Investing Ideas

ETNs involve substantial risks and are not for everyone. Read the prospectus and consult you financial adviser and tax consultant before investing in them.

Last month Morgan Stanley launched two new ETN’s(Exchange Traded Notes) offering exposure to the Chinese Renminbi and Indian Rupee . The notes charge 0.55% in annual fees. ETN’s are Debt securities not Stocks or ETF’s. The site is http://www.marketvectorsetns.com/index_ETN.cfm.

CNY tracks the performance of the S&P Chinese Renminbi Total Return Index (ticker:SPCBCNY). SPCBCNY seeks to track the performance of rolling investments in short-term forward contracts in China’s currency, the Renminbi. Prospectus for Chinese Renminbi CNY.

INR tracks the performance of the S&P Indian Rupee Total Return Index (ticker:SPCBINR). SPCBINR seeks to track the performance of rolling investments in short-term forward contracts in India’s currency, the rupee. Prospectus for Indian Rupee INR.

I have been bearish on the dollar (read my article Kaching in on the dollars decline). The dollar has declined substantially compared to the Yen, Euro, Australian Dollar, Canadian Dollar, Brazilian Real and a host of other currencies. It hasn’t declined as much against the Chinese and Indian currencies. Indian and Chinese governments have restrictions on currency transactions which prevents most individuals from investing directly in these currencies. China and India get a lot of their trade surplus from exporting goods and services to the US. To keep their cost advantage they maintain their currencies at a rate that benefits exports. While exports have been great and have benefited their economies it has also increased inflation.

A lot of commodities are priced in US dollars and as the dollar has been declining in value the last few years and the value of the Renminbi and Rupee has also declined along with the dollar. The Renminbi and Rupee have dropped in relation to non US currencies and commodities. Unless the US dollar increases in value China and India will have to loosen up or completely drop their peg to the dollar and allow their currencies to appreciate. This is the only way they can fight against commodity inflation. A couple of years ago China started linking the Renminbi to a basket of currencies instead of just the US dollar but the currency hasn’t been allowed to appreciated much. The US and other countries which have growing trade deficits with China are pushing for an increase in the value of the Chinese currency. China itself knows that it will need to reprice the Renminbi be it would prefer to do it slowly, this is probably why Jim Rogers has been a Renminbi bull for quite sometime.

Disclosure : I do not own the ETN’s CNY/INR, I am not invested in Morgan stanley.

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Please investigate investment suitability and your own tax implications before investing in Royalty trusts. The details i have provided may be incomplete or inaccurate.

What is a Royalty Trust?
Royalty Trusts are natural resource companies that because of their company structure do not have to pay taxes at the company level as long as they pay out 90% or more of their earnings to shareholders. Canadian Royalty trusts pay very high dividends typically in the range of 10-20%. Canadian trusts (unlike US trusts) are set up to perform exploration and development and/or aquire new proporties to replenish their reserves. They are set up to operate indefenitely.

Whats this new Tax Rule I hear about and what effect will it have?
The finance minister has a proposal that starting in 2011 all existing trusts should pay corporate taxes.

If the proposal goes thru, in the 4 years till 2011 you will recieve back 40-72% of your investment in the form of dividends. While the company is paying out 90% of its earnings there is very little left to aquire additional reserves. After 2011 most of these companies will use the money to fund expansion of their resource base. The dividend payment will drop to about 3-5% because the companies dont need to pay out their income. However because of increases in reserves dividend payments in the future will grow at a much faster rate. If the proposal does not become law (the trusts are lobbying against it or asking for an extension to 10 years) companies will keep paying dividends at these high rates and the stocks will climb as dividend investors pour back in.

List of CanRoys

• Advantage Energy Income Fund (AAV) - 14.16%
• Baytex Energy Trust (BTE) - 10.75%
• Canetic Resources Trust (CNE) - 15.97%
• Enerplus Resources Fund (ERF) - 9.63%
• Harvest Energy (HTE) - 16.7%
• Pengrowth Energy Trust (PGH) - 15.06%
• Penn West Energy Trust (PWE) - 11.53%
• PrimeWest Energy Trust (PWI) - 13.11%
• Provident Energy Trust (PVX) - 11.46%

My favourite is Penn West Energy (PWE) the largest energy trust in North America. It is an exploration and production company which converted to a trust in 2005 to increase shareholder returns. I think the company can increase their production significantly without the need for additonal capital. It has 89% working interest in 4 million acres of undeveloped land which is suitable for oil and natural gas exploration and production. The management is also very good at making acquisitions. To top it all Murray Edwards who used to be chairman of PWE is still one of the biggest shareholders in the company. Since the company has a history of being an exploration and production company it should do well post 2011 compared with other energy trusts.

What about taxes?
The Canadian government applies a 15% non-resident withholding tax on distributions to U.S. investors. You can apply for a refund of a portion of the amount withheld. If you hold the shares in a taxable account (non IRA) then you can claim it on your US tax return as a foreign tax that you paid. You can claim the foreign tax credit on your 1040. The limit is $300.00 single or $600.00 filing jointly per year. If the amount is greater than what you can fill out on your 1o40 then you need to use IRS Form 1116. If your marginal tax bracket is over 15% you should get a full refund. If below 15% then you will only get a partial refund.

For more details check IRS publication 514 (You need to select the document from the list and then retrieve it)

Conflicts: I do not own shares in any of the companies mentioned but am considering PWE.

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So you’re invested in dollars? You heard on TV or someone told you that the dollar is losing value. Is this true? Yes. The reason is simple. The US trade deficit for the last 12 months is 800 Billion, thats the annual GDP of countriles like Brazil or India. You want to know how to invest to protect against the dollar’s decline? If you want to protect yourself against the dollars decline the simple answer is to invest internationally. There are lots of ways to invest internationally and I will look at each of them.

Currencies: When the US dollar goes down, it reduces in value compared to other currencies. So an easy way to protect against the decline is to invest in foreign currencies. This is an option i do not like because investing and trading foreign currencies is extremely risky. The other reason is buying currencies is a short term hedge, once the dollar declines the trade is over. You get one time returns on the actual decline but that’s all. Investing in companies is a better way to go as i’ll explain later.

A series of new Trusts have started trading on the NYSE that allow people to own various currencies. I dislike investing in currencies and would never recommend them. They are extremely risky. I just included them for completness.

• Euro Currency (FXE)
• British Pound Sterling (FXB)
• Canadian Dollar (FXC)
• Australian Dollar (FXA)
• Swiss Franc (FXF)
• Swedish Krona (FXS)
• Mexican Peso (FXM)

Two mutual fund families have started new funds that protect against the falling dollar. These are professionally managed but still risky especially high risk is the Direxion Dollar Bear which seeks daily invstment returns of 2.5x the inverse of the dollar.

• ProFunds Falling U.S. Dollar Investor
• ProFunds Falling U.S. Dollar Service
• Rydex Dynamic Weakening Dollar A
• Rydex Dynamic Weakening Dollar C
• Rydex Dynamic Weakening Dollar H
• Direxion Dollar Bear 2.5X Inv

Why Companies over currency?
A declining dollar helps US/Foreign companies that have a lot of international sales. This is because they earn the same amount in international currencies but when its converted into US dollars they earn a lot in dollar terms. Lets take Coca-Cola in a hypothetical example.

If the company recieves the same 20 P/E in 2007 as it did in 2006 the stock should rise to $50.20. If the US$ drops by 20% the international profits would be reported as $2.11 instead of $1.76 and the company would be valued at $57.23 thats a 14% increase because of the drop in the US$. Every subsequent year that the dollar remains at the lower level the company would report higher EPS by 14% so you benefit every year that you hold the stock over a 1 time benefit in owning a foreign currency.

US Multinational Companies: The best bet is to look for large multinational companies which do business in all major international markets. When the dollar declines these companies will recieve major increases in EPS.

• Coca-Cola(KO) - 70% International
• Johnson & Johnson(JNJ) - 45% International
• Proctor & Gamble(PG) - 40%+ International
• Citigroup(C) - 43% International
• PepsiCo(PEP) - 35% International
• News Corp(NWS)

International Stocks: International Multinationals have the same earnings increase benefit as US multinationals and an added benefit for international stocks is their assets may also get higher value.

• Cadbury Schweppes (CSG)
• Siemens (SI)
• Toyota (TM)
• Sony (SNE)
• ING Group (ING)

Commodities: The last way to play the decline in the dollar is to bet on commodities. Since commodity prices are set in US$ terms they rise in relative value when the dollar declines. All commodities traded in dollars should increase in value if the dollar declines. Companies in the energy, metals and mining industry should perform well.

• Integrated Oil - Exxon Mobile(XOM), Conoco Phillips(COP), PetroChina(PTR).
• Independent Oil and Gas - Encana(ECA), Suncor(SU), Chesapeake Energy(CHK), Devon(DVN), Canadian Natural Resources(CNQ).
• Metals and Mining - Anglo American (AAUK), Rio Tinto (RTP), BHP Billiton (BHP)

Mutual Funds : For anyone that would prefer an International mutual fund (Which is the safest way to play the dollar decline). I list my favourite International Funds.

• Julius Baer International Equity (BJBIX)
• First Eagle Global (SGENX)
• Dodge and Cox International(DODFX)
• Oakmark International(OAKIX)

Note: I would stay away from international stocks that get most of their earnings in US dollars. If you find an international stock that gets most of its earnings from the US market. Since the company is paid in USD When the dollar declines the revenue of that company will drop while their costs will remain the same.

Conflicts : I own shares of Chesapeake Energy

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Heres a question. What will be the richest countries in the world in a few decades? If you answered any of the following USA, UK, Germany, Japan you got it wrong. Try again. Did you think it was China, India, Brazil, Russia? Wrong again.

Where does wealth come from?
Wealth comes from natural resources which can be harvested and sold to those who want them. Wealth also comes from material that can be changed into something more valuable through proper application of knowledge, skill, labor and equipment. So we have 2 ways to generate wealth. Harvesting natural resources and improving resources thru knowledge and labor. With world population bursting at the seams there is an ever increasing availability of people and labor. Natural resources on the other hand are finite.

What makes a country wealthy?
If a country consumes everything it produces it creates no wealth. If a country consumes more than it produces its poor. Only countries that have a surplus are wealthy. You may feel that China fits the bill since it has a trade surplus with most countries. China has an extremely large population that is currently living on basic necessities. As the population starts to become more consumer oriented more of their manufacturing and production will be used to satisfy internal needs. The countries that I feel are the richest are Australia and Canada.

Why these 2 countries?
Lets look at some Figures first

USA - Population 300 Million - Area 9.6 Million sq kms.
Canada - Population 32 Million - Area 9.9 Million sq kms.
Australia - Population 20 million - Area 7.7 Million sq kms.

These two countries have extremely large land masses with barely the population of 2 major american cities. Furthermore Canada and Australia are developed countries with good infrastructure and stable governments unlike the middle east and africa. Geographically Canada’s proximity to the US and Australia’s relative proximity to China gives both these countries major customers that need natural resources.

How to invest?
A simple way to get exposure to these countries is to use an ETF.
IShare MSCI Australia (EWA)
IShare MSCI Canada (EWC)

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India is the seventh-largest country by geographical area, the second most populous country, and the most populous democracy in the world with a population of 1.1 Billion. It ranks 15th in the world by GDP and 4th by GDP-PP (Purchasing Power). With so many people buying items its no wonder that its one of the worlds biggest markets.

Background : India has the largest middle class in the world, a billion consumers and half a billion strong well educated workforce.

The population of India till now have had a saving mentality. The new generation is more consumer oriented, they buy more and they buy often. The current generation is not against using credit to fund their purchase. Credit cards usage has increased significantly and sales of mobile phones, gadgets, cars, designer clothing and footwear, electronics, computers are going thru the roof. Companies like Reliance telecom, Tata Motors, Maruti Udyog, HDFC will benefit from these changes.

The country lacks infrastructure which has become the major hurdle for foreign investments into India. The government is focusing on the infrastructure so companies in the steel, cement, construction and infrastructure industries like L&T (Larsen & Toubro) and ACC(Accociated Cement Companies), TISCO (Tata Iron and Steel Company) will do well.

The biggest advantage India has is a large, young, highly educated english speaking workforce with the average person studying till a Masters degree.. The key here is english speaking. China has a larger workforce but the majority of them do not speak English. Language is a very big factor that influences the success of any outsourcing initiative. The biggest outsourcing companies in India are TCS (Tata Consultancy Services), Infosys, Cognizant, Wipro and Satyam. All off these should perform well.

Investment options : Very few indian companies trade on the US Stock. Some of my favourites like TCS, L&T and HDFC (not HDFC Bank, there are 2 different companies) are unavailable. The best ways to invest in the indian stock markets is thru ETFs or Mutual Funds. Ive listed the good companies and Funds and have highlighted my favourites.

I like Infosys and Cognizant because they are the best outsourcing companies. These two companies attract and retain the best talent in the country. They have excellent growth and profit margins and have performed consistently well in the past. The stocks are priced for perfection however so any miss could cause them to drop significantly. My other favourite is Tata Motors. The Tata brand has a lot of goodwill in India. They run a lot of highly profitable businesses. The brand name stands for quality and is highly respected in India. They treat their employees like family which is in turn gets them highly motivated and productive employees.

US ADRs :
DR Reddy’s Laboratories (RDY)
HDFC Bank (HDB)
ICICI Bank (IBN)
Tata Motors (TTM)
Infosys (INFY)

ETFs :
Morgan Stanley India Investment Fund (IIF)
India Fund (IFN)

Mutual Funds :
Eaton Vance Greater India Fund (ETGIX/EMGIX)
Matthews India Fund (MINDX)

Conflicts : I do not own any of the listed stocks or funds but i will be purchasing some soon.

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