Actionable ETF Investment Ideas: March 2011

Published on by on February 28, 2011 | Updated March 1, 2011

International turmoil dominated the headlines during the month of February, with protests across the Middle East taking the spotlight off of Europe’s fiscal woes and stubbornly high unemployment in the U.S. A sharp run-up in oil prices has complicated the investment picture for the short-term, presenting another potential obstacle to both consumer spending and corporate earnings in coming months. We see several opportunities in the current environment, ranging from commodities to currencies:

iPath Sugar ETN (SGG)

After surging higher last year, sugar has pulled back a bit in 2011 as some of the supply concerns that fueled the 2010 rally have eased a bit. For investors looking for an inflation hedge or just looking to bet that the broader commodity rally still has some legs, we believe that an attractive entry point now exists for SGG.

There are a few reasons for our bullish take on sugar. Major inflation concerns have popped up in India in recent months, sparking concerns that one of the largest emerging markets will struggle to combat rising prices and that the impact will be felt throughout global financial markets. India is the world’s largest consumer of sugar and second largest producer behind Brazil. Given the upward pressure on prices that has intensified in recent months, as well as the tendency for supply disruptions in both Brazil and India, the current environment seems to be positioned for a further climb in prices.

Though the fundamentals in the sugar market seem to indicate that a further jump in prices is possible, our primary rationale for SGG is related more to the slope of the futures curve. Sugar futures are in relatively steep backwardation, with October 2012 contracts trading at a discount of more than 30% to the next-to-expire March contracts. While backwardation alone isn’t enough to guarantee strong performance, that significant drop-off in prices provides a significant amount of padding for an investment in SGG. Given the demographic shifts under way in emerging markets–urbanization leading to a swelling middle class that demands more protein and sweeteners in their diet–it’s hard to imaging that sugar prices are going to fall off of a cliff any time soon.

Long CurrencyShares Canadian Dollar Trust (FXC)/ Short CurrencyShares Japanese Yen Trust (FXY)

As oil markets continue to trend around the $100/bbl mark, a number of sectors of the ETF world are bound to be in focus. While the spotlight has been on oil producing companies and the retail sector–two industries directly impacted by a move in oil prices–there are a number of ways to play this trend via the currency markets as well. One popular strategy that can be replicated via exchange-traded funds is by going long in the Canadian dollar (FXC) and simultaneously shorting the Japanese yen (FXY).

This could be an interesting way to play high oil for several reasons. First and foremost is the oil production levels in both of the countries. Japan produces a paltry 130,000 barrels a day, or roughly 3% of their daily needs–suggesting that virtually all of the oil needed to power the Japanese economy must be imported from abroad. Furthermore, Japan uses oil for roughly 50% of its energy needs, so switching to coal or nuclear power isn’t as feasible as it might be in other countries, at least in the short-term. Meanwhile, Canada has become an oil powerhouse, exporting more than two million barrels of oil a day, putting it in the top ten in terms of oil exporting countries and top six for total production. Due to these facts, both countries’ currencies tend to be disproportionately impacted by moves in oil prices but in opposite ways.

Should oil prices continue to remain high, it could create extra demand for Canadian dollars as investment crowds into the country in order to exploit the vast oil deposits in the nation or to purchase the country’s oil exports. These moves could lead to a spike in the value of the Canadian dollar and thus lead to an increase in value of FXC. Meanwhile, a similar, but opposite situation should occur in Japan as yen demand decreases as money flows out of the country in order to buy up more oil and investment flees the already low yielding currencies for greener pastures in nations with more robust commodity profiles.

ETF currency products tend to far less volatile than their counterparts in the commodity space while providing similar exposure levels and also paying out decent dividend yields. In fact, the CAD/JPY currency pair has seen correlation about 80% since 2005 with the price of oil, suggesting that while it isn’t a perfect match it could be a lower risk way to play oil prices and a way to gain even if oil does not continue higher but merely remains elevated over the near-term.

Guggenheim Solar ETF (TAN)

Clean energy was a major focus in 2010 following the wake of the Deepwater Horizon spill, but all in all, not much really happened in the push for alternative energies. In fact, 2010 marked a rough year for clean energy ETFs across the board, as some sunk nearly 30%. But in 2011, many clean funds have begun to regain their ground, especially solar and wind. Solar has an exceptionally promising future, and March may be the perfect time to cash in on this ETF.

In recent weeks, the stars have all aligned for the alternative energy sector, which has fueled TAN to gain over 15% on the year alone. Firstly, conflicts in the Middle East in recent weeks have caused oil prices to surge. Tunisia and Egypt led the way with social revolutions, causing Egyptian leader Mubarak to step down from his presidency. Since then, several other countries have erupted with violent protesting such as Bahrain and Libya. Because the majority of these nations are in the Middle East, where the vast majority of the world’s oil supplies lie, oil prices have skyrocketed as of late, make alternative energies much more attractive. One of the biggest factors hindering a major switch to green energy is that fossil fuels have always been much cheaper, but now that oil prices are rising, it may be time for nations to take a hard look at where their energy comes from. In fact, on average, gas prices in the U.S. saw the highest priced month of February since 1990. Coupled with rising oil prices, the Obama administration’s recently announced 2012 budget will have a strong impact on the energy sector. The budget will aim to cut tax breaks for major oil companies, and greatly increase spending on alternative sources such as wind and solar. With these two major factors aligning, TAN could make a bright addition to your portfolio this month.

MSCI New Zealand Index Fund (ENZL)

The devastating earthquake which hit Christchurch, New Zealand took the lives of many and unfortunately the death toll continues to rise. Recovery efforts are underway and the situation is improving, although slowly, for the locals. Following the catastrophe the iShares MSCI New Zealand ETF sank nearly three percent, and the days following it was able to hold support above key technical support levels. Recent fundamental economic news out of New Zealand have been less than cheerful and unfortunately the Kiwis are not yet on a robust recovery path much like their Aussie neighbors. Nevertheless, the recent sell-off presented an attractive entry point for active traders, as well as a great opportunity for those with a longer-term bullish view on New Zealand. The fund is currently inching higher and its likely it will climb to (and perhaps above) its 200day moving average which comes in at around $29 a share. If the fund closes below $28 a share, further downside pressure may force ENZL to sink even deeper.

From a correlation perspective, ENZL can make for a great diversifying agent for your portfolio given the funds remarkable correlation with the price of gold and geographic exposure to the Asia-Pacific region. Also, rising gold prices strengthen the Australian dollar given the country’s heavy economic exposure to the precious yellow metal. Likewise, as the Aussie dollar strengthens, New Zealand can benefit because it will export more to their number one trading partner.

Last Month’s Actionable ETF Plays

Ticker ETF Monthly Return Our Take
KBWD High Dividend Yield Financial Portfolio +3.3% February was kind to both dividend payers and the financial sector, leading to a stellar month for the high-yielding KBWD. We continue to like this play for investors looking to enhance their current returns, as the distribution yield is a whopping 8.7% and the SEC 30-day yield remains above 9.5%. Good luck finding return figures like those anywhere else.
USO/BNO Long United States Oil Fund/ Short United States Brent Oil Fund -9.4% Unfortunately, this choice did not turn out as planned thanks to Libya throwing a wrench into the oil markets. As a result, Brent crude continued its surge, leaving WTI crude and USO in the dust despite a large runup in the American oil benchmark as well. We still think that the premium for BNO over UNO will eventually subside, but if tensions remain high in the Middle East this could be a long time coming and investors should probably wait until things cool down in the region.
EWP iShares MSCI Spain Index Fund
This fund saw a rough month as protests in the Middle East ensued. The country receives approximately 13% of its oil and 2% of its gas from Libya, driving this fund down as conflicts continue to escalate in the Middle Eastern Nation.
FXY Rydex CurrencyShares Japanese Yen Trust -0.3% This position would have generated a nice return had it been exited halfway through the month following Japan’s decision to keep interest rates unchanged. However, recent international developments have been working against a short-Yen position. FXY is still due for a correction from a technical perspective, and the fund is likely to slowly but surely decline over the coming months.
ETFdb 60 Index +2.3% This broad measure of asset classes available through ETFs climbed higher in February as winners outnumbered losers by more than six-to-one on the month.

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