (XME), global coal (PKOL), steel (SLX), etc.

4. ETFs index of commodities. Before you buy a commodities index ETF in your taxable account you should read the following article about tax consequences of ETFs:
http://www.investopedia.com/articles/exchangetradedfunds/08/etf-taxes-introduction.asp.

The following are 2 examples of commodities index ETFs:

Powershare DB Commodity Index Tracking Fund - DBC
Dow Jones AIG Commondity Index Fund - DJP

These ETFs have about 20 commodities in the index. They include, for example, oil, NG, heating oil, gold, corn, wheat, etc. These ETFs have large total assets of over $2 billion and at the same time large bid / ask spreads (also very high fees for ETFs). These funds all use future contracts and may also be affected by contango.


5. ETFs or MFs index of commodity producing countries. These also have currencies implications. I own the following ETFs and MFs indices of commodity producing countries (each of these funds has about 50% commodity stocks within its index):

S & P BRIC 40 SPDRS - BIK
Claymore/BNY BRIC - EEB
DWS Latin America - SLA

6. Real commodity assets (owning a forest or mine). If you have a lot of money like the Yale Endowment Fund (http://www.yale.edu/investments/Yale_Endowment_09.pdf) you may want to buy real assets such as a forest, large commercial building, or oil or natural gas fields. The Yale portfolio manager, David Swensen, one of the top investors in the world for the last 25 years, has been increasing his holdings in real assets over the last 3 years. It is an investment category through which you can take advantage of pricing efficiencies. One of the best ways for the average investor to buy real assets is by buying Real Estate Investment Trust (REIT) companies. For example, timberland has been one of the best investments for the last 20 years. Its return during the past two decades has been 12.8%. There are a number of timberland REIT companies that own extensive timberland acres. For example, Plum Creek (PCL) owns over 7 million acres and has a yield of 4.3%.

7. Companies that export a majority of their sales from the US. QE2 should have a positive effect on US companies that export a majority of their products. Their products should cost less and be more competitive in the world marketplace. This should increase their revenue and profit and should have the effect of increasing their stock price. This will not work if the products they sell have a large component of commodities (since commodity prices will be increasing).

Please chime in with comments about the QE 2 investment strategy. What investments do you are think best for QE 2? Future blogs that I will be writing:

Income generating bucket of money

Investing in possible buyout companies

Investing in Brazil

Using Fisher’s 15 points for researching companies to evaluate one company

Reviewing 2011 tax changes

© 2010 Paul Cusick

Paul