A Comment -- General Comments From an Expert (A Commentary)

Markets. What we saw last year was an unprecedented pessimism in the precious metals. Gold was being sold to buy equities. The pace was unprecedented. China stepped up in a major way, but India stepped back through tariffs and quotas. It is putting a dampening effect on gold demand. When any asset class is down this much it represents a buying opportunity. ETF selling looks to be tapering off. Many mines will not be developed in this price environment. The velocity of money has collapsed. Fiscal balances are a mess and indebted sovereign level is getting worse.

Gold as Opposed to Silver. He is more bullish on gold than silver. You have emerging economies buying gold. It is trading well into the supply curve. Silver supply is exploding, growing at 5% a year. Low cost mines coming on line over the next few years. Your cost curve is much lower in silver.

Markets. Thinks this market retreat is just profit-taking. S&P 500 chart shows the market has formed an uptrend and has created a channel. The drop we have seen today is a continuation of what we’ve seen since the beginning of the year but is well within the predefined channel. We have had a significant rally and it is not unusual to see this kind of a drop. Feels the Canadian market is going to have more of a reversion to the mean and have more potential to outperform. He is pretty much fully invested right now.

Markets. Has been cautious because markets have advanced significantly, about 2 years without a 10% correction, which is unusual. There is usually one 10% correction per year so we are overdue. There is a lot of uncertainty with regard to tapering that is going on, as well as emerging-market currencies impact. On a technical analyst perspective, the original pain point was $1706 on the S&P 500 and we crossed that in the last couple of days. Now where to from here? The next level is down about 3% followed by a 52 week moving average down about 6%. He thinks there will be very positive surprises in the market overall but investors should be very selective.

Markets. He had been looking for a pullback for several months that hadn’t really happened but has finally started. In his view, this is simply a “risk off” trade in a response to volatility and emerging markets. People are pulling money out and putting it into bonds and into the market in general. This is not a financial crisis. It is healthy and he is looking to be buying. Markets are doing very well in terms of their recovery from the crisis. We are definitely on a growth period and he doesn’t think it is going to be that difficult for the market to survive nicely. Also the market has deleveraged a lot in terms of the banking system. There are a lot of paths here that are pretty much straight ahead. We have gone through all the crisis in Europe and have done quite well so he is not worried about the current situation.

Does buying a one-year to expiry $500 Call and a $480 Put make a “no man’s land” zone between $500 and $480? This is basically a Straddle. The problem with this strategy is that you are putting it on for 1 year so you have a huge amount of time value in those options. You really have to have a lot of volatility to make money because you have to make money on the combined price of the Call and the Put. Options are a wasting asset and you could really get wasted.

Would it be a good tactic to invest directly in the indexes or ETFs? For the smaller investor he recommends that they buy the Canadian and US index rather than ETFs. All the banks have a Canadian index and some of them have a US index fund. The cost is about 75-85 basis points and there is no commission. If you’re putting money in on a monthly basis, you don’t get dinged for transaction costs. For other investors, there are just not enough indexes in Canada and he would recommend ETFs.

Short-term bond ETF? He normally has the iShares DEX Short Term Bond (XSB-T) but lately has been using Horizons Floating Rate Bond (HFR-T) which has pretty well been rock solid and didn’t get affected when it looked like the tapering was coming into play. (See Top Picks.)

Should the Strike Price for selling a Covered Call be a certain percent over the market price or be where most of the open interest is? This really gets down to what you want to do and what your objective is in doing the trade. He likes to Sell as close to the money as possible, 6 months out, because this gives him a better return by selling them at the money.

As an option becomes deeper in the money, it’s time value tends to decrease. Why? Option traders want leverage. If it’s a $50 stock, they are willing to pay $2.50 for that option for it to go up $4-$5. If it goes up $2, the price until $55, will suddenly be the intrinsic value of $2.50, but the time value will actually only be about $1.25. This means that as the option increases in intrinsic value (i.e. above the strike price), the time value is compressed because they don’t want to pay for that much leverage.

Markets. He is comfortable in the Natural Gas space. Cost has doubled in the last couple of weeks. See a range between 1100 and 1300 for gold. Thinks Nat Gas will come off a little when temperatures go up. Inventories were normal and US production leveled off. Sees strong demand trends. Inventories coming out of this year’s winter could be at 5 year lows. Nat Gas is a North American phenomenon. For Base metals it is about emerging markets.

Markets. Investors may be in danger of chasing US’s last year returns. Last year was such a great year, particularly for those outside of Canada. He expects what we are seeing now is just a slowing down of expectations. We are only seeing 1.5%-2% growth in the US, so why would you pile money into the US. The catalysts for the US are there, but this is not going to be a 3%-4% or 5% type of environment for growth. Expectations in the US for many sectors are well, well ahead of themselves. He would say the same for Europe. Thinks the defensive, slow-growing opportunities in the developed economies definitely have developing opportunities, especially in Europe where companies have exposure to international/emerging markets.

Asia. He is staying away from Japan because he thinks it is a financial engineering play. However, he is starting to look quite closely in Asia because there are a few countries with really good balance sheets and currencies are obviously being pushed down. When the blood stops, he’ll definitely be looking to take advantage.

Do you find any value in the trend of country-specific ETFs like NORW or ENOR? Generally, he is not an ETF person. If you like Norway, go find some good Norwegian companies. On ETFs, you want to find a market that has good fiscal fundamentals, which Norway does have. You want to find a market where it has companies where you like the growth prospects of the top portion of the ETF. You also go to one that is relatively liquid that you can trade in and out of.

Economy. Expects the US Fed will be announcing another $10 billion a month of tapering. This is Bernanke’s last meeting so doesn’t expect he will change anything. US deficit is shrinking faster than the tapering will take place, so it won’t have a material impact on the supply/demand on the bond market. The S&P earnings yield minus the 10 year treasury yield has narrowed 5% a year to 3%, which suggests that bond yields are still too low so perhaps the equity market has room to go higher. This means that it is a borrower’s market, not a lender’s market. His Real Yield chart shows that bonds are expensive. Real Yield since 1920 has averaged 2% on government bonds but has gotten to negative several times since 2008. Now it is above zero and we are at about 1%, but really should be 2%. It will gravitate towards that as these anomalies come out of the marketplace. He is bearish on the bond market but thinks yields will rise that will cause some pain for long-term bondholders. He’s in the camp that suggests you Buy 3, 4 and 5 year investment grade corporates and roll down the yield curve. The yield curve is very steep, say 20 basis points a year, so if you buy a five-year bond today at 3%, a year from now it is going to be 280 and if nothing changes, the year after that it will be 260. This means you are gaining price momentum off the bond as it gets closer to maturity, so you are getting less downside risk in the price and you get positive return. The Capital Gains days are over for “real yield bonds” and you’ll probably earn 5% this year, which is not bad. This is the time to be buying high quality securities.