Commodities 2011 Halftime Report
Published: July 15, 2011 by Nrtadmin
By Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors
Commodities don’t all perform in the same way. In any given year, a particular commodity will go gangbusters and outperform the group. However, that commodity will typically come back to Earth and underperform the following year or the year after that. This is why active management is important when investing in commodities. Active managers can benefit from rotating from winners to laggards or by investing in the companies which produce, farm or mine commodities most effectively.
After two straight years of tremendous gains for many commodities, the first six months of 2011 haven’t been as kind. As of the end of June, only two commodities (silver and coal) saw double-digit increases, and only six of the 14 commodities we track—less than half—were in positive territory.
Silver was the leader, rising more than 12 percent, followed closely by coal (up 11.95 percent). Other commodities increasing in value included gold (5.6 percent), crude oil (3.83 percent), lead (2.16 percent) and aluminum (1.73 percent).
Returns are based on historical spot prices or futures prices. Past performance is no guarantee of future results.Silver
Silver prices got ahead of themselves earlier this year, climbing 58 percent to nearly $50 an ounce. This registered a four standard deviation move, representing extreme territory on our models. Thinking silver, which has historically been a narrowly-traded market, had become a potential haven for speculators, officials stepped in and raised margin requirements on the Comex. This quickly deflated the bubble and prices naturally reverted back toward the mean but remain well above where they began the year.
Strong demand from reconstruction projects in Japan along with reduced supply because of flooding in Australia, Indonesia, South Africa and Colombia led coal to be the second-best performer.
No country was more affected by the lower supply than China as coal powers the Chinese economy. The country is the world’s largest consumer, gobbling half of the world’s coal. Coal accounted for 71 percent of China’s energy in 2008—more than three times the United States’ share. The Electricity Council estimates that China’s coal demand will reach 1.92 billion tons in 2011, up nearly 10 percent from 2010. Chinese electricity use was up 13.4 percent on a year-over-year basis in May and is now expected to rise 12 percent this year. (Read: Coal Use in China Shines Light on Growth)
Gold prices passed $1,500 for the first time ever in mid-April of this year and ended the quarter just slightly below that mark as a mixture of the Fear Trade and Love Trade proved to be an enticing concoction for investors here and abroad. The World Gold Council reported that demand for gold as an investment was up 26 percent on a year-over-year basis during the first quarter. In China, demand for gold was so strong it outpaced the combined gold demand of the U.S., France, Germany, Italy, Switzerland, the U.K. and other European countries. (Read: Asian Tiger Sinks Teeth Into Gold)
Although gold prices held steady during the first half of the year, the share prices of gold companies have lagged. Ralph Aldis and I discussed this hot topic in depth a few weeks ago. (Read: Will Gold Equity Investors Strike Gold?) Many gold companies’ corporate cash flows and earnings per share have been rising, and more companies are paying dividends. Gold stocks also appear cheap compared to the price of gold. We believe investors will be drawn to these qualities, lifting gold stocks along with the strong bullion price.
After two straight years of solid gains, oil prices finally surpassed the $100 per barrel mark once again early in 2011. This time, it was a dose of geopolitical risk and a natural disaster that sent oil prices shooting upward. Oil prices have since bounced around the $90-$100 range for West Texas Intermediate (WTI). That range has held up despite U.S. consumers cringing at gasoline prices, the International Energy Agency (IEA) releasing an additional 60 million barrels of oil to the market and China’s ardent attempts to cool its economic growth. (Read: Playing Cat and Mouse with Global Oil)
Despite tightening measures, China’s per capita oil consumption has retained its upward trajectory and is headed toward levels similar to Taiwan and South Korea. There’s still quite a gap to close before that happens, but China’s oil consumption per capita has increased over 350 percent since the early 1980s to an estimated 2.7 billion barrels per year in 2011. Nearly 100 percent of that has taken place in the past decade. In addition, oil consumption per capita has risen sharply in recent decades in other Asian countries such as Malaysia (nearly quadrupled) and Thailand (doubled).
Looking Forward to the Second Half of 2011
We think commodity price movements will fare better during the second half of the year. Goldman Sachs wrote in a report last week that it expects global economic growth to be “generally supportive of rising commodity demand” and “this demand growth will be sufficient to tighten key commodity markets over the next six to 12 months.” We believe gold, oil and copper are some of the commodities which could see the biggest gains. For the sake of brevity, we’ll highlight gold here today. Check out my “Frank Talk” blog next week for our previews on oil and copper. (www.usfunds.com/franktalk)
As BCA Research puts it, “[gold] prices have benefited from a ‘perfect storm’ in recent months: falling real interest rates, a weak dollar, fears of a U.S. recession and/or debt default, and European stress.” Those factors, which I affectionately refer to as the Fear Trade, are what sent gold prices flirting with the $1,600 an ounce level this week. There was also the release of Federal Reserve meeting minutes that showed QE3 is possible, though not yet probable given Chairman Bernanke’s testimony this week. By the way, if you haven’t already seen Bernanke’s exchange with Congressman Ron Paul on gold, go to YouTube and check it out for a good chuckle. Washington’s reluctance to present a solution to the debt ceiling issue also contributed heavily to gold’s performance.
Paul was bringing attention to the threat of currency debasement, a major reason investors all over the world are turning to gold. According to U.K. research firm Capital Daily, the U.S. monetary base has increased more than 200 percent since September 2008. Meanwhile, gold prices have risen only about 70 percent over the same time period. Capital Daily says “if the two had been directly related, gold should already have risen to around $2,800 [an ounce].” That’s obviously a lofty expectation but illustrates that gold prices haven’t appreciated nearly as much as currencies, such as the U.S. dollar, have been debased.
In fact, don’t believe what you read about record high gold prices. Yes, gold hit a high in nominal terms, but the price is more than 30 percent below the 1980 peak of $2,400 an ounce if you adjust for inflation.
This was a banner week for the Fear Trade but don’t count out the Love Trade. Gold is about to get even more attractive because we are heading into the fall and winter gift-giving season. This is the time of year when gold jewelers typically do their biggest business. The kickoff is the Muslim holy month of Ramadan, which starts next month and ends with generous gift-giving in early September.
The key to this seasonal strength over the past few years has been demand from China and India. You can see from the chart that the rise in gold prices has been closely tied to the rise in gold demand from China and India. Back when the average per capita income in China and India was well below $1,000 a year, gold prices hovered just above $200 an ounce. As average incomes have approached $3,000 a year over the past decade, gold prices have followed. With the long-term outlook for wages in both these economies rather rosy, gold demand should continue to feel the trickle-down effect.
Those investors looking for more of a technical indicator can take a look at the ratio of gold and oil. Capital Daily says that the ratio of the price for one ounce of gold to one barrel of oil (Brent crude) is currently 13.5. Since 1970, the average has been around 16. Gold prices would need to rise to $1,870 an ounce in order to reach historical ratio levels with $117 per barrel Brent crude oil, according to Capital Daily.
Based on seasonal demand strength and sovereign debt fears of the U.S. and several European countries, we think gold prices could be headed higher.
Tune in to “Frank Talk” on Tuesday and Wednesday for second half 2011 previews of oil and copper.
Domestic Equity Market
The figure below shows the performance of each sector in the S&P 500 Index for the week. One sector increased slightly and nine sectors declined. The best-performing sector for the week was energy which increased 0.12 percent. Other top-three sectors were utilities and consumer staples. Financials was the worst performer, down 3.91 percent. Other bottom-three performers were industrials and consumer discretion.
Within the energy sector, the best-performing stock was Range Resources, which rose 10.03 percent. Other top-five performers were Southwestern Energy, Chesapeake Energy, Nabors Industries, and EQT Corp.
Near-Term Tax Free Fund - NEARX • Tax Free Fund - USUTX
The Economy and Bond Market
The yield on the 10-year U.S. Treasury note decreased by 12 basis points this week to yield 2.91 percent.
Although initial jobless claims decreased in the week ended July 9, continuing jobless claims in the U.S. were 3.73 million in the week ended July 2. The chart below shows the number of continuing claims in thousands. The current level of claims is still substantially above the level existing in the years 2004 thru 2007. Also, the continuing claims figure does not include the 3.83 million people who have used up their traditional benefits and are now collecting emergency and extended payments under federal programs.
For the week, spot gold closed at $1,593.55 per ounce, up $49.40 per ounce, or 3.2 percent for the week. Gold equities, as measured by the Philadelphia Gold & Silver Index, gained 4.40 percent. The U.S. Trade-Weighted Dollar Index was essentially unchanged for the week.
Energy and Natural Resources Market
Global Emerging Markets Fund - GEMFX
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 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, 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.
These market comments were compiled using Bloomberg and Reuters financial news.
Holdings as a percentage of net assets as of 03/31/11:
Range Resources Corp.: 0.00%
Southwestern Energy Co.: 0.00%
Chesapeake Energy Corp.: 0.00%
Nabors Industries Ltd: 0.00%
EQT Corp.: 0.00%
Google, Inc.: 0.00%
Newmont Mining Corp.: 0.00%
Goodyear Tire & Rubber Co.: 0.00%
FLIR Systems, Inc.: 0.00%
GameStop Corp.: 0.00%
Best Buy Co.: 0.00%
CB Richard Ellis Group, Inc.: Holmes Growth Fund: 1.81%; Global MegaTrends Fund: 1.29%
Microchip Technology, Inc.: 0.00%
Southern Copper Corp.: 0.00%
BHP Billiton Ltd: 0.00%
Petrohawk Energy: 0.00%
Perdigao SA: 0.00%
Sadia SA: 0.00%
Tyson Foods: 0.00%
Sberbank: Eastern European Fund, 8.80%; Global Emerging Markets Fund, 2.21%
KBC Bank: 0.00%
Kredyt Bank: 0.00%
Komercni Banka: 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 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.
The MSCI China Free Index is a capitalization weighted index that monitors the performance of stocks from the country of China.Index is a capitalization-weighted index that tracks the companies in the telecom sector as a subset of the S&P 500.
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