Today’s blog is going to be short and ‘sweet’. Over the next couple of weeks I will be turning my attention to some fun activities that include working on my taxes and college financial aid documents. Since the time I have to work on my blog will be limited I have decided to post some brief and to the point blogs on bonds. Today I’ll be talking about interest rate risk and average duration of bond funds.
The key to understanding the interest rate risk associated with bond funds is to be aware of bond funds average duration. If you like mathematics and have an interest in how bond duration is calculated you can check out the following URLs:
- http://en.wikipedia.org/wiki/Bond_duration
- http://www.investopedia.com/university/advancedbond/advancedbond5.asp
If you are interested in minutia, for giggles you can verify that the duration of zero coupon bonds is the same as the maturity of the bond. If the zero coupon bond has a 10 year maturity the duration will be 10 years. The good news is that some of the bond fund companies will give you the average duration for each of their bond funds. For example, the Vanguard and Fidelity bond funds will display the average duration when they are talking about their funds. I could not find any average duration of the Pimco funds on their website (I tried using my browser’s find command and could not find it).
Why are average durations for bond funds important for understanding interest rate risk? Here’s why: if the average duration for the bond fund is 7 years and interest rates go up 2% the value of your investment will decrease 14% (average duration X interest rate change = gain/loss). For example, suppose you have $10,000 invested in a bond fund the average duration of which is 7 years and interest rate goes up 2% you just lost $1400 of your investment. It works the opposite if the interest rate goes down by 2% -you just made $1400. This is the reason why some bond funds earned returns greater than 10% last year.
The first time you look at this, the inverse relationship between interest rates and bond prices seems somewhat illogical but, if you think about it, it does make sense. For example, if a bond is guaranteed by the issuer to pay 3% every year for ten years but the bond is sold in year 2 when the going interest rate is 4.5%, you would not receive the full price for the bond. The bond price would be discounted to make up for the 1.5% difference in the interest rate.
Examples of bond fund durations and interest rate risk:
Bond Fund Average Duration Interest Rate +2% Interest Rate -2%
Vanguard Total Bond
Market Index (VBMFX) 4.4 years -8.8% loss 8.8% gain
Vanguard Long-Term
Investment Grade (VWESX) 7 years -14% loss 14% gain
Fidelity Series Investment
Grade Bond Fund (FSIGX) 4 years -8% loss 8% gain
If you are risk averse or think interest rates are going up you would want to buy bond funds with low average durations (less than 1 year). You’d want to own high average duration bond funds (> 3 years) when you think interest rates are going down. Please do your homework. For any bond funds you own or want to buy you need to understand both the duration average for that fund as well as what you think the future interest rate environment will be.
Next week, I will write about different type of bonds. Future topics may include:
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Financial rules / lessons (school of hard knocks)
In April I will be starting a financial website (www.paulsgang.com) and in the summer I will be kicking off a financial podcast with Fullstacks and Mr. C.
Please add your insight. Let’s have an on-going discussion of financial and investing ideas.
Paul
Saturday, February 27, 2010
Friday, February 19, 2010
Derivatives
Derivatives
Today my topic is investing in derivative Exchange Traded Funds (ETFs) and other information about derivatives. What is a derivative? It is a security, the price of which is related to one or more underlying assets. An example of the underlying assets can be commodities (i.e. Gold, Natural Gas or Oil), currencies (i.e. US or foreign), options, stocks, bonds, stock indexes, etc. It is a contract between two or more parties. Its price fluctuates with the price of the underlying asset and some derivatives can be highly leveraged. The most common types of derivative are future and forward contracts, options, swaps and stock indexes. Underlying other derivatives are such things as weather, amount of rain, number of sunny days, etc. Virtually anything that bears risk in one direction or the other can be a type of derivative.
Why and how are derivatives used for hedging against risk and investing? They can be used to hedge risk, speculate, maximize profit whatever direction the market or assets go and to help manage portfolios. The following is an example of how derivatives can hedge risk for sellers and buyers. A farmer who plants wheat wants to reduce his risk of losing money and the possibility of losing his farm if the price of wheat is low at the end of the growing season. At the beginning of the planting season he sells his future wheat via a derivative contract to a manufacturer that uses wheat as a raw material. The farmer knows what he will be paid at the end of the growing season for a bushel of wheat and the manufacturer knows what the cost of his raw material will be. This reduces the risk of both the farmer and the manufacturer. This is one of the reasons why derivatives have become so popular: they enable risks to be traded efficiently. If you review the 10K reports of major corporations you will see that many of them use derivatives to hedge against risk. For example, corporations that sell goods worldwide will use currencies derivatives to hedge against currencies risk. Natural Gas (NG) drilling corporations sometimes use future contracts to hedge against risk for some of their production. They at times use future contracts to know what price they will get for NG over the next year, thus improving their ability to plan and reducing risk to the corporation.
You can also use derivatives for investing by using ‘exotic’ or ‘simple’ ETFs. Exotic ETFs use, for example, interest rate swaps and forward one month future contracts. A simple ETF might use the Standard and Poor’s (S&P) 500 index. An example of an exotic ETF is the following: in the summer of 2008 you determined that the financial sector was going to have a major drop in stock prices. You could have used an inverse (also known as ‘bear’ or ‘short’) derivative to play this opportunity. Inverse derivative ETFs could have been used for this investment (you could have shorted the financial sector 2 or 3 times). If you think the oil sector is going to increase its profits and that oil corporation share prices will increase you could use an Oil stock index ETF (simple) or leveraged ETF (exotic) to take advantage of the increasing share prices. You can maximize your profit whatever direction the market is going by using derivative ETFs.
If you are going to use exotic ETFs you should have a very good understanding of the underlying assets and the advantages and disadvantages of using these financial products. You may want to ‘Google’ exotic ETFs and read up on their associated pros and cons. For example, the US government looks at the underlying assets to determine tax rates. Some exotic ETFs can be taxed at ordinary gains and not long term gains if the asset is held over one year (you could use these ETFs in your deferred tax account). The Commodity Future Trading Commission is reviewing whether it should put limits on energy future trading ETFs using one month forward contracts. Examples of these ETFs are OIL (tracks Oil) and UNG (tracks Natural Gas).
Derivative ETFs can also help you manage your portfolio to maximize your profit and tax liability. For example you buy a financial corporation stock that pays a high dividend that you think is a very good long term investment. You have only held the stock for three months and the market for financial stocks looks like it is going to decline. You don’t want to sell the stock because of the high dividend, tax implication (it would be a short term gain) and you like the stock. You could use an inverse leverage derivative financial sector index ETF to hedge your risk with the stock.
Please do your homework (as you should do on any investment) before buying derivative ETFs. You should always understand the underlying assets of the derivative, tax implications, advantages and disadvantages, selling strategies (i.e. stop orders) etc.
Next week, I will write about bonds. Future topics may include:
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Other topics
In April I will be starting a financial website (www.paulsgang.com) and in the summer I will be kicking off a financial podcast with Fullstacks and Mr. C (need to talk with him).
Please add your insight. I would like to have an on-going discussion of financial and investing ideas.
Paul
Today my topic is investing in derivative Exchange Traded Funds (ETFs) and other information about derivatives. What is a derivative? It is a security, the price of which is related to one or more underlying assets. An example of the underlying assets can be commodities (i.e. Gold, Natural Gas or Oil), currencies (i.e. US or foreign), options, stocks, bonds, stock indexes, etc. It is a contract between two or more parties. Its price fluctuates with the price of the underlying asset and some derivatives can be highly leveraged. The most common types of derivative are future and forward contracts, options, swaps and stock indexes. Underlying other derivatives are such things as weather, amount of rain, number of sunny days, etc. Virtually anything that bears risk in one direction or the other can be a type of derivative.
Why and how are derivatives used for hedging against risk and investing? They can be used to hedge risk, speculate, maximize profit whatever direction the market or assets go and to help manage portfolios. The following is an example of how derivatives can hedge risk for sellers and buyers. A farmer who plants wheat wants to reduce his risk of losing money and the possibility of losing his farm if the price of wheat is low at the end of the growing season. At the beginning of the planting season he sells his future wheat via a derivative contract to a manufacturer that uses wheat as a raw material. The farmer knows what he will be paid at the end of the growing season for a bushel of wheat and the manufacturer knows what the cost of his raw material will be. This reduces the risk of both the farmer and the manufacturer. This is one of the reasons why derivatives have become so popular: they enable risks to be traded efficiently. If you review the 10K reports of major corporations you will see that many of them use derivatives to hedge against risk. For example, corporations that sell goods worldwide will use currencies derivatives to hedge against currencies risk. Natural Gas (NG) drilling corporations sometimes use future contracts to hedge against risk for some of their production. They at times use future contracts to know what price they will get for NG over the next year, thus improving their ability to plan and reducing risk to the corporation.
You can also use derivatives for investing by using ‘exotic’ or ‘simple’ ETFs. Exotic ETFs use, for example, interest rate swaps and forward one month future contracts. A simple ETF might use the Standard and Poor’s (S&P) 500 index. An example of an exotic ETF is the following: in the summer of 2008 you determined that the financial sector was going to have a major drop in stock prices. You could have used an inverse (also known as ‘bear’ or ‘short’) derivative to play this opportunity. Inverse derivative ETFs could have been used for this investment (you could have shorted the financial sector 2 or 3 times). If you think the oil sector is going to increase its profits and that oil corporation share prices will increase you could use an Oil stock index ETF (simple) or leveraged ETF (exotic) to take advantage of the increasing share prices. You can maximize your profit whatever direction the market is going by using derivative ETFs.
If you are going to use exotic ETFs you should have a very good understanding of the underlying assets and the advantages and disadvantages of using these financial products. You may want to ‘Google’ exotic ETFs and read up on their associated pros and cons. For example, the US government looks at the underlying assets to determine tax rates. Some exotic ETFs can be taxed at ordinary gains and not long term gains if the asset is held over one year (you could use these ETFs in your deferred tax account). The Commodity Future Trading Commission is reviewing whether it should put limits on energy future trading ETFs using one month forward contracts. Examples of these ETFs are OIL (tracks Oil) and UNG (tracks Natural Gas).
Derivative ETFs can also help you manage your portfolio to maximize your profit and tax liability. For example you buy a financial corporation stock that pays a high dividend that you think is a very good long term investment. You have only held the stock for three months and the market for financial stocks looks like it is going to decline. You don’t want to sell the stock because of the high dividend, tax implication (it would be a short term gain) and you like the stock. You could use an inverse leverage derivative financial sector index ETF to hedge your risk with the stock.
Please do your homework (as you should do on any investment) before buying derivative ETFs. You should always understand the underlying assets of the derivative, tax implications, advantages and disadvantages, selling strategies (i.e. stop orders) etc.
Next week, I will write about bonds. Future topics may include:
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Other topics
In April I will be starting a financial website (www.paulsgang.com) and in the summer I will be kicking off a financial podcast with Fullstacks and Mr. C (need to talk with him).
Please add your insight. I would like to have an on-going discussion of financial and investing ideas.
Paul
Monday, February 8, 2010
Natural Gas
Today my topic is investing in Natural Gas (NG) using Natural Gas sector Exchange Traded Funds (ETFs) and why NG may be a good investment. I already own two Canada Trade Corporations that produce NG and Oil, Penn West Energy Trust (PWE) and Pengrowth Energy Trust (PGH) both of which have paid a high monthly dividend. I also own Advantage Oil and Gas Limited (AAV) which was a Canada Trust but has converted to a corporation. (Canada is in the process of changing their Corporate trust tax laws; in the next couple years almost all Canada Trusts will convert to non-trust corporations,)
NG is an extremely important source of energy for reducing pollution and maintaining a clean environment. NG is the cleanest of the fossil fuels - much cleaner than coal and oil. For a long time, until the 1950s, it was regarded as a useless by-product of oil production. It now provides 23% of all the energy used in the world and demand continues to grow. The major difficulty in the use of natural gas is transportation and storage due to its low density. Natural gas pipelines are economical, but are impractical across oceans. There is also a foreseeable shortage of pipeline capacity in the US and it is difficult to go over high mountains because of NG’s low density (particularly problematic for California).
NG is also important because it is abundant in the US and Canada which is why we import very little of it. The US has the 6th biggest reserves in the world. Russia has the largest reserves in the world and exports a lot of NG to Europe. Europe has very little NG and that’s why France and other European countries are building nuclear power plants so as not to be dependent on Russia for their energy. The more the US uses NG for energy, the more it helps with the import / export balance of payments and reduces US dependency on OPEC countries.
There is lot of good information available on the T. Boone Pickens website about the Pickens Plan and how NG could improve the environment and help the US get off its oil dependency: http://www.pickensplan.com/theplan/. Some of the highlights from the Pickens Plan:
“By aggressively moving to shift America's car, light duty and heavy truck fleets from imported gasoline and diesel to domestic natural gas we can lower our need for foreign oil - helping President Obama reach his goal of zero oil imports from the Middle East within ten years.
Nearly 20% of every barrel of oil we import is used by 18-wheelers moving goods around and across the country by burning imported diesel. An over-the-road truck cannot be moved using current battery technology. Fleet vehicles like buses, taxis, express delivery trucks, and municipal and utility vehicles (any vehicle which returns to the "barn" each night where refueling is a simple matter) should be replaced by vehicles running on clean, cheap, domestic natural gas rather than imported gasoline or diesel fuel.”
With the advantages of NG over other fossil fuels so obvious, it should drive up the overall demand for NG and increase the revenue, profitability and stock prices of NG exploration, production, equipment and service (for example, companies that run NG pipelines) corporations. New technology over the last year has unlocked trillions of cubic feet of natural gas in the US and Canada, meaning energy producers do not have to deal with difficult political environments overseas. Major oil companies have started to do Merger and Acquisition of NG companies in an effort to increase their NG business component. For example, Exxon Mobile bought XTO Energy for an all-stock deal of $31 billion to increase their play in NG. Will other major oil companies like Chevron, Shell, BP, etc. follow suit and buy NG corporations? If the answer is yes, it will increase the stock price of NG corporations.
There are a number of Oil and NG exploration & production index ETFs, for example, FCG, IEO and XOP. These are all low net assets (less than $450 million) ETFs with $.30 bid / ask spreads for FCG and XOP and $.90 bid / ask spread for IEO. The turnover is very high for FCG (you may only want to buy FCG in a tax exempt account). FCG had the highest growth for 1 year of 41.92% but the highest expense of $.60. I will add FCG and IEO to my blog watch list.
If you are interested in investing in leveraged Oil and NG ETFs there are two (which have the same advantages and disadvantages of derivative investing that I will be blogging about next week).
- Ultra Oil & Gas ETF (DIG) targets returns that are 200% of the daily performance of the Dow Jones U.S. Oil & Gas Index.
- UltraShort Oil & Gas ETF (DUG) targets returns that are 200% of the inverse of the daily performance of the same index.
Next week, I will write about how derivatives work and their advantages and disadvantages. Should you be investing in derivative ETFs? What are the rewards and risks of investing in these ETFs? Future topics may include:
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Other topics
In April I will be starting a financial website and in the summer I will be kicking off a financial podcast with Fullstacks and Mr. C (need to talk with him).
Please add your insight. I would like to have an on-going discussion of financial and investing ideas.
Paul
NG is an extremely important source of energy for reducing pollution and maintaining a clean environment. NG is the cleanest of the fossil fuels - much cleaner than coal and oil. For a long time, until the 1950s, it was regarded as a useless by-product of oil production. It now provides 23% of all the energy used in the world and demand continues to grow. The major difficulty in the use of natural gas is transportation and storage due to its low density. Natural gas pipelines are economical, but are impractical across oceans. There is also a foreseeable shortage of pipeline capacity in the US and it is difficult to go over high mountains because of NG’s low density (particularly problematic for California).
NG is also important because it is abundant in the US and Canada which is why we import very little of it. The US has the 6th biggest reserves in the world. Russia has the largest reserves in the world and exports a lot of NG to Europe. Europe has very little NG and that’s why France and other European countries are building nuclear power plants so as not to be dependent on Russia for their energy. The more the US uses NG for energy, the more it helps with the import / export balance of payments and reduces US dependency on OPEC countries.
There is lot of good information available on the T. Boone Pickens website about the Pickens Plan and how NG could improve the environment and help the US get off its oil dependency: http://www.pickensplan.com/theplan/. Some of the highlights from the Pickens Plan:
“By aggressively moving to shift America's car, light duty and heavy truck fleets from imported gasoline and diesel to domestic natural gas we can lower our need for foreign oil - helping President Obama reach his goal of zero oil imports from the Middle East within ten years.
Nearly 20% of every barrel of oil we import is used by 18-wheelers moving goods around and across the country by burning imported diesel. An over-the-road truck cannot be moved using current battery technology. Fleet vehicles like buses, taxis, express delivery trucks, and municipal and utility vehicles (any vehicle which returns to the "barn" each night where refueling is a simple matter) should be replaced by vehicles running on clean, cheap, domestic natural gas rather than imported gasoline or diesel fuel.”
With the advantages of NG over other fossil fuels so obvious, it should drive up the overall demand for NG and increase the revenue, profitability and stock prices of NG exploration, production, equipment and service (for example, companies that run NG pipelines) corporations. New technology over the last year has unlocked trillions of cubic feet of natural gas in the US and Canada, meaning energy producers do not have to deal with difficult political environments overseas. Major oil companies have started to do Merger and Acquisition of NG companies in an effort to increase their NG business component. For example, Exxon Mobile bought XTO Energy for an all-stock deal of $31 billion to increase their play in NG. Will other major oil companies like Chevron, Shell, BP, etc. follow suit and buy NG corporations? If the answer is yes, it will increase the stock price of NG corporations.
There are a number of Oil and NG exploration & production index ETFs, for example, FCG, IEO and XOP. These are all low net assets (less than $450 million) ETFs with $.30 bid / ask spreads for FCG and XOP and $.90 bid / ask spread for IEO. The turnover is very high for FCG (you may only want to buy FCG in a tax exempt account). FCG had the highest growth for 1 year of 41.92% but the highest expense of $.60. I will add FCG and IEO to my blog watch list.
If you are interested in investing in leveraged Oil and NG ETFs there are two (which have the same advantages and disadvantages of derivative investing that I will be blogging about next week).
- Ultra Oil & Gas ETF (DIG) targets returns that are 200% of the daily performance of the Dow Jones U.S. Oil & Gas Index.
- UltraShort Oil & Gas ETF (DUG) targets returns that are 200% of the inverse of the daily performance of the same index.
Next week, I will write about how derivatives work and their advantages and disadvantages. Should you be investing in derivative ETFs? What are the rewards and risks of investing in these ETFs? Future topics may include:
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Other topics
In April I will be starting a financial website and in the summer I will be kicking off a financial podcast with Fullstacks and Mr. C (need to talk with him).
Please add your insight. I would like to have an on-going discussion of financial and investing ideas.
Paul
Sunday, January 31, 2010
Gold
I haven't in the past spent much time researching or thinking about investing in gold. But these days it seems every second or third radio advertisement or TV talking head is telling you that the US dollar will be worthless in the next year and you need to buy gold to survive the looming financial crisis. Generally gold is a hedge or safe haven against any economic, political, social or currency based crisis. For example, if the US were to decide to invade Iran, the price of gold would go up; if tomorrow the US GDP growth magically rose to 6%, gold would go down. Gold price changes by sentiment, not growth in production. The price can also change with countries either selling or buying gold. India recently bought 200 tons of gold to help drive the price higher. I have decided to do some research on how to invest in gold and consider possibly making an investment.
There are several methods you can use to invest in gold:
- Directly through ownership.
o Buying gold coins (ie. Canada Maple Leaf) or bullion
- Indirectly
o Gold certificates. You buy a certificate that says you own x amount of gold (you do not need to store it).
o Gold Exchange Trade Funds (GETF). Each share originally represented exactly one-tenth of an ounce of gold (today it is less because fund cost comes out of the gold that is stored).
o Accounts - You can buy gold just like any foreign currency in Swiss banks.
o Derivatives – ETFs that you can short and long (2x) the price of gold.
o Shares
§ Gold mining companies stock
§ Gold mining companies ETFs
Let’s review some of these methods of investing in gold and show the pros and cons of each. You can buy gold coins (ie. Canada Maple Leaf) or bullion from a dealer and have it shipped to you or stored for you. Hopefully you buy it from a reputable dealer. The Canada Maple Leaf is .9999 pure gold; I don’t know how to verify the gold content. Buying coins or bullion is not cheap. The gold end day price was $1097 for 1 oz of gold (January 25, 2010), the lowest price that I could find to buy a Canada Maple Leaf 1 oz gold coin was $1188 (this does not include the 3% brokerage fee or shipping cost). You could have sold it for $1079 that day. You need to make at least a 10% gain just to break even (GETF had a gain of only 14.25% for the last year). You also have to store it and hope that it actually is .9999 gold. I think the only time I'll be buying gold coins or bullion is when I want to get a gold chain and wear the coin on my chest.
There are GETFs that you can buy. A share used to represent exactly one-tenth of an ounce of gold (less today because fund cost comes out of the gold that is stored). GETF GLD (SPDR Gold Shares), a large fund with $42 billion of assets with a low bid / ask spread, sells for $1 below Net Asset Value and has an expense ratio of .40%(which reduces the amount of gold it stores). The year to date performance growth was 14.25%. This is the easy way to buy or sell gold. It’s just like buying or selling a stock. This is also much like buying gold certificates or accounts and you don’t have to ‘trust’ Swiss bankers. I would invest in the GETFs before gold certificates or accounts (I don't have a lot of faith in Swiss bankers).
You can play the derivatives game with gold (like everything else). Long Powershare ETFs would be DGL and double long DGP. DGL gain was 12.82% last year which is less than GLD (GETF). Short ETFs would be DGZ and double short would be DZZ. The only way I would buy gold derivatives ETFs is if I had inside information a big event was going to happen (ie. US are planning to invade Iran) that would affect the price of gold.
Next are gold mining companies stocks or gold mining companies index ETFs. Since I don’t want to do a lot of research on gold mining companies stocks I decided to review gold mining companies index ETFs. For example, Market Vectors Gold Miners (GDX) ETF has a very low bid / ask spread of $.01, an expense ratio of 55% and low turnover of 13% (which is good if you are in a taxable account). The year to date return was over 33%. This ETF follows the AMEX gold miners index and tries to match the index performance. There is a lot of volatility in the price of gold mining stock because of leveraging. The price of gold production is fixed and the price of gold is more variable; this leads to a great deal of instability in gold mining profits. Gold mining companies will hedge gold prices to try to reduce volatility.
At this time I am not interested in gold investing, but I will add the ETF GTX to my blog watch list.
Next week I will write about buying Natural Gas (NG) ETFs. Big US oil companies, for example, Chevron made be looking to do Merger and Acquisition (M and A) of NG companies in an attempt to increase their NG reverses. Future topics may include:
- Review on how derivatives work. Should you be investing in a derivative ETF? What are the rewards and risks of investing in these ETFs?
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Other topics
In April I will be starting a financial website and in the summer I will be starting a financial podcast with Fullstacks and Mr. C (need to talk with him).
Please chime in! I would like to have an on-going discussion of financial and investing ideas.
Paul
There are several methods you can use to invest in gold:
- Directly through ownership.
o Buying gold coins (ie. Canada Maple Leaf) or bullion
- Indirectly
o Gold certificates. You buy a certificate that says you own x amount of gold (you do not need to store it).
o Gold Exchange Trade Funds (GETF). Each share originally represented exactly one-tenth of an ounce of gold (today it is less because fund cost comes out of the gold that is stored).
o Accounts - You can buy gold just like any foreign currency in Swiss banks.
o Derivatives – ETFs that you can short and long (2x) the price of gold.
o Shares
§ Gold mining companies stock
§ Gold mining companies ETFs
Let’s review some of these methods of investing in gold and show the pros and cons of each. You can buy gold coins (ie. Canada Maple Leaf) or bullion from a dealer and have it shipped to you or stored for you. Hopefully you buy it from a reputable dealer. The Canada Maple Leaf is .9999 pure gold; I don’t know how to verify the gold content. Buying coins or bullion is not cheap. The gold end day price was $1097 for 1 oz of gold (January 25, 2010), the lowest price that I could find to buy a Canada Maple Leaf 1 oz gold coin was $1188 (this does not include the 3% brokerage fee or shipping cost). You could have sold it for $1079 that day. You need to make at least a 10% gain just to break even (GETF had a gain of only 14.25% for the last year). You also have to store it and hope that it actually is .9999 gold. I think the only time I'll be buying gold coins or bullion is when I want to get a gold chain and wear the coin on my chest.
There are GETFs that you can buy. A share used to represent exactly one-tenth of an ounce of gold (less today because fund cost comes out of the gold that is stored). GETF GLD (SPDR Gold Shares), a large fund with $42 billion of assets with a low bid / ask spread, sells for $1 below Net Asset Value and has an expense ratio of .40%(which reduces the amount of gold it stores). The year to date performance growth was 14.25%. This is the easy way to buy or sell gold. It’s just like buying or selling a stock. This is also much like buying gold certificates or accounts and you don’t have to ‘trust’ Swiss bankers. I would invest in the GETFs before gold certificates or accounts (I don't have a lot of faith in Swiss bankers).
You can play the derivatives game with gold (like everything else). Long Powershare ETFs would be DGL and double long DGP. DGL gain was 12.82% last year which is less than GLD (GETF). Short ETFs would be DGZ and double short would be DZZ. The only way I would buy gold derivatives ETFs is if I had inside information a big event was going to happen (ie. US are planning to invade Iran) that would affect the price of gold.
Next are gold mining companies stocks or gold mining companies index ETFs. Since I don’t want to do a lot of research on gold mining companies stocks I decided to review gold mining companies index ETFs. For example, Market Vectors Gold Miners (GDX) ETF has a very low bid / ask spread of $.01, an expense ratio of 55% and low turnover of 13% (which is good if you are in a taxable account). The year to date return was over 33%. This ETF follows the AMEX gold miners index and tries to match the index performance. There is a lot of volatility in the price of gold mining stock because of leveraging. The price of gold production is fixed and the price of gold is more variable; this leads to a great deal of instability in gold mining profits. Gold mining companies will hedge gold prices to try to reduce volatility.
At this time I am not interested in gold investing, but I will add the ETF GTX to my blog watch list.
Next week I will write about buying Natural Gas (NG) ETFs. Big US oil companies, for example, Chevron made be looking to do Merger and Acquisition (M and A) of NG companies in an attempt to increase their NG reverses. Future topics may include:
- Review on how derivatives work. Should you be investing in a derivative ETF? What are the rewards and risks of investing in these ETFs?
- Shorting US currencies
- What sector will do the best in 2010?
- Update on performance of blog trades
- Other topics
In April I will be starting a financial website and in the summer I will be starting a financial podcast with Fullstacks and Mr. C (need to talk with him).
Please chime in! I would like to have an on-going discussion of financial and investing ideas.
Paul
Thursday, January 21, 2010
This blog I would like to talk about shorting US treasuries.
There are two Exchange Traded Funds (ETFs) that you can short 2x, mid (7 to 10 year treasuries) and long (20+ years) term treasury bonds, using the Barclays US Treasury Index. These ETFs are (information from ProShares website):
- PST: Per prospectus, ProShares UltraShort 7-10 Year Treasury seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 7-10 Year U.S. Treasury Index.
- TBT: Per prospectus, ProShares UltraShort 20+ Year Treasury seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Index.
You would think that this trade would make a lot of sense and would be a 'no brainer’. The US government is running a huge deficit and needs to sell a lot of US treasuries to fund it. (The next 4 years' deficit may equal or exceed the accumulation of the US deficit since Washington became president in 1789.) It's reasonable to expect that US treasury interest rates should be increasing. But the Feds (Federal Reserve Bank) have been keeping the interest rate low by buying mid and long term treasury bonds. They bought $300 billion of mid and long treasuries in 2009 and will buy another $175 billion bonds by end of the first quarter of 2010. The Feds do this for the following reasons:
- Increase money supply to reduce the threat of deflation in the US.
- Reduce the interest rate on bonds. This should boost spending and investment in the US in the long run.
- Make it easier to sell enough treasuries to support the large US deficit.
- Help to keep mortgage rates low to aid in moving the large house inventory in the US. Over the last 5 years the 10 year treasury and 30 year fixed mortgage have been moving in tandem. Over the last 6 months it hasn’t moved in tandem. The US government has been buying mortgage backed securities to keep the price down.
With the government keeping the long term treasury rate low the performance of these Ultra-short treasury index ETFs over the last year has not been good: PST - 21% and TBT - 29% (as of January 18, 2010. You do not want to be on the wrong side of this trade, which is 2x performance using interest rate swaps. If I was going to buy these ETFs today I would buy TBT (+20 year bond). I will put these ETFs on my watch list waiting for Feds to stop buying large amounts of treasuries and keeping interest rates artificially low. This could be a very good investment once mid and long term treasure rates start to climb.
A lot of foreign governments have been buying short term treasuries (less than 4 years). 65% of the outstanding treasury bonds are 4 years or less. When interest rates go up it is going to be very expensive to fund the US debt (an increasing amount of the US budget will be interest payments). This will lead to still higher deficits and an increase in the selling of treasuries which should drive the interest rates up.
It is going to be an interesting ride over the next year or two. What do you think of shorting treasuries? Will the Feds continue to buy treasuries and print a lot of dollars? What will the investing environment be like the next two years? What should be my next blog?
- Investing in Gold
- Shorting US currencies
- What sector will do the best in 2010?
- Other topics
In March I will be starting a financial website and in the summer I will start podcasting with Fullstacks and Mr. C (need to talk with him).
Please add your comment.
Paul
There are two Exchange Traded Funds (ETFs) that you can short 2x, mid (7 to 10 year treasuries) and long (20+ years) term treasury bonds, using the Barclays US Treasury Index. These ETFs are (information from ProShares website):
- PST: Per prospectus, ProShares UltraShort 7-10 Year Treasury seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments, that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 7-10 Year U.S. Treasury Index.
- TBT: Per prospectus, ProShares UltraShort 20+ Year Treasury seeks daily investment results, before fees and expenses and interest income earned on cash and financial instruments that correspond to twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Index.
You would think that this trade would make a lot of sense and would be a 'no brainer’. The US government is running a huge deficit and needs to sell a lot of US treasuries to fund it. (The next 4 years' deficit may equal or exceed the accumulation of the US deficit since Washington became president in 1789.) It's reasonable to expect that US treasury interest rates should be increasing. But the Feds (Federal Reserve Bank) have been keeping the interest rate low by buying mid and long term treasury bonds. They bought $300 billion of mid and long treasuries in 2009 and will buy another $175 billion bonds by end of the first quarter of 2010. The Feds do this for the following reasons:
- Increase money supply to reduce the threat of deflation in the US.
- Reduce the interest rate on bonds. This should boost spending and investment in the US in the long run.
- Make it easier to sell enough treasuries to support the large US deficit.
- Help to keep mortgage rates low to aid in moving the large house inventory in the US. Over the last 5 years the 10 year treasury and 30 year fixed mortgage have been moving in tandem. Over the last 6 months it hasn’t moved in tandem. The US government has been buying mortgage backed securities to keep the price down.
With the government keeping the long term treasury rate low the performance of these Ultra-short treasury index ETFs over the last year has not been good: PST - 21% and TBT - 29% (as of January 18, 2010. You do not want to be on the wrong side of this trade, which is 2x performance using interest rate swaps. If I was going to buy these ETFs today I would buy TBT (+20 year bond). I will put these ETFs on my watch list waiting for Feds to stop buying large amounts of treasuries and keeping interest rates artificially low. This could be a very good investment once mid and long term treasure rates start to climb.
A lot of foreign governments have been buying short term treasuries (less than 4 years). 65% of the outstanding treasury bonds are 4 years or less. When interest rates go up it is going to be very expensive to fund the US debt (an increasing amount of the US budget will be interest payments). This will lead to still higher deficits and an increase in the selling of treasuries which should drive the interest rates up.
It is going to be an interesting ride over the next year or two. What do you think of shorting treasuries? Will the Feds continue to buy treasuries and print a lot of dollars? What will the investing environment be like the next two years? What should be my next blog?
- Investing in Gold
- Shorting US currencies
- What sector will do the best in 2010?
- Other topics
In March I will be starting a financial website and in the summer I will start podcasting with Fullstacks and Mr. C (need to talk with him).
Please add your comment.
Paul
Wednesday, January 13, 2010
BRIC ETFs, Ford and Shorting US Treasuries
Last week (blog dated 1/05/2010) I talked about the advantages and disadvantages of Exchange Trade Funds (ETFs) vs. Mutual Funds and two BRIC (Brazil, Russia, India and China) index ETFs. Today I will review two BRIC index ETFs and decide which one I am going to buy (or both) and what is the buying / selling strategy:
- S&P BRIC 40 SPDRS (BIK): up 66.9% year-to-date
- Claymore/BNY BRIC (EEB): up 66.1% year-to-date
The following are the primary reasons to invest in BRIC index ETFs:
- Much higher GDP growth than the western development countries of Japan, EU and US. In 2008 China was 9.6%, India 7.4%, Russia 5.6% and Brazil 5.1% compared to US 1.1%, EU .8% and Japan .7%. Their growth rate should be higher than most developing and developed nations over the next 10 years.
- Hedging against a declining US dollar.
- China and India have much higher savings and investment rates than the US which will help to fuel their GDP growth.
- It is always good to have emerging / international markets in your portfolio. I would suggest including at least 15% international and 5% emerging investments.
Let’s look at the two BRIC index ETFs: BIK and EEB (data as of 1/12/2009). BIK uses the S&P BRIC Index which has 43% invested in China and 28% in Brazil (and the rest in India and Russia). The fund has the following weighting: 48% energy and industrial materials and 32% financial services. The expense ratio is .50% and the bid / ask spread is 2.7% (this is like a front end fee). The Net Asset Value (NAV) price is higher than the stock price. The yield is 2.62, much higher than a 3 year Certificate of Deposit (CD).
EEB uses the Bank of New York BRIC Select APR Index which invests 54% in Brazil and 31% in China. The fund has almost the same weighting as BIK. The expense ratio is .60% and the bid / ask spread is 2.1% which is lower than BIK (EEB has 100% higher net assets than BIK). The NAV price is higher than the stock price. The yield is 2.42% which is lower than BIK.
After reviewing the two BRIC index ETFs, I have decided to buy the BIK and EEB BRIC index ETFs in equal amounts (less than 1% of my total portfolio).The correlation of growth over the last year is very close. One has a higher expense ratio (expense ratio + bid / ask spread ratio), but has a higher yield. In a surprise announcement on Tuesday (January 12, 2010) the Chinese authorities stated they are raising the proportion of deposits that banks must hold in reserve; this has caused a 3% pullback in the ETFs. I have decided to put in an order for one half of investment today and wait for a further pullback to place the other half (dollar cost average the investment). I am also putting together a selling strategy using trailing stop orders.
Regarding Ford: I talked about possible trading strategies (blog dated 12/29/2009) with the Ford (F) stock that I bought October 2008 at $2.09 and have sold the amount that equaled cost of buying and an annual return of 10% for 3 years (I am playing with ‘free’ money). Today (01/11/2010) F price is $12.11 and after a 475% gain I have decided to sell a subset of my shares with a trailing stop of 3%. My selling price was $11.74. I will wait for a pullback to increase my number of shares with the gross revenue from the recent sale.
In the next blog I am going to talk about strategies for shorting middle and long US treasuries. Please comment on the BRIC index ETF strategy, selling some of Ford and waiting for a pullback to buy more, and strategies for shorting US treasuries.
Paul
- S&P BRIC 40 SPDRS (BIK): up 66.9% year-to-date
- Claymore/BNY BRIC (EEB): up 66.1% year-to-date
The following are the primary reasons to invest in BRIC index ETFs:
- Much higher GDP growth than the western development countries of Japan, EU and US. In 2008 China was 9.6%, India 7.4%, Russia 5.6% and Brazil 5.1% compared to US 1.1%, EU .8% and Japan .7%. Their growth rate should be higher than most developing and developed nations over the next 10 years.
- Hedging against a declining US dollar.
- China and India have much higher savings and investment rates than the US which will help to fuel their GDP growth.
- It is always good to have emerging / international markets in your portfolio. I would suggest including at least 15% international and 5% emerging investments.
Let’s look at the two BRIC index ETFs: BIK and EEB (data as of 1/12/2009). BIK uses the S&P BRIC Index which has 43% invested in China and 28% in Brazil (and the rest in India and Russia). The fund has the following weighting: 48% energy and industrial materials and 32% financial services. The expense ratio is .50% and the bid / ask spread is 2.7% (this is like a front end fee). The Net Asset Value (NAV) price is higher than the stock price. The yield is 2.62, much higher than a 3 year Certificate of Deposit (CD).
EEB uses the Bank of New York BRIC Select APR Index which invests 54% in Brazil and 31% in China. The fund has almost the same weighting as BIK. The expense ratio is .60% and the bid / ask spread is 2.1% which is lower than BIK (EEB has 100% higher net assets than BIK). The NAV price is higher than the stock price. The yield is 2.42% which is lower than BIK.
After reviewing the two BRIC index ETFs, I have decided to buy the BIK and EEB BRIC index ETFs in equal amounts (less than 1% of my total portfolio).The correlation of growth over the last year is very close. One has a higher expense ratio (expense ratio + bid / ask spread ratio), but has a higher yield. In a surprise announcement on Tuesday (January 12, 2010) the Chinese authorities stated they are raising the proportion of deposits that banks must hold in reserve; this has caused a 3% pullback in the ETFs. I have decided to put in an order for one half of investment today and wait for a further pullback to place the other half (dollar cost average the investment). I am also putting together a selling strategy using trailing stop orders.
Regarding Ford: I talked about possible trading strategies (blog dated 12/29/2009) with the Ford (F) stock that I bought October 2008 at $2.09 and have sold the amount that equaled cost of buying and an annual return of 10% for 3 years (I am playing with ‘free’ money). Today (01/11/2010) F price is $12.11 and after a 475% gain I have decided to sell a subset of my shares with a trailing stop of 3%. My selling price was $11.74. I will wait for a pullback to increase my number of shares with the gross revenue from the recent sale.
In the next blog I am going to talk about strategies for shorting middle and long US treasuries. Please comment on the BRIC index ETF strategy, selling some of Ford and waiting for a pullback to buy more, and strategies for shorting US treasuries.
Paul
Tuesday, January 5, 2010
BRIC ETFs and ETFs vs Mutual Funds
Today I am going to reply to Blondie’s comments (December 12, 2009 blog) about investing in ETFs (Exchange Traded Funds), Asia ETFs (not including Japan) and BRIC (Brazil, Russia, India and China) index ETFs. Let’s start with the advantages and disadvantages of investing in ETFs vs. mutual funds:
Advantages
1. Tax efficient. You get to decide when it makes sense tax-wise to sell the ETF. Mutual funds by law have to distribute short and long tax gains every year (the fund could lose money for the year and still distribute tax gains).
2. ETFs have much lower fees than mutual funds (you do have to pay the cost of buying the ETF shares just like buying shares of Apple (AAPL). You can use a low cost broker (i.e. ETRADE) to keep the cost down).
3. ETFs are like stocks: you can sell them at any time, you can use “limit” and “stop” orders and can buy on margin and do options on the ETF within a brokerage account.
4. ETFs are very easy to buy. All you need is a brokerage account.
Disadvantages
1. Market spread. If you buy an ETF that has low volume the bid/ask spread can be significant (same as for a stock). For example, if the bid price is $100 and the ask price is $105 the ETF would need to gain 5% before you break even. For most widely traded ETFs the spread is very low. This is the hidden cost of an ETF (much like a front load fee for mutual funds). Blondie commented that he is reviewing the following Asia (non Japan) index ETF: AAXJ. The bid price for this ETF is $54.08 (as of December 31, 2009) and the ask price is 57.80. This is fairly high and I would not buy it. This was caused by the volume of the trades for the day. The higher the volume, the lower the spread.
2. Net Asset Value (NAV). Mutual funds are always the current marketing value of the underlying stock. This is not always the case with ETFs. ETF value is set by the market price which can cause a discount or premium to the share price. So the share price can be lower than the NAV of the underlying shares - it could also be higher. Lower NAV is usually a reflection of low volume of the ETF.
Blondie was also looking to find BRIC index ETFs. The following are BRIC index ETFs:
- S&P BRIC 40 SPDRS (BIK): up 66.9% year-to-date
- Claymore/BNY BRIC (EEB): up 66.1% year-to-date
The yield for these index ETFs are around 2.5% - more than a 3 year CD. Next week I will talk about these BRIC ETFs and decide whether I should add to my portfolio for 2010 and, if so, which one (or both).
If you have any suggestions for future blogs please leave a comment. The following are some possibilities:
Ways to play world currencies
Inflation hedges
How to short US treasures (with yields increasing in the future for treasures)
Please leave comments.
Paul
Advantages
1. Tax efficient. You get to decide when it makes sense tax-wise to sell the ETF. Mutual funds by law have to distribute short and long tax gains every year (the fund could lose money for the year and still distribute tax gains).
2. ETFs have much lower fees than mutual funds (you do have to pay the cost of buying the ETF shares just like buying shares of Apple (AAPL). You can use a low cost broker (i.e. ETRADE) to keep the cost down).
3. ETFs are like stocks: you can sell them at any time, you can use “limit” and “stop” orders and can buy on margin and do options on the ETF within a brokerage account.
4. ETFs are very easy to buy. All you need is a brokerage account.
Disadvantages
1. Market spread. If you buy an ETF that has low volume the bid/ask spread can be significant (same as for a stock). For example, if the bid price is $100 and the ask price is $105 the ETF would need to gain 5% before you break even. For most widely traded ETFs the spread is very low. This is the hidden cost of an ETF (much like a front load fee for mutual funds). Blondie commented that he is reviewing the following Asia (non Japan) index ETF: AAXJ. The bid price for this ETF is $54.08 (as of December 31, 2009) and the ask price is 57.80. This is fairly high and I would not buy it. This was caused by the volume of the trades for the day. The higher the volume, the lower the spread.
2. Net Asset Value (NAV). Mutual funds are always the current marketing value of the underlying stock. This is not always the case with ETFs. ETF value is set by the market price which can cause a discount or premium to the share price. So the share price can be lower than the NAV of the underlying shares - it could also be higher. Lower NAV is usually a reflection of low volume of the ETF.
Blondie was also looking to find BRIC index ETFs. The following are BRIC index ETFs:
- S&P BRIC 40 SPDRS (BIK): up 66.9% year-to-date
- Claymore/BNY BRIC (EEB): up 66.1% year-to-date
The yield for these index ETFs are around 2.5% - more than a 3 year CD. Next week I will talk about these BRIC ETFs and decide whether I should add to my portfolio for 2010 and, if so, which one (or both).
If you have any suggestions for future blogs please leave a comment. The following are some possibilities:
Ways to play world currencies
Inflation hedges
How to short US treasures (with yields increasing in the future for treasures)
Please leave comments.
Paul
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