Sovereign Debt: Emerging Markets Advantage

By Frank Holmes, CEO and Chief Investment Officer

It’s not a good time to be a developed economy.

Sovereign debt is at or near the crisis point in Greece, Spain, Ireland and Portugal. It’s also a big issue and getting bigger in the United States, Britain, Japan and a number of other countries.

Mohamed El-Erian, CEO at bond giant Pimco, was right when he wrote in Thursday’s Financial Times that sovereign debt represents “a significant regime shift in advanced economies with consequential and long-lasting effects.”

Debt conditions are much better in the major emerging markets, as you can see in the chart below. In the G-20 largest developed economies, sovereign debt burdens are now at about 100 percent of GDP, while in the 20 most important emerging markets, debt represents only about 40 percent of GDP.

In the next few years, the forecast sees the G-20 ratio rising another 20 percent. In the U.S., the ratio is already at its highest level since World War II, and another $10 trillion (70 percent of current GDP) will be added over the next decade. Meanwhile, the emerging 20’s sovereign debt-to-GDP actually goes down as a result of smaller budget deficits.

The lighter debt load benefits emerging markets in a number of ways, particularly in how risks are measured and perceived.

Sovereign credit ratings for emerging markets are improving, while the credit ratings of developed markets are dropping off significantly. This can be seen in the chart below—of course, developed markets still have higher ratings (left axis versus right axis) but the trend is for the key emerging markets is notably upward.

Higher credit ratings mean lower costs of capital for these countries, which is a positive for economic growth in countries that are already growing faster than the developed markets.

Now what about equity prices? Historically, there has been a negative correlation between bond prices and equity prices in developed markets, in what can be viewed as a safety trade. In emerging markets, however, we see a positive correlation between bond prices and equity prices in recent years. This makes sense to us, because both of these asset classes are driven by money flows from investors attracted by improving economic prospects in emerging countries.

Emerging markets have had appeal for risk-tolerant investors because these economies are growing faster and their companies have generated higher returns. The sovereign debt issue is reducing the relative risk of investing in both bonds and equities in these dynamic markets—in this scenario, investors should consider the equities to capture the higher return.

Index Summary

• The major market indices were higher this week. The Dow Jones Industrial Index (1) rose 0.55 percent. The S&P 500 Stock Index (2) advanced 0.99 percent, while the Nasdaq Composite (3) finished 1.78 percent higher.
• Barra Growth (4) outperformed Barra Value (5) as Barra Value finished 0.97 percent higher while Barra Growth gained 1.01 percent. The Russell 2000 (6) closed the week with a gain of 1.59 percent.
• The Hang Seng Composite (7) finished higher by 2.06 percent; Taiwan (8) was up 1.07 percent and the Kospi (9) advanced 1.72 percent.
• The 10-year Treasury bond yield closed at 3.70 percent, up 1 basis point for the week.

All American Equity Fund - GBTFX • Holmes Growth Fund - ACBGX • Global MegaTrends Fund - MEGAX

Domestic Equity Market

The figure above shows the performance of each sector in the S&P 500 index for the week. The best-performing sector was telecom services, up 2.5 percent. Other better-performing sectors included financials and technology.

Underperforming sectors were utilities, consumer staples, and healthcare.
Within the telecom services sector the best-performing stock was Sprint Nextel Corp., up 9.8 percent. Other better-performing stocks in the sector were Windstream Corp. and MetroPCS Communications Inc.

Strengths

• The industrial REIT (real estate investment trust) group was the best-performing group for the week, up 9 percent, led by its single member, ProLogis. The company sold $1.5 billion in notes during the week. At a conference in the prior week, ProLogis said that it has observed more demand in the market and noted that market rents are beginning to bottom out.
• The diversified REIT group was the second-best-performer, rising 7 percent. Its single member, Vornado Realty Trust, said at a conference the prior week that it expects to make acquisitions this year that can generate returns for shareholders.
• The regional banks group was among the outperformers, rising 5 percent. This strength likely came from investors anticipating a turn in the credit cycle, with loan losses beginning to diminish during 2010.

Weaknesses

• The agricultural products group was the worst performer, down 6 percent, led by its single member, Archer Daniels Midland Co. (ADM). Officials from the Obama Administration conducted a hearing on competition in agriculture that may shape a new era of antitrust enforcement. Along with ADM, names mentioned in the press that might be affected include Monsanto Co. and Tyson Foods Inc.
• The gas utility group underperformed, falling 3 percent. EQT Corp., a member of the group, priced a public offering of 12.5 million shares at $44 per share.
• The gold group underperformed, declining 3 percent, led by its single member, Newmont Mining Corp. The price of gold declined during the week.

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.

U.S. Government Securities Savings Fund - UGSXX • U.S. Treasury Securities Cash Fund - USTXX
Near-Term Tax Free Fund - NEARX • Tax Free Fund - USUTX

The Economy and Bond Market

Bond yields moved higher across most of the Treasury curve, the exception being the 30-year bond, which rallied after strong auction results late in the week.

February retail sales rose 0.3 percent month over month and 3.9 percent year over year. Overall, retail sales continue to positively surprise when considering the high unemployment levels. Several factors may offer at least a partial explanation. Household net worth rose 1.3 percent in the fourth quarter and is now up 12.4 percent year over year. Tax refunds are also running ahead of last year by more than 7 percent. Another explanation may be tied to pent-up demand—after 18 months of frugality, consumers may feel comfortable enough to spend again.

Strengths

• Retail sales in February were stronger than expected in virtually all areas.
• The U.S. Labor Department reported that job openings rose 7.6 percent in January, hitting an 11-month high.
• China released February economic data this week and it was generally stronger than expected. Retail sales rose 22.1 percent, money supply rose 25.5 percent and fixed asset investment rose 26.6 percent.

Weaknesses

• Along with the strong growth data out of China this week also came higher-than-expected inflation data. CPI rose 2.7 percent on a year-over-year basis and continues to stoke concerns of continued tightening measures from the government.
• University of Michigan Consumer Confidence modestly disappointed expectations.

Opportunities

• If financial markets are a good mechanism for discounting the future, the future appears relatively robust. The markets have been able to shake off bad news relatively easily recently, probably a good sign for the economic recovery.

Threats

• When 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 the economy.

March 12, 2010 Natural Gas on the Big Screen	March 11, 2010 “Extreme” Hurricane Forecast – Energy at Risk	March 10, 2010 Travel With Us to India

Gold Market

For the week, spot gold closed at $1,101.90 per ounce down $32.75 or 2.89 percent. Gold equities, as measured by the XAU Gold & Silver Index (XAU) fell 2.79 percent for the week. The U.S. Trade-Weighted Dollar Index (DXY) also slipped, losing 0.77 percent.

Strengths

• Hedge fund managers John Paulson and George Soros both made significant investments, at discounts to market, in a potential gold-mining company with significant mineral assets. These transactions point to an expectation of future economics in the gold mining sector which are deemed to be more attractive.
• John Embry, chief investment strategist at Sprott Asset Management, was recently interviewed on Mineweb.net and noted the public is becoming increasingly aware of the looming sovereign debt crises. He noted that historically they would counsel investors to have 5 to 10 percent of their assets in the precious metals sector, but now that suggestion is above 20 percent.
• A recent IMF Staff Position Note “Rethinking Macroeconomic Policy," released this quarter, is making the argument that traditional inflation targeting of 2 percent may not be optimal and opens the discussion of inflation targets at 4 percent.

Weaknesses

• Some of the recent weakness in gold was attributed to liquidations of long position related to an upcoming hearing by the Commodity Futures Trading Commission to investigate speculative interest in the precious metal market.
• South African has fallen to the world’s fourth largest gold producer behind China, Australia and the United States. Falling production is partly being driven by declining ore grades, down 8 percent over the past year. Reportedly, China is very active within South Africa trying to secure supplies of industrial metals, but likely would not rule out opportunities to obtain production interest in the precious metals sector.
• The prime minister of Greece has been busy trying to find governmental allies to create regulations that would limit the use of credit-default-swaps in financial markets, which he blames for driving up the borrowing costs of issuing debt.

Opportunities

• Last year was the first time union membership in the public sector rose above private sector membership. The average hourly wage of public employees last year was $39.66, about 45 percent higher rate than the average hourly wage of $27.42 paid in the private sector. According to U.S. Bureau of Labor Statistics, businesses have cut 8.5 million jobs while government job losses are almost nil. Public spending to support these jobs could contribute to massive deficits that could weaken the dollar and benefit gold.

Threats

• RBC recently highlighted that the South African rand could rise 10 percent in the next three months as the country prepares to host soccer's World Cup. Unless the gold price rises an equal amount, some of the miners could see a margin squeeze.
• Several reports have highlighted whether the days of big gold companies is over. While this can be an opportunity, uncertainty is more prevalent in the near term.
• The world’s biggest gold miner is planning to list its African assets as a separate company in London. In another case, the world’s third largest gold miner hinted the company could rationalize assets.

Global Resources Fund - PSPFX • Global MegaTrends Fund - MEGAX

Energy and Natural Resources Market

The source of this graph is IHS Herold. The securities identified in the graph were selected for inclusion by IHS Herold and may or may not be held by portfolios managed by U.S. Global Investors, Inc., whose holdings may change daily.

Strengths

• Chinese crude oil import surged in the first two months of the year up 45 percent year over year. The apparent demand growth is up 25 percent over the same period.
• Chinese floor space under construction rose 29.3 percent year over year in January and February (combined).
• German crude steel production increased 34 percent year over year to 3.4 million metric tons in February 2010, according to WV Stahl. This marks an acceleration on the rate of increase recorded in January, when crude steel production rose by 28 percent year over year.
• Crude steel production in China, the largest maker, rose 22.5 percent to 50.36 million metric tons, according to data from the National Bureau of Statistics.
• Indian coal imports climbed 20 percent year over year in February. It received 6.1 million metric tons of the fuel from suppliers in Australia, Indonesia and South Africa. India plans to almost double electricity generation capacity by 2012 and by then the shortage of coal is expected to exceed 200 million metric tons.
• In January 2010, U.S. coal exports were up 17.5 percent year over year to 5.8 million tons, driven by a 62.9 percent year-over-year increase in metallurgical coal exports, the highest level since September 2008.
• Copper imports by China, the world’s largest consumer, increased 10 percent in February from the previous month on sustained demand.

Weaknesses

• Italian oil and gas group Eni SpA cut its production growth target on Friday and said investors would have to wait until 2011 to see any growth in output or dividends. Eni, the world's seventh-biggest listed oil company, said production is expected to grow more than 2.5 percent per year on average through 2013—this estimate was down from 3.5 percent per year in its previous plan.

Opportunities

• ExxonMobil, the largest U.S. oil company by market value, said at its annual analyst meeting in New York that it expects to boost its capital spending 3.3 percent to $28 billion in 2010 and that it would spend $25 to $30 billion per year through 2014. The bulk of the company's capital budget would go toward developing dozens of major projects around the world.
• Quadra Mining Ltd. gained 10 percent this week after State Grid Corp. of China agreed to buy 9.9 percent of the company for $148 million to secure a share of the copper from Quadra’s Chilean projects. Beijing-based State Grid is the larger of China’s two grid operators.
• BP on Thursday confirmed it would enter the deep waters off the coast of Brazil, one of the world’s most promising areas for oil exploration, with a $7 billion deal to buy international oil and gas assets from Devon Energy.
• The active land-drilling rig count is on the rise, but North Dakota has been one of the fastest growing in the Lower 48 since the bottom last year, more than doubling its rig count since mid-2009. Driving the North Dakota rig count higher has been a sharp rebound in activity in the Bakken Shale, considered one of the largest oil formations in the U.S.

Threats

• China’s inflation reached a 16-month high, industrial output climbed and new loans exceeded forecasts, adding to the case for the government to pare back stimulus measures. Consumer prices rose 2.7 percent in February from a year earlier, the National Bureau of Statistics said, compared with the 2.5 percent median estimate of 29 economists surveyed by Bloomberg News. Seasonal factors stemming from a weeklong holiday may have boosted prices. Production rose 20.7 percent in the first two months of 2010, the most in more than five years.
• A glut of unconventional natural gas supplies from U.S. shale deposits has fundamentally recast the long-term prospects for liquefied natural gas imports that were once considered the linchpin of the nation's energy security, industry executives said at the Ceraweek energy conference in Houston.
• China is idling up to 40 percent of its wind-turbine factories following a surge in investment driven by the government’s renewable energy goals, the vice president of Shanghai Electric Group Corp. said this week.

China Region Opportunity Fund - USCOX • Eastern European Fund - EUROX
Global Emerging Markets Fund - GEMFX

Emerging Markets


Strengths

• The number of people living at or above the level of “medium development”— considered to live in reasonable conditions and have access to education, health care, clean water and electricity—has grown by more than 2 billion people during the past several decades. That is more than the entire global population in 1900.
• The Asia Pacific region provided 234 names to the latest Forbes World’s Billionaires list released this week, up from 130 last year. The region accounted for 23 percent of the total 1,011 billionaires globally.
• China’s February exports grew by a higher-than-expected 45.7 percent year over year due to a strong rebound in exports of textile, steel products, televisions and motorcycles. Imports rose 44.7 percent in February from a year earlier thanks to a large swing of crude oil prices from last year.
• Brazil highway traffic in February rose by 6 percent year over year. It was driven mainly by heavy vehicles traffic (up 11.9 percent) and passenger traffic (up 4.3 percent).
• Brazil’s budget minister says his country is likely to see 6 percent GDP growth this year and the creation of 2 million jobs.
• January retail sales in Brazil increased 10.4 percent year over year.
• Industrial production in India in January rose 16.7 percent and was driven by higher activity in the mining sector (up 14.6 percent) and manufacturing (up 17.9 percent).
• Turkish new-car sales in February jumped 42 percent year over year, aided by tax incentives and a low base. The rise was above industry expectations.

Weaknesses

• China’s growth in fixed-asset investment moderated to 26.6 percent year over year in January and February combined, compared with the stimulus-driven rate exceeding 30 percent between March and October 2009, as the government wound down new public investment projects.
• Despite restraining government policies, property prices in 70 cities in China climbed another 10.7 percent year over year in February, the fastest pace in 23 months, after January’s 9.5 percent gain. New and existing home prices increased 1.3 percent and 0.4 percent month over month, respectively.
• All three publicly traded airport groups in Mexico reported declines in passenger traffic during February.
• Turkey ended IMF negotiations without a loan agreement. In absence of the IMF loan, there will be little upside to 4 percent GDP growth projections for 2010.

Opportunities

• If home-buying sentiment in China has shifted toward “wait and see,” auto purchases have remained very strong as the government maintained policy incentives. Even in the seasonally slowest month of February, 1.21 million vehicles were sold. The combined 2.88 million units sold in January and February was 84 percent higher than the same period in 2009. Such strength is likely to carry into March and April, typically strong months for car sales, as potential auto buyers rush to purchase before subsidy programs are withdrawn. Opportunities still exist for Chinese automakers and steel mills.

• It is estimated that damage to Chile’s infrastructure from recent earthquakes will be $20 billion to $30 billion, and will result in a massive government revival program. Dealing with effects of the earthquake is going to be a priority for the new president, Sebastian Pinera. Chile has a very healthy fiscal position and should easily fund the program from its copper fund, as well as from local and external debt.
• After years of neglect, there is a structural shortage at the residential end of Russian real estate market. New strategy announcements from the Russian real estate companies suggest that they are coming out of hibernation and are planning to launch construction and start pre-sales.

Threats

• While China’s central bank governor said February’s 2.7 percent increase in consumer prices from a year earlier was in line with his expectation, the latest inflation figure did surpass the one-year deposit rate of 2.25 percent. Negative real interest rates may provide an additional incentive to drive asset prices further ahead, creating fears of imminent monetary tightening that may introduce short-term volatility into the market.

• Mexico’s official inflation in February rose 0.58 percent month over month (vs. 0.50 percent expected) and was up 4.8 percent on an annualized basis. While the rate is still within the 4.75 percent to 5 percent target range, we will closely monitor the trend in coming months.
• The issue of exiting from monetary stimulus becomes pressing in countries like Brazil and Turkey, where inflation pressures are building. The chart below shows Citi’s estimates of upcoming rate increases in emerging countries in 2010.

---

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(%)
Hang Seng Composite Index	2,994.59	+60.43	+2.06%
Korean KOSPI Index	1,662.74	+28.17	+1.72%
S&P BARRA Value	547.27	+5.24	+0.97%
Nasdaq	2,367.66	+41.31	+1.78%
Oil Futures	81.19	-0.31	-0.38%
Gold Futures	1,102.40	-32.80	-2.89%
S&P 500	1,149.99	+11.29	+0.99%
Russell 2000	676.59	+10.57	+1.59%
S&P/TSX Canadian Gold Index	320.94	-12.75	-3.82%
DJIA	10,624.69	+58.49	+0.55%
S&P BARRA Growth	594.30	+5.97	+1.01%
XAU	166.04	-4.77	-2.79%
S&P Energy	434.42	+1.96	+0.45%
S&P Basic Materials	200.97	+0.71	+0.35%
10-Yr Treasury Bond	3.70	+0.01	+0.41%
Natural Gas Futures	4.38	-0.21	-4.55%

Monthly Performance

Index	Close	Monthly Change($)	Monthly Change(%)
Oil Futures	81.19	+7.44	+10.09%
XAU	166.04	+10.97	+7.07%
Russell 2000	676.59	+81.42	+13.68%
S&P/TSX Canadian Gold Index	320.94	+4.34	+1.37%
Gold Futures	1,102.40	+25.20	+2.34%
Nasdaq	2,367.66	+216.79	+10.08%
S&P BARRA Value	547.27	+38.41	+7.55%
DJIA	10,624.69	+566.05	+5.63%
S&P 500	1,149.99	+79.47	+7.42%
S&P BARRA Growth	594.30	+40.41	+7.30%
S&P Basic Materials	200.97	+15.24	+8.21%
10-Yr Treasury Bond	3.70	+0.09	+2.43%
S&P Energy	434.42	+21.69	+5.26%
Korean KOSPI Index	1,662.74	+92.25	+5.87%
Natural Gas Futures	4.38	-0.91	-17.13%
Hang Seng Composite Index	2,994.59	-332.01	-14.83%

Quarterly Performance

Index	Close	Quarterly Change($)	Quarterly Change(%)
10-Yr Treasury Bond	3.70	+0.15	+4.16%
Russell 2000	676.59	+76.22	+12.70%
Oil Futures	81.19	+11.32	+16.20%
Nasdaq	2,367.66	+177.35	+8.10%
Korean KOSPI Index	1,662.74	+5.84	+0.35%
S&P BARRA Value	547.27	+22.84	+4.36%
S&P 500	1,149.99	+43.58	+3.94%
DJIA	10,624.69	+153.19	+1.46%
S&P BARRA Growth	594.30	+20.13	+3.51%
Hang Seng Composite Index	2,994.59	-66.64	-2.18%
S&P Basic Materials	200.97	+5.25	+2.68%
S&P Energy	434.42	+11.07	+2.61%
Gold Futures	1,102.40	-18.80	-1.68%
Natural Gas Futures	4.38	-0.78	-15.09%
S&P/TSX Canadian Gold Index	320.94	-24.25	-7.03%
XAU	166.04	-6.40	-3.71%

Please consider carefully the fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting Home - U.S. Global Investors 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 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. 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.
These market comments were compiled using Bloomberg and Reuters financial news.
Holdings as a percentage of net assets as of 12/31/09:
Sprint Nextel Corp.: 0.0%
Windstream Corp.: 0.0%
MetroPCS Communications Inc.: 0.0%
ProLogis: 0.0%
Vornado Realty Trust: 0.0%
Archer Daniels Midland Co.: 0.0%
Monsanto Co.: 0.0%
Tyson Foods Inc.: 0.0%
EQT Corp. : 0.0%
Newmont Mining Corp.: Gold and Precious Metals Fund 1.01%, World Precious Minerals Fund 0.46%
Eni SpA: 0.0%
ExxonMobil Corp.: 0.0%
Quadra Mining Ltd.: 0.0%
BP: 0.0%
Devon Energy: 0.0%
Shanghai Electric Group Corp.: 0.0%
*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 University of Michigan Confidence Index is a survey of consumer confidence conducted by the University of Michigan. The report, released on the tenth of each month, gives a snapshot of whether or not consumers are willing to spend money.