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E x c h a n g e T r a d e d F u n d s M a g a z i n e - A s i a

All you need toprofit from ETFs

NOVEMBER/DECEMBER 2010

www.etfsmag.com

ASIA EDITION

The leading source of Exchange Traded Funds research in Asia for professional investors

Why has Currency Volatility Jumped?

Asian ETF Awards 2010

Platinum in 2011?

Is There an Alternative to Gold?

in asia From the Editor / Contents – Page 01

From the Editor’s Desk

Contents

It’s been a busy few months for us in China. The press uses a lot of ink writing about the country’s consumer and industrial growth. But they overlook what is going on with the burgeoning growth of family wealth and the increasing sophistication of the banking industry and investment markets in China. Wealth management in China is growing at a phenomenal rate, some banks are experiencing a 100% annualised growth in assets under advice. However, China isn’t Hong Kong or Singapore, it’s very unique and the whole wealth management proposition is uniquely Chinese. At the heart of this is the fact that the banks see the development of wealth management as part of the natural evolution in assisting their clients to navigate an ever challenging local regulatory and tax environment (for example, it is clear now that an Inheritance Tax will be introduced over the next 2-3 years). Wealth management clients are not merely treated as a new source of revenue to milk commissions from. Wealth management in China is truly about the partnership between the bank as trusted advisor and the client – it’s not about giving them access to the current ‘hot ‘ product. China is poised to develop probably the most efficient and client centric wealth management market globally because it doesn’t have to deal with the legacy practices that hinder more developed markets from actually delivering what their clients seek. And, more importantly the banks view themselves as being in partnership with their clients. Considering the wall

of money building up in China and the likely changes to facilitate more foreign investments – you need to get your head around China sooner rather than later.

Our inaugural Asian ETF Awards were a great success and demonstrated how far the regional market has developed over the last few years. The quality of the nominees was particularly high and the selection committee found it challenging to pick the winners. As investors you can have confidence that the providers in Asia we selected for nomination operate robust and dynamic businesses (we grilled them and undertook some comprehensive due diligence that is available to each of you). They also share our view that ETFs should play an increasing role in regional capital markets (not just merely from a self-serving perspective). So as investors, feel free to contact us about what you want from the providers in the future. The scope for product development is endless, but as always all good ideas need to have investor support. And you are the people they want to service, but at this stage they are only providing a slither of what they could provide you with. Don’t be shy, we will as always act with the utmost discretion on your behalf.

Andrew CrawfordEditor

From the Editor / Contents – Page 01

ETF Awards DinnerAsian ETF Award Dinner 2010

NewsLatest news in ETFs

Touching the Void

Where are We Now?

The U.S. Dollar is a Third Rate Currency

Technical Trading IdeasFor SPDR GLD Trust

pg 02

pg 07

pg 14

pg 16

pg 20

pg 23

In 2010 it was all about GoldIn 2011 it might be all about PLATINUM



China Wealth Management ForumChina Wealth Management Forum 2010

From Quantitative Easing to Stagflation?

Market DataMacro Monthly November 2010

Next Issue / ETFs Asia Magazine InfoComing up next issue and publishing details

pg 26

pg 28

pg 35

pg 38

pg 41

pg 44

pg 48

Page 02 – ETF Awards Dinner

Asian ETF Award Dinner 2010The inaugural Asian ETF Awards were a great success thanks to the support we received from Asia’s leading ETF recruiter, Zak Allom from Kinsey Allen. The awards ceremony was held at the China Club in Hong Kong and was the who’s who of the Asian ETF industry.

We were also very honoured to welcome some distinguished overseas guests including Jim Ross, the Global Head of ETFs at State Street, Dan Draper the Global Head of ETFs at Credit Suisse, Deborah Fuhr from BlackRock and Mr Imai the Head of ETFs for Nikko AM. We would like to especially thank the panel of judges who selected the winners:Dr Miodrag Janjusevic, SAIL AdvisorsMr Sammy Yip, Lippo InvestmentsMichael McGauchy, Stonewater CapitalZak Allom, Kinsey Allen

The selection process was very rigorous and required nominees to submit a 15-page due diligence questionnaire on their funds and business. This was followed by a 20-minute ‘beauty parade’ interview by the selection committee held in Hong Kong. Then the award winners were selected by a committee vote – which involved a fair amount of lively discussion amongst the judges. Our aim was to ensure every winner was the leader in their category.

For all those providers who participated – thank you very much for your efforts.

ETF Awards Dinner – Page 03

Michael McGaughy presents Marco Montanari, Head of db x-trackers ETFs Asia, with the Best New ETF in Asia Award for the DB x-trackers CSI300 Index Series

Michael McGaughy presents Jimmy Chan and Timothy Tse with Best new ETF in Asia for the Value China ETF

Zac Allom, Managing Director Kinsey Allen International presents Kelly Driscoll of State Street Global Advisors with the best ETF product in Australia: the SSgA SPDR 200 ETF

Mr Jim Ross, Global Head of ETFs at State Street Global Advisors makes some opening remarks at the Inaugral Asian ETF Awards Dinner

Deborah Fuhr Managing Director Global Head of ETF Research and Implementation Strategy presents Chew Sutat from the Singapore Stock Exchange the award for the Best ETF Exchange in Asia


Zac Allom presents Nick Good of BlackRock iShares the award for the Best ETF provider in Asia

Marco Montanari picks up the Best ETF in Asia award from Zac Allom for the DB x-trackers CSI300 Index Series

Mr. Fan Yue, Director of Fund Supervision Department, Shenzhen Stock Exchange is presented with the award for the best Listed Fund Exchange in Asia

Joseph Ho was presented with a special award in recognition of his contribution to the industry

China Listed Funds Forum 2011

Organised by:

March 31st, 2011

0830 to 1700h

Futian shangri-la Hotel, Futian district, shenzhen, China

Why attend?• Co-organisedbytheShenzhenStockExchange – find out

directly from Asia’s best and largest Listed Funds exchange how they see their market evolving over the new few years and the opportunities that presents for both local and foreign investment professionals

• Toptierlocalandoverseasspeakers – you will be hearing from and have the opportunity to meet the leading lights of China’s Listed Funds market and the global ETF industry

• Seniorlevelforum- with a line-up including CEOs, CIOs, Chair-men and more, we ensure that you hear from and will meet the people that matter

• ExclusivePresentations- regulatory updates, exchange prod-uct overviews and future looking input locally as well as from industry leaders in the US and Europe

• LearnfromtheleadingprovidersinChinaandOffshore about innovative new product launches, changes to QDII/QFII on the horizon, investor behaviour and trends in China

• Buy-sidefocussed– we will endeavour to have China’s top Listed Fund and ETf investors attending

Partnership opportunities are available for the event. To find out more information please contact Mr. roger Zhuang, Director of China Operations for Republic Partners at [email protected].

The China Listed Funds Forum will be the largest gathering of China’s burgeoning listed funds market and will focus on giving foreign investment professionals with a window into Asia’s fastest growing exchange traded funds market.

www.republicltd.com


Sensible AM Launches a Hong Kong Physical Gold Backed ETF

Sensible Asset Management, the joint venture between Ping An of China and Value Partners launched another innovative ETF in

Hong Kong this month, the Value Gold ETF.

Breaking new ground, the Value Gold ETF is the first gold ETF in the world backed by physical gold bullion that is stored in Hong Kong. Under safekeeping at the Hong Kong International Airport Precious Metals Depository Limited, the Value Gold ETF provides investors with a convenient and efficient way to invest in the gold bullion market.

Standard Bank is the Metal Provider, which is responsible for the quality of the gold – its ‘fineness’ – to have a minimum fineness of 99.5%, and to meet the London Good Delivery standards as set out in the Good Delivery Rules published by the London Bullion Market Association.

Investors benefit from having access to the gold bullion market by way of trading the Value Gold ETF on the Stock Exchange of Hong Kong, like other exchange-listed securities. The Value Gold ETF handles the purchase and storage of the physical gold bullions.

Mr. Cheah Cheng Hye, Chairman and Co-Chief Investment Officer of Value Partners said, “we break new ground, offering an investment vehicle that was previously not available – the world’s first gold ETF, where the gold is physically stored in Hong Kong, under Hong Kong law and under the sovereignty of the People’s Republic of China.”

“Apart from its relatively low transaction charges,” Mr. Cheah said that, “this is the new fund’s distinguishing characteristic – the gold bullion is kept in Hong Kong, in the new precious metals warehouse at Chek Lap Kok airport. Not in New York, or in London or in Zurich, as may be the case with other gold funds available to the investing public.”

“This is a fund backed by physical gold,” he continued, stressing that “the Fund is not allowed to purchase paper-gold contracts or derivatives – only real gold with a small amount of cash to pay for expenses.”

State Street was the main mover in new Asia ETFs over the past fortnight, adding two more products to its range. In Hong Kong, the firm has launched the SPDR FTSE Greater China ETF, which invests in Hong Kong, Taiwan and mainland China.

The underlying index is a new Hong Kong dollar-based version of the FTSE Greater China benchmark, which is significantly broader than those tracked by the most popular China and Hong Kong ETFs, with around 350 stocks. It currently has about 32% of the basket in Hong Kong companies, 28% in Taiwanese firms, 39% in Chinese companies listed in Hong Kong, and about 1% in mainland-listed stocks, all through B shares due to restrictions on foreigners investing in the larger, more liquid A share market. Financials are the largest single benchmark at 35%, followed by industrials (15%) and tech (13%). The anticipated total expense ratio (TER) is 0.7%.

Interestingly, it looks like this could be the first of many launches from a firm that was an early leader in the field but has lost ground in recent years. State Street launched Asia’s first equity and bond ETFs, both in Hong Kong, and the first ETF in Singapore, but has produced little in either market since then. However, its new product is structured as an umbrella trust with a master prospectus, which State Street says should allow it to easily roll out several ETFs a year using the same core structure, with add-on filings for each new fund.

The launch provides yet more evidence of the Hong Kong Securities and Futures Commission’s (SFC) cautious attitude toward ETFs and their risks at present. Even though this is a physical product – rather than the synthetic ETFs that most concern the SFC – it has taken longer than intended to get approval; State Street filed for registration in January and had originally hoped to list by June, the firm told Asian Investor.

State Street Looks to Expand in Hong Kong

Source: Cris Sholto Heaton

News – Page 07

After winning the coveted Best ETF Provider in Japan at our recent Asian ETF Awards, Nikko has unveiled three new funds on the Tokyo Stock Exchange, giving local investors access to US and emerging markets.

The Listed Index US Equity fund (1547 JP) will be the first ETF listed in Japan to offer exposure to the S&P 500 index, allowing domestic investors to gain efficient local access to the US market.

The Listed Index Fund China H-share ETFs (1548 JP) tracks mainland Chinese companies listed on the Hong Kong Stock Exchange by replicating the Hang Seng China Enterprises index. The fund aims to capture the movements in stock prices of mainland Chinese companies.

The Listed Index Fund S&P CNX Nifty Futures (1549 JP) fund invests in futures contracts to gain exposure to the S&P CNX Nifty Futures index.

Nikko AM head of ETFs Koei Imai says “the firm will continue to expand its range of equity and fixed income ETFs.“

Elsewhere, the most concrete promise of new products was in Australia, where iShares announced that it is planning four new ETFs, all focused on the local market. These are trackers for the MSCI Australia 200, S&P/ASX 20, S&P/ASX High Dividend and S&P/ASX Small Ordinaries indices.

The high dividend ETF will be the third of its kind in Australia after launches by State Street and Russell, while the small cap fund is the first such product announced. No details such as TER or even proposed launch date were given as the registration filings have not been completed, posing the question as to why iShares felt the need to put out a press release before the ink is dry.

Perhaps the firm fears being left behind in one of Asia’s fastest-growing ETF markets. Assets under management in Australia are up around 50% year-on-year, with the lion’s share in domestic equity and commodity trackers. And while iShares has an extensive list of international ETFs cross-listed from elsewhere, these new products will be its first to focus on the domestic market. It may have to fight to make up ground on State Street, which has around A$3.2 billion in AUM in three funds, up 40% year-on-year, as well as Vanguard, which has seen AUM in its main fund quadruple this year to around A$220 million.

Seoul-based Mirae beefed up their ETF range with the addition of the first ETF tracking the Nasdaq 100 index in South Korea.

The Mirae Asset Management Tiger Nasdaq 100 ETF (133690 KS) gives domestic investors with exposure to the 100 largest, global non-financial securities listed on the Nasdaq exchange, including well known companies like Apple, Google and Microsoft.

There are now 23 ETFs linked to the Nasdaq 100 index with more than $400bn in global assets.

Nikko Lists Three ETFs in Japan

iShares Lines Up New Australia ETFs

Mirae Launches Nasdaq 100 ETF in Korea

Page 08 – News

On the topic of cross-border ETFs, Thailand’s Securities and Exchange Commission has said that it would allow foreign ETFs to be sold directly to Thai investors and listed on the Stock Exchange of Thailand (SET). The goal is to expand Thai investors’ options given that the local ETF market remains underdeveloped, with just three products currently listed and under US$100 million in total AUM.

As mentioned in this column some months ago, SET has said it will provide seed capital to four new ETFs in order to broaden the range, but further details of the products have yet to emerge. And a decision earlier in the year to allow feeder ETFs in Thailand that would invest in ETFs overseas does not seems to have excited the financial services industry much, since no such products have been launched.

In contrast to China, it seems pretty debatable as to whether foreign providers will care much about these new rules. Most will surely have bigger targets for cross-listing than Thailand, although it’s possible that a financial group aiming to become a regional heavyweight,

Thailand Allows Foreign ETFsBut Does Anyone Care?

such as Malaysian bank CIMB, might consider it worthwhile if the requirements are easy to fulfil.

On the plus side, however, this does show that Thailand is pushing ahead with opening up and extending its market. In addition to the move on ETFs, the SEC has this week approved in principle the establishment of infrastructure funds and, as discussed in our previous roundup, intends to introduce a framework for real estate investment trusts in the near future.

Source: Cris Sholto Heaton

In China, local investors in funds now have access to foreign bonds via the Qualified Domestic Institutional Investor (QDII) scheme for the first time – and seem to be showing some

early interest. Fullgoal Asset Management, the Chinese asset management arm of Bank of Montreal, opened subscriptions to the country’s first QDII overseas fixed income fund last month and this week reported that it had attracted RMB828 billion in assets. That compares with an average RMB550 million raised this year by other QDII products.

Fullgoal’s product is a fund of funds, investing in foreign bond funds from providers such as Pimco and BlackRock, which invest in the US, Europe and Asia Pacific. But it may not have its niche to itself for long: local firm Yinhua Fund

Chinese QDII Scheme Gets First Bond Fund But No ETFs Yet

Management is reported to be about to launch a fund of funds that will invest in US Treasury Inflation-Protected Securities and other inflation-protection thematic funds.

Launched in 2006, the QDII scheme allows mainland funds to invest in assets outside China, subject to quota limits. At the end of June, it had 81 approved institutional investors with a total quota of US$64 billion, according to Reuters, although both numbers will have risen since then. The current line-up includes 23 mutual funds with a QDII licence, according to data provider Wind, plus a frozen product from Hua An Fund Management that was caught up in the Lehman Brothers bankruptcy.

Investor interest in these funds seems to be growing again after a period of disillusionment sparked by poor performance in the first few launches. Investment consultancy Z-Ben Advisors says that at least 12 funds are in the pipeline and thinks there could be at least 60 on the market by end-2011.

So far, the vast majority of QDII products are actively managed stock funds, with just one index fund launched in April (a Nasdaq 100 tracker from Guotai Asset Management). Rumours about a number of overseas-focused ETFs to be launched under the scheme have yet to turn into anything more substantial.

News – Page 09

Citi has recently filed with the U.S. SEC to offer a Long/Short Alternative to VIX ETFs. From the supplement we were able to glean two key attributes of these new offerings.

Firstly, the Index is a new index established by Citigroup Global Markets Inc., as index sponsor. The Index is published by the Chicago Board Options Exchange (the “CBOE”) and is a measure of directional exposure to the implied volatility of large-cap U.S. stocks. As a total return index, the value of the Index on any day also includes daily accrued interest on the hypothetical notional value of the Index based on the 3-month U.S Treasury rate and reinvestment into the Index. The methodology of the Index is designed to produce daily returns that are correlated to the CBOE Volatility Index (the “VIX Index”), which is another measure of implied volatility of large-cap U.S. stocks. However, the Index is not the VIX Index, and returns on each of these indices may differ substantially.

Secondly, the ETFs will be offered as ETNs with an index methodology uses a combination of returns on (a) a long exposure to third- and fourth-month futures contracts on

Citi to Launch a Long/Short Alternative to the VIX ETFs

the CBOE Volatility Index (the “VIX Index”) published by the Chicago Board Options Exchange, Incorporated (the “CBOE”) (the “VIX futures contracts”), multiplied by a factor of two, (b) a weighted short position in the S&P 500® Total Return Index (Bloomberg L.P. ticker symbol “SPXT:IND”) (the “S&P 500® Total Return Index”), as reduced by the Treasury Return determined by the formula described below under “—Composition of the Index—Treasury-Based Interest Accrual Component; Calculation of the Index Level” (the “Treasury Return”) and (c) an interest accrual on the notional value of the Index based on the 3-month U.S Treasury rate and reinvestment into the Index, all as described below.

The weighting of the S&P 500 Total Return Index short position is determined monthly by a regression over a 6-month backward-looking window of (a) the difference between the VIX Index daily returns and twice the daily returns of the relevant VIX futures contracts versus (b) the S&P 500® Total Return Index as reduced by the Treasury Return. See “Risk Factors Relating to the C-Tracks—The Index May Underestimate the Volatility Levels” in this pricing supplement.”

In summary the new Citi product aims to find a balance between the iPath S&P 500 VIX Short-Term Futures ETN (VXX) and the iPath S&P 500 VIX Mid-Term Futures ETN (VXZ) by using an intermediate point in the VIX term structure and adding leverage. Most investors have found that the biggest problem with VXX has been the negative roll yield associated with the persistent contango in the VIX futures. At the other end of the spectrum, the problem with VXZ is the amount of basis risk between the VIX and VXX.

Vanguard continued its blitz of new ETF products recently in the US, rolling out an international counterpart to its highly successful real estate ETF (VNQ). The Vanguard Global ex-U.S. Real Estate Index Fund will seek to replicate the S&P Global ex-U.S. Property Index, a benchmark that includes real estate investment trusts (REITs) and real estate operating companies (REOCs) in emerging and developed markets outside the U.S.

“Modest exposure to real estate investments in a broadly diversified investment portfolio can help moderate overall portfolio volatility and serve as a hedge against inflation,” said Vanguard’s chief investment officer Gus Sauter in a press release. “With international real estate securities representing a growing portion of the overall real estate market, a counterpart to our domestic REIT Index Fund is a natural addition to our index fund lineup.”

The launch of VNQI represents the latest expansion of the Vanguard ETF product lineup. In September the company rolled out nine ETFs linked to popular S&P indexes, including the S&P 500, S&P MidCap 400, and S&P SmallCap 600. In Australia, Vanguard have launched the Vanguard Australian Property Securities Index ETF (ASX:VAP AU)… more to come!

Vanguard Launches Real Estate ETFs

Page 10 – News

More Hedge Fund ETFs on the Way

BlackRock Established Global iShares Investment Strategy Group

U.S based ETF provider, ProShares recently filed plans with the U.S. SEC for their first Hedge Fund Replication ETF. The proposed fund would track the performance of the Merrill Lynch Factor Model – Exchange Series. That benchmark is designed to maintain a high correlation with hedge fund beta, as represented by the HFRI Fund Weighted Composite Index, an equally-weighted composite of more than 2,000 constituent funds.

The fund won’t invest directly in hedge funds, instead it will aim to replicate an index based on a model that establishes weighted long or short positions on six factors on a monthly basis: the S&P 500 Total Return Index, ProShares UltraShort Euro ETF, MSCI EAFE U.S. Dollar Net Total Return Index, MSCI Emerging Markets Free U.S. Dollar Net Total Return Index, Russell 2000 Total Return Index, and one-month USD LIBOR [see Door Opens For Hedge Fund ETFs].

Currently, IndexIQ is the best known provider of hedge fund replication ETFs; the firm’s lineup includes the broad IQ Hedge Multi-Strategy Tracker (QAI), as well as the more targeted IQ Hedge Macro Tracker ETF (MCRO) and IQ Merger Arbitrage ETF (MNA). Other players in the hedge fund ETF space include iShares, which offers the actively-managed Diversified Alternatives Trust (ALT). That product seeks to maximize absolute returns from investments with historically low correlations to traditional asset classes, while minimizing volatility by taking both long and short positions. Credit Suisse also jumped into the space recently, rolling out both a fund designed to capture returns available through a merger arbitrage strategy (CSMA) and a long/short offering (CSLS). Both of the Credit Suisse products are structured as exchange-traded notes (ETNs), meaning that they are debt instruments whose return is linked to the performance of an underlying benchmark.

In total, there are seven ETFs in the Hedge Fund ETFdb Category, with aggregate assets of nearly $350 million [see Closer Look At Hedge Fund ETFs].

Source: ETF Database

The Global ETF behemoth, BlackRock has recently announced the launch of their Global iShares Investment Strategy Group to bolster their

research efforts with more thorough coverage on ETF investment trends and insights.

Russ Koesterich will head the group and fill the role of global chief investment strategist.

Michael Latham, global head of iShares at BlackRock, says Koesterich combined deep macro investment knowledge with a profound understanding of iShares and the needs of clients.

Koesterich has played a leading role driving forward investment strategy in the Scientific Active Equity division since 2005, and will be fuelling thought leadership on behalf of iShares.

The Group is will provide iShares' clients with expert information on economic and investment topics, including insights into the asset classes, sectors and markets in which iShares offers access to investors.

Latham says the move was part of a commitment by iShares to provide clients with the best services in addition to the largest ETF product line-up in the market.

The group is intended to work closely with iShares research, product and client teams, providing expertise in both broad market insights and customized investment solutions.

With the resources of the larger BlackRock organization behind them, iShares' new Strategy Group will be able to leverage the large collection of investment professionals available for the benefit of their clients.

News – Page 11

U.S. based ETF provider, Global X, recently launched their Gold Explorers ETF (GLDX), the first pure play fund offering exposure to gold exploration companies. The new fund will offer exposure to this unique segment of the gold mining life cycle by tracking the Solactive Global Gold Explorers Index, a benchmark that measures the performance of companies engaged in exploration for precious metals. The index underlying GLDX consists of about 30 different securities, with a heavy tilt towards Canadian (70%) and U.S. (18%) securities. It should be noted, however, that many of the component companies maintain operations–exploring for gold reserves–throughout the world, not only in the country where the stock is listed.

GLDX offers investors a new way to establish exposure to gold by focusing on one of the most speculative and risky points along the precious metal’s supply chain. A look at the fund components sheds some light on the nature of exposure offered by GLDX. NovaGold Resources (NG), one of the largest components of the underlying index, describes itself as a “precious metals company…with the objective of becoming a low-cost million-ounce-a-year gold producer.” During the third quarter of 2010, NovaGold generated revenue of only C$ 462,000, and posted a massive operating loss. But the company maintains ownership interest in some of the world’s largest undeveloped gold projects in the world, and engages in exploration projects to expand known deposits or discover new gold reserves. If the gold reserves at

Global X Launches First Ever Gold Explorers ETFexisting projects prove to be massive and reasonably easy to access, NovaGold could hit it big. “Gold exploration companies offer high risk-return characteristics with the potential to strike a gold mine, literally,” CEO Bruno del Ama said. But NovaGold, like many other companies that make up GLDX, is currently losing cash by the boatload–and there is no guarantee that it will ever become cash flow positive.

So GLDX offers exposure to the smallest–and often riskiest–firms engaged in the general gold production industry without concentrating risk in any one project or company. “We believe an ETF is a fantastic structure to provide access to this segment of the gold mining industry,” said Jose C. Gonzalez, Head of Operations at Global X. “This is the venture capital of gold, and GLDX offers the opportunity to capture the fantastic returns of one company striking gold while smoothing over the losses generated by failed projects.” This fund could be appealing to investors interested in accessing the potentially high returns generated through exposure to gold explorers, but without the time, knowledge, or risk tolerance to select individual exploration companies. GLDX allows investors to instead bet on the entire industry in hopes that near-record gold prices will spur explorers to find new deposits, which could lead to enormous gains for a few lucky companies.

The Bank of Japan (BoJ) is committing $6bn to buying ETFs as part of its recently sanctioned quantitative easing plan, Standard Life Investments says.

The firm's global investment strategist Richard Batty says the BoJ is allocating $60bn to buying assets as part of its policy to keep current interest rates at around zero and suppress longer-term interest rates.

Batty says although the $6bn allotted to buying ETFs is a small figure, it is an "interesting departure" by the BoJ, which will look to boost asset values and buy more ETFs going forward.

He says: "$6bn is not enough - but this is a signal of what the BoJ wants to do, it's part of a staged quantitative easing measure."

Japan Commits $6bn to ETFs in QE PlansHe says Japan is currently experiencing a liquidity trap, where people are not willing to spend or borrow enough, which is also posing a danger for other economies.

As a result, the BoJ is moving towards this quantitative easing plan of buying assets such as ETFs and Japanese Reits.

Batty adds: "If there are zero interest rates, BoJ can buy assets to push up the value, then the owners who sell these assets to the central bank will make a wealth gain."

Source: ETFM


Page 12 – News • ABF Pan Asia Bond Index Fund (the “Trust”) is an exchange traded bond fund investing primarily in local currency government and quasi-government bonds in eight Asian markets, comprising of China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand.

• Investment involves risks. Investing in the Trust may involve a higher risk as it involves exposure to bonds in both developed and emerging Asian markets. Investors should be aware that the Trust is different from a typical unit trust. The trading price of units of the Trust on the stock exchange may differ from the net asset value per unit of the Trust.

• In the case of turbulent market situation, investors may suffer significant loss.• Investment is a personal decision. Investors should consider the product features, their own investment

objectives, risk tolerance level and other circumstances and seek independent financial and professional advice as appropriate before making any investment decision.

Uniquely Asian • Universally Appreciated

PAIF is an authorized unit trust in Hong Kong and Singapore only. Authorization does not imply official recommendation. Nothing contained here constitutes investment advice or should be relied on as such. The past performance of PAIF is not necessarily indicative of its future performance. Investors should read the prospectus including the risk factors carefully before deciding to purchase units in PAIF. The prospectus for PAIF is available and may be obtained from State Street Global Advisors Singapore Limited (the Manager) (Singapore Company Registration number: 200002719D) and authorized participants. The value of PAIF and the income from them, if any, may fall or rise. The semi-annual distributions are dependent on PAIF’s performance and are not guaranteed. Redemption of PAIF’s units could only be executed in substantial size through designated dealers and the listing of PAIF on the stock exchanges do not guarantee a liquid market for the units, and PAIF may be delisted from the stock exchanges. 1) Fund size grew to US$2.04 billion as of April 30, 2010, from US$1.1 billion since listing on July 7, 2005. 2) This is PAIF annualized returns since listing on July 7, 2005 to April 30, 2010. PAIF’s net-of-fees returns in USD terms on NAV-to-NAV basis, taking into account transaction fees and on the assumption that all distributions are reinvested. PAIF historical annualized returns: 4/2006: 9.90; 4/2007: 9.86; 4/2008: 9.22; 4/2009: 6.55. 3) PAIF is not guaranteed or endorsed by the governments of the eight investment markets. 4) PAIF is denominated in US Dollar. 5) The estimate is reached by multiplying a board lot size of 10 units of PAIF by the closing price of US$118.75 as of April 30, 2010, excluding brokerage commissions, transaction costs etc. 6) Annualized ratio of expenses to weighted average net assets for the period July 1, 2009 to 31 December, 2009, which is computed in accordance with the revised Investment Management Association of Singapore’s (“IMAS”) guidelines on disclosure of expense ratio. Brokerage and other transaction costs, interest expense, foreign exchange gains/losses, tax deducted at source or arising on income received and dividends paid to unitholders are not included in the calculation of expense ratio. This advertisement is issued by State Street Global Advisors Singapore Limited and has not been reviewed by the Securities and Futures Commission.

Just as rice is a staple in Asia, Asian local currency bonds have become a core driver to fuel the growing appetite of investors worldwide. Since its launch in July 2005, ABF Pan Asia Bond Index Fund (PAIF) has grown in size, price and value:

Fund Size Up 86% to US$2.04 billion1

Annualized Returns 7.43%2

Source: State Street Global Advisors (as of April 30, 2010)

PAIF is an Exchange Traded Fund (ETF) investing in local currency government and quasi-government bonds in 8 Asian markets3:

CHINA • HONG KONG • INDONESIA • KOREA • MALAYSIA • PHILIPPINES • SINGAPORE • THAILAND

The PAIF Advantage:• The first and only Asian bond fund listed on Stock Exchange of Hong Kong (SEHK) & Tokyo Stock Exchange (TSE)• Gain market & currency diversification with a single fund4

• Opportunity to receive income (semi-annually)• Low entry price (approximately US$1,187.50)5

• Low total expense ratio (0.20% of the Net Asset Value (NAV) p.a.)6

• Trades like a share (stock code, SEHK: 2821/TSE: 1349)

To learn more about PAIF, please call customer hotline: (852) 2103 0288,or visit www.abf-paif.com, or contact your financial advisor.

• ABF Pan Asia Bond Index Fund (the “Trust”) is an exchange traded bond fund investing primarily in local currency government and quasi-government bonds in eight Asian markets, comprising of China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand.

• Investment involves risks. Investing in the Trust may involve a higher risk as it involves exposure to bonds in both developed and emerging Asian markets. Investors should be aware that the Trust is different from a typical unit trust. The trading price of units of the Trust on the stock exchange may differ from the net asset value per unit of the Trust.

• In the case of turbulent market situation, investors may suffer significant loss.• Investment is a personal decision. Investors should consider the product features, their own investment

objectives, risk tolerance level and other circumstances and seek independent financial and professional advice as appropriate before making any investment decision.

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Page 14 – Touching the Void – CheckRisk

The EU is lurching from one crisis to the next. The so called solution to the Irish solvency problem is never going to be resolved with a liquidity solution. The injection into Ireland of €85bn at a 5.8% rate is nothing more than a band aid on a severely wounded patient. The likelihood that Ireland will default on its debts at some point in the next few years is almost assured by the bailout terms.

Meanwhile, Germany and France will now be forced to look at Portugal, Spain and Italy. It is clear that the current bailout fund is insufficient to support all three states. In fact if Spain was to falter, it is hard to see how the euro could survive. Readers will know that our stance on the euro for over two years has been, in the words of Private Frazer, that the euro is doomed. Our view is more technical than ideological. The point being that without fiscal and political unity, the euro is vulnerable on virtually all levels.

“What really broke Germany was the constant taking of the soft political option in respect of money. The take-off point, therefore, was not a financial but a moral one.”Adam Fergusson, When Money Dies, the Nightmare of the Weimar Hyper-Inflation. (1975, William Kimber & Co Ltd)

The above quotation is about the Weimar republic’s hyper-inflation in 1923. It is depressing that so many of the same mistakes are being made today, and that few of history’s lessons have been learnt. That being said, the memory of

Touching the Void

hyper-inflation lies deep in the German psyche and is likely to resurface as further bailouts are required.

The end game is difficult to predict. If it is market led then the collapse will be swift and ugly with many unpredictable risks emerging. It is safe to assume that EU leaders will do everything in their power to stop that outcome. Even so, it is not safe to think that they will succeed. Following the Irish bailout market reaction has been muted, with European bond markets falling. If markets decide that the whole euro area is becoming too risky, then a collapse becomes more likely.

The alternative end game is not much better; death by a thousand cuts. In this scenario the EU manages to struggle on with monetary union. The critical period to survive is the first half of 2011. During Q1, refinancing of sovereign debt will be very much on the agenda. Italy has a rumoured €85bn of critical debt roll over, and Spain may have as much again. Portugal too, has critical financing requirements in Q1. If the burden falls on the Germans (which essentially

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Our analogy of climbers roped together; with Germany and France as mountain guides rings true. Greece and now Ireland have slipped and are hanging free. Portugal, Spain and Italy are just holding and the pressure on the lead climbers Germany and France is immense. For the moment ice axes and crampons are straining but holding. It will not be the weaker climbers who decide to cut the rope, but the mountain guides, when they realize that they too will be pulled from the rock face and fall into the void.

it does if rates move too high) then there may be a crunch point. Certainly it is clear that Angela Merkel is facing increasing hostility at home for bailing out the rest of Europe. If that political pressure becomes too much, it is unlikely that she can be re-elected without abandoning the euro project.

Proper risk analysis shows that the Irish, and Greek bailouts are transfers of risk to the European Union, they do not eradicate risk. The Irish, ahead of the banking problem, had a very soundly managed economy from a budget deficit perspective. The fault lies in the lack of regulation of the banking system and the collusion of government in the process of allowing debt to fund excess growth. The Irish government either knew of these risks and chose to ignore them or was oblivious to them. The point stands that the bailouts are merely kicking the can down the road. The bond markets already appreciate this fact. It is less clear whether the EU’s leadership has fully appreciated the futility of back stopping bankrupt nations.

The lesson to be learnt from the Irish bailout is that the moment the Finance Minister, Brian Lenihan, gave an unconditional bank guarantee to the Irish banking system, the stage was set. Perhaps, it was not clear at that time to him that the tsunami of debt in the Irish banking system would overwhelm the Irish state. But that is no excuse; clearly he or someone in the Irish ministry of finance should have known. The risks had been building over a long time and advisors like CheckRisk LLP were aware and speaking actively of the risk. It is therefore legitimate to pose the same question on a wider European scale. Does the EU leadership not fully appreciate the tsunami of debt it is now underwriting or about to underwrite?

Our analogy of climbers roped together; with Germany and France as mountain guides rings true. Greece and now Ireland have slipped and are hanging free. Portugal, Spain and Italy are just holding and the pressure on the lead climbers Germany and France is immense. For the moment ice axes and crampons are straining but holding. It will not be the weaker climbers who decide to cut the rope, but the mountain guides, when they realize that they too will be pulled from the rock face and fall into the void.

Risk AnalysisThe major risks to the euro are as follows:1. An increase in euro area bond yields blocking Portugal,

Spain and Italy from accessing bond markets. This would necessitate an increase in the bailout fund, perhaps a doubling to €1.5tn which would have to be banked rolled by Germany and France.

2. The political fallout of further bailouts is clearly a major risk to Merkel and Sarkozy.

3. It is essential to properly evaluate the difference between a transfer of risk and the eradication of risk. At present only transfers of risk have occurred.

4. A currency trade war with the US dollar may soon kick off. Obama’s US economic recovery is highly dependent on exports. If the euro comes under pressure that is a boon to European exporters and a problem for the USA.

CheckRisk – Touching the Void – Page 15

Page 16 – Where are We Now? – Robin Griffiths

Where are We Now? It is very unusual to find that bonds, equities and gold all go up at the same time, but recently almost all asset classes have done this. It seems that excess liquidity goes equally into all different asset classes, so that in effect there is only one market, and only one trade, risk on, or risk off.

Written by Robin Griffiths, Technical Strategist Cazenove Capital

The reason is that politics has intruded into economics on a far greater extent than we have been used to. The US Federal Reserve is not the only central bank to be printing money. The Chinese Central Bank also has printing presses.

In non-communist countries, even bastions of capitalism, the fact is that more than 50% of people’s income is now dependent on the state.

In the ‘old normal’ the month of September would have been the weakest of all months. It was not so this time as the Fed put in billions of dollars by using Permanent Open Market Operations - POMO for short. After late October in a normal year the market picks up again into the strongest six months. We expect a rise till late May next year. However if seasonality is not working now then maybe we will not get our year end rally.

On the four year cycle, which is driven by the Presidential elections, we are now in a very favourable time. It is after the mid-term election that the cycle turns up. On our own road map, which shows the shape of a bull and bear cycle round the four year pattern, we should be in a positive period now at least till March 2011.

If indeed we are on the standard road map then the four year low was last in March 2009. We would have a run up through next year and top out in early 2012. 2013 would be the next bear phase.

However I have always argued that we are, in the western markets, in a secular downtrend. In which case the rise only lasts into next year and the fall takes place earlier. On this road map there is a high probability of going back

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down to the lows of 2009. In a worst case scenario it may even go lower.

The major question is, “Has QE2 been able to drive markets back to the standard pattern or not?” We do not know the answer, but that may not matter. Much of the money produced by the Fed’s printing press goes overseas to drive the markets we always did like, even higher than we thought they would go. We still come down long of gold and silver, and liking the markets of India, China related, and Brazil.

If we plot the rise in the US stock market in Euro or more importantly Swiss Francs, then to us it has been falling. Overseas investors cannot make money buying US dollar denominated stocks as the currency is being trashed quicker than the market can rise.

If we read the History of the Decline and Fall of Great Powers, then normally the great power is finally attacked by an invading barbarian, like Atilla the Hun. In the case of the USA this did not happen. The US chose to deliberately give away their advantage and trash their currency as a matter of deliberate and wilful policy.

The bottom-line is this: we are in times when politics enters into and overrides economics and normal market moves. In Europe the Euro, Ireland, and Greece will not fail for the same reasons. Major trends are driven by political decisions, and so many of the normal rules of technical analysis may be temporarily suspended.

‘Where ignorance is bliss, ‘tis folly to be wise’Markets are rising, but they are being driven by injections of truly huge sums of printed money coming from central banks, especially the US Fed. We do know enough not to fight the Fed. However the Fed itself is now under pressure.The Democrat losses in the mid-term elections mean that the Fed will not have its QE2 confiscated, but any idea of QE 3, 4, or 5 may be cancelled.

Currency wars are upon us. It is a brave man that thinks he knows where this conflict ends. Restrictive barriers are already coming into place. This negative development, if allowed to continue, ends very badly indeed, if history is any guide.

Those things which cannot continue, don’tThe really big debate is about inflation or deflation. In the West and especially the USA we are likely to see unemployment at a structurally high level for many years to come, and house prices have not bottomed. They might have another 20% to fall.

The only way out of the defaulting problem, with lack of title to deeds, is to change some laws. This may happen,

but it takes time. Without this fix, the problems are huge and the Banks are not out of the mess. The second shoe in the banking crisis is still to drop. The share price of Bank of America has fallen 40% since June.

Meanwhile much of the money that the Fed prints goes overseas. On the 18th November the Fed used another POMO, this time of over $8.5billion. This is the biggest yet and is after and in addition to QE2. Much of this money goes overseas and blows inflation bubbles there.

The problem is that in the West the Fed is worried about deflation in the future, but in Asia they have inflation right now.

There are good economists arguing the deflation case; Gary Schiller and David Rosenberg come to mind. However in Asia the Chinese and Indians are acting right now to cool the inflation that they already have. Can we really have the east inflating and the West deflating, is not the world too joined-up for that outcome to persist?

On balance I think the best outcome that can be achieved is that the West in general, and the USA in particular, will bump along for many years in sub par growth. GNP will be positive in the range 1.5% to 2%, but there will be regular recurring crises. Some will come from the high unemployment issues, others will come from bank or even sovereign debt crises, but on balance we will muddle through. There will be cyclical bull and bear phases, but within a secular trend that is mildly negative and going nowhere.

The alternative to this is a breakdown and a depression. All of the Fed’s actions are justified if it succeeds in avoiding a depression. Unfortunately the price of this success is the trashing of the dollar.

In Asian economies, especially China, must, and will, move away from just making cheap stuff to sell in America. They will need to allow wages to rise, and probably their currencies at a modest rate of 5% a year. In this way we will all muddle through.

A new currency matrix not dominated by the dollar will have to form. It will include, and we need to own, some gold and silver.

Page 18 – Where are We Now? – Robin Griffiths

Robin Griffiths, Technical Strategist Cazenove CapitalFor over 30 years Robin Griffiths has been one of the most respected technical analysts of world stock markets, bonds, currencies and commodities. He became a technical analyst with WI Carr, based first in Hong Kong and then Tokyo before returning to London. During this time he started to develop his own trading system, analysing stock and market trends. He was then chief technical strategist with HSBC for over 20 years and in 2008 he joined Cazenove Capital.

Page 20 – The U.S. Dollar is a Third Rate Currency – Brad Zigler

The U.S. Dollar is a Third Rate CurrencyTo many investors’ surprise, the Yankee dollar’s earned only a third-place ribbon for its depreciation against gold over the past 12 months.

To many investors' surprise, the Yankee dollar's earned only a third-place ribbon for its depreciation against gold over the past 12 months.

With all the recent hoopla and headlines about gold making new highs against the greenback, the destruction derby of the world's reserve currencies is actually won by the euro, with sterling close behind.

Over the past year, the U.S. dollar lost 29.8 percent vs. bullion compared with a 39.7 percent tumble for the European common currency and a 34.5 percent decline in the British pound. Bringing up the rear is the Swiss franc, with a 23.1 percent loss, and the Japanese yen, which gave up 16.4 percent to gold. Gold Value In Reserve Currencies

Written by Brad Zigler

Oddly enough, the U.S. dollar’s the least volatile reserve currency when it comes to bullion purchasing power. Its standard deviation is just 15.3 percent over the past year. This may not seem like a testament to the Fed’s steady hand on the nation’s economic tiller, but it’s something. It actually bespeaks the wait-and-see attitude of the central bank after last year’s stimulus and accommodation.

Oddly enough, the U.S. dollar's the least volatile reserve currency when it comes to bullion purchasing power. Its standard deviation is just 15.3 percent over the past year. This may not seem like a testament to the Fed's steady hand on the nation's economic tiller, but it's something. It actually bespeaks the wait-and-see attitude of the central bank after last year's stimulus and accommodation.

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the Fed's handling of the dollar. What's economically expedient may not be politically fruitful.

On the other side of The Pond, sterling's been the most volatile currency, flopping about with a 17.8 percent standard deviation. Largely, this reflects the rising and falling fortunes of the former Labour government. Just this week, the coalition government's declaration of austerity measures sent the pound into free fall vs. bullion.

The Longer PerspectiveWith all this, one can't ignore the longer-term trends. Since the euro's introduction in 1999, the pound's lost more ground to bullion than any other reserve currency. Sterling's average annual loss in gold purchasing power has been 15.3 percent. The U.S. dollar follows with an average loss of 14.8 percent per year. Meantime, the euro's given up an average 13.1 percent each year. Gold Value In Reserve Currencies

Kinda makes you wonder who'll take the pennant next year, doesn't it?

Page 22 – The U.S. Dollar is a Third Rate Currency – Brad Zigler

The likelihood of Fed intervention increases when commodity prices—a basic metric of inflation—rise or fall significantly compared with Treasury securities. In the chart below, the red Fed Indicator line dances within a neutral zone—a condition that compels the central bank to watch, but not act. A sustained move in the indicator above the upper band would signal an increased likelihood of accommodation—or lower money rates and a weaker dollar. A dip below the lower band flashes a higher probability of tightening, or higher rates and a stronger dollar. Fed Operation Indicator

Keep in mind that this indicator is just that—an indicator. It measures the likelihood of Fed intervention, not its certainty. Political considerations—which can be substantial—are put aside here.

For now, the Fed's keeping a fairly even keel—even though it's been economically painful for employees or the unemployed. There's nascent inflation, reflected in the blue line's recent trajectory, which complicates

TRJ/CRB Index Aggregate Treasury Index Fed Indicator

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The markets have managed once again to take investors on a wild ride this week, with the S&P 500 breaking and closing above the psychologically important 1,200 level. The rally on Thursday was an overwhelmingly positive reaction to the Fed’s decision to pump more money into the market, sending both equities and commodities sharply higher. Friday’s positive unemployment report represented another round of good news, giving investors hope that job creation is beginning to accelerate.

TECHNICAL TRADING IDEAS:for SPDR GLD Trust

Gold has been no stranger to the headlines in 2010, as the precious metal has surged higher thanks to lingering anxiety over the global economic environment, concerns about long-term inflation, and consistent weakness in the U.S. dollar. The yellow metal has repeatedly touched new highs throughout the year, generating handsome returns for several large hedge fund managers who have established huge positions in bullion.

Gold has been no stranger to the headlines in 2010, as the precious metal has surged higher thanks to lingering anxiety over the global economic environment, concerns about long-term inflation, and consistent weakness in the U.S. dollar. The yellow metal has repeatedly touched new highs throughout the year, generating handsome returns for several large hedge fund managers who have established huge positions in bullion. And some think that the gold rally still has more room to run; Goldman Sachs recently set its 12-month price target at $1,650 an ounce, an increase of more than 20% from recent

Technical Trading Ideas – Page 23

Trade IdeasWhen trading gold (or physically-backed gold ETFs), it is extremely important to exercise caution since bullion prices are subject to price volatility and shifts in investor psychology–making it difficult to gauge appropriate entry points. Also, it is critical to note that the Stochastic Momentum Index is signaling that GLD is overbought from a monthly time perspective, as well as from a weekly and daily view. If GLD is to chase its next price target of $156.16, it first needs a reasonable retracement so it can build support as it prepares to make the next move higher.

Once again, we can use the Fibonacci Retracement tool to identify significant price levels that GLD is likely to retrace to, considering that it is overbought from multiple time perspectives. If we draw the retracement from the start of its last uptrend to its current peak, the first price level suggested for GLD is $134.74, and the next comes at $133.60.

A conservative suggestion for trading GLD is to watch its 1-hour Stochastic Momentum Index as it retraces, and take note of whether GLD is building new support at a higher price level. If the view on gold is aggressively bullish, one strategy is to add to GLD positions as the fund dips by keeping an eye on the 15-min Stochastic Momentum Index. It’s not impossible for GLD to continue to climb higher aggressively, as its Daily Stochastic Momentum Index was overbought from the end of September through the beginning of October.

closing prices. The bank cites this week’s price action and U.S. monetary policy developments–which could spur eventual inflation–as significant factors in driving the price of gold higher.

As interest in gold has surged, so too have assets in physically-backed ETFs, a popular tool for all types of investors to establish exposure to precious metals. The SPDR Gold Trust (GLD) is the second largest U.S.-listed ETF by total assets, currently standing at about $57 billion. GLD, which stores gold bullion in secure vaults, has climbed to all-time highs this week, managing to close above its previous high of $134.85 set on October 14th. GLD has been in an uptrend since its appearance on the exchange in 2005, as gold prices have steadily climbed higher. The last significant correction that GLD experienced was in the second half of 2008, when it retraced from slightly above $100 to $66 per share.

Technical InsightsOne popular technical analysis approach to trading GLD is to draw a reverse Fibonacci Retracement from the peak to the low point of its last correction (mentioned above). This process reveals key price levels that many technical traders will consider when evaluating GLD’s recent rally. Looking back, we can see that GLD struggled with the 161.8% level–a key threshold in reverse Fibonacci retracements–before managing to break through last month. With this level in the rear view mirror, the next significant price level when looking at Fibonacci Retracements is 261.8%, which corresponds to a per share price of about $156 for GLD. Given current economic conditions of low interest rates and a falling dollar, the technical prediction for GLD seems reasonable (it is, in fact, well below Goldman’s more bullish prediction).

Page 24 – Technical Trading Ideas


Page 26 – Gold & Platinum

In 2010 it was all about Gold

Gold set continues to set new record high prices, and the London Bullion Market Association – at its annual conference recently went as far as forecasting that the “yellow metal” would advance to $1,450 over the next 12 months.

With the U.S. Fed, the Bank of England and the Bank of Japan all reaching near-zero interest rates and moving toward more “quantitative easing” – pumping money into the global economy – the case for gold looks more convincing than ever. However, I think all the focus on gold has made many investors neglect platinum, with prices languishing over the past 2 years.

In 2011 it might all be about PLATINUM

Yet there are other precious metals that stand to benefit from the same inflation-hedging-related demand that’s driving gold to record after record.

So why Platinum? Well there are three good reasons why we think it might outperform gold over the next 12 months as it heads back to pre-GFC price levels:

Chinese automobiles do use less fuel than their “gas guzzling” U.S. counterparts, but they still need a catalytic converter. In the last year or so, Chinese manufacturers have tended to use palladium converters, while the European manufacturers used platinum. But rising global auto demand and the two metals’ recent convergence in price has made platinum relatively more attractive.Therefore platinum demand, driven by the worldwide automobile industry – including a certain amount of the rapidly growing Chinese and Indian auto sectors will display continued strength.

The other interesting twist is the strong level of demand from investors in China for platinum. In the case of platinum, demand takes the form of platinum jewellery, whose sales in China rose from a 2008 level of 1.06 million ounces to a 2009 all-time record of 2.08 million ounces – an amount equal to about 35% of the world’s platinum mine output of 5.9 million ounces.

Since annual catalytic converter demand is estimated to run at 50% of world platinum output, it’s easy to see the potential for a supply/demand imbalance and a jump in platinum prices.

Chinese automobiles do use less fuel than their “gas guzzling” U.S. counterparts, but they still need a catalytic converter. In the last year or so, Chinese manufacturers have tended to use palladium converters, while the European manufacturers used platinum. But rising global auto demand and the two metals’ recent convergence in price has made platinum relatively more attractive.

1. It’s scarcePlatinum is probably the rarest of the precious metals with annual production of around 7 million troy ounces. South Africa is the world's leading producer, with almost an 80% market share in 2009. Russia was a distant second, with 11%. Relying primarily on one source for platinum is a big concern. Every miners' strike, political tremor or other production disruption triggers a ripple in the trading pits.

2. Demand is rising quicklyAs mentioned, platinum is needed for catalytic converters in automobiles. Current fuel cell technology also uses platinum, which unlike many metals, is non-magnetic. While about half the platinum production is used for vehicle emissions control, about one-sixth goes toward jewelry, with smaller percentages used in electronics and other industrial uses. Some even is needed for certain cancer-fighting drugs. Platinum's unique properties make it popular for jewelry. Fine watches often have platinum cases, because unlike gold, it never tarnishes and doesn't wear. Recycling of catalytic converters is leading to the recovery of a substantial amount of platinum. But demand continues to rise, especially as China's demand for automobiles continues to increase. Concerns over climate change are also expected to lead to increased use of the antipollution devices in more industrial equipment. But production isn't expected to drastically increase, in the near term, to meet the rising demand.

3. Investment demand is increasingHolding platinum itself is possible, with the New York Mercantile Exchange among the exchanges trading futures and options contracts, but not really that practical for most Asian investors. Instead, investors have taken notice of platinum exchange traded funds. The first platinum ETFS appeared in first on the Johannesburg Stock Exchange, and most recently in the US and Europe. As a result the level of investment-related demand for platinum has increased significantly, and is set to continue for the foreseeable future.

Well that all sounds pretty logical. Platinum’s main competitor is palladium, which is quite a bit cheaper, but considerably less effective. So the pricing of the two metals tends to move in sync, with platinum being three-times to four-times as expensive as palladium. However, over the last 12 months palladium prices have risen by more than 35%, bringing the platinum/palladium price ratio down to an exceptionally low level around 2.5.

If we consider that the primary market for automobile catalytic converters is China, whose automobile market last year passed its U.S. counterpart to become the largest in the world, and where sales in August this year were up about 18% ahead of its 2009 totals.

Gold & Platinum – Page 27

Page 28 – Why has Currency Volatility Jumped? – CrossBorder Capital

Why has Currency Volatility Jumped? The latest plunge in the US dollar has been met with consternation in many World capitals. Emerging market (EM) economies that shadow the greenback have been forced to purchase some US$250 billion of US Treasuries over recent weeks simply to hold down their soaring units. An angry Brazilian official provocatively dubbed these actions a ‘currency war’.

Written by CrossBorder Capital

Many other debt-burdened major developed economies will be forced to follow the US. But it also seems likely that China, like-Japan in the 1980s, will fight American (and wider Western) attempts to force it to revalue its currency upwards. China’s stubbornness will drag out the adjustment process for all. Western currencies will try to leapfrog each other downwards against the Chinese RMB, in much the same way that forex markets did eighty years ago in the wake of the 1930s Depression. It is not the Euro, the Yen or even Sterling that will gain from this process, but the gold price. Some years ago we tackled the long-term prospects for emerging market currencies in a research note. Our conclusion then, as now, is that economies enjoying faster productivity growth should also see their real exchange rates rise.

Currency Wars?Is this the Time for a New Gold Standard? Central Banks frequently try to demonetise gold. They fail because gold is always an asset the private sector wants to hold. A new gold standard would not require Central Banks to accumulate gold. All it needs is for them to operate a 'price rule', i.e. a gold price target.

Latest mayhem in currency markets reflects the secular rise of emerging markets. Western economies have lost the unequal struggle, which has devastated their financial systems and led to vast debt accumulation. Western paper units need to devalue, but the reluctance of emerging economies to allow this has led to competitive devaluations.

The main winner will be the gold price. But like a similar episode in 1980s Japan, domestic asset bubbles will feature across emerging economies.

The real exchange rate is simply the nominal exchange rate adjusted by (relative) price changes. Thus, fast-growing EM economies will likely experience either a strong nominal exchange rate, or relative price appreciation, or some combination of the two effects. In practice, there are four possible ways that the real exchange can increase: 1. rising nominal exchange rate (e.g. stronger RMB/weaker US$) 2. faster consumer price inflation in, say, EM 3. strong gains in asset prices across EM 4. slower inflation or even deflation in the US (or West).

Each nominal paper currency has two moving parts: the nominal gold price measured in the home currency and the nominal gold price measured in the competitor currency. The optimal economic strategy is for the fast-productivity growth economy to allow its currency to appreciate against gold, while other economies maintain a fixed parity with gold. This permits productivity-induced cost deflation to adjust the nominal exchange rate, without the potentially nasty monetary side-effects elsewhere. In this ideal case, the RMB would today rise against gold and the US dollar would remain stable against gold. Monetary inflation, a.k.a. ‘QE’ would be absent, and the inflation risks therefore mitigated.

We are far from this ideal World. Like the previous Bretton Woods fixed exchange rate system, the international adjustment process today is asymmetric. Strong economies rarely act voluntarily, which means that it is the weak that must move first. Thus, ‘the strong’ creditor economies are not forced to appreciate their nominal exchange rates, whereas ‘the weak’ deficit economies are ultimately corralled by market forces to either devalue or seek outside capital. In contrast, the much-lambasted Gold Standard operated as a rule-based symmetric adjustment process, with debtor and creditor nations both compelled to adjust. Or at least it did until the US and France each fatally decided to break the rules in the late-1920s. The reputation of the Gold Standard has suffered unfairly ever since.

A Japan-like Bubble Threat Nominal exchange rates, like national soccer teams and state anthems, have become political counters. Inertia frequently rules. The important fact for investors today is that nominal exchange rates are often ‘sticky’, particularly upwards. So, if many consumer and traded goods prices are increasingly determined globally, the only national ‘prices’ left to adjust, and so shift the real exchange rate, are domestic asset prices. Therefore, the more that, say, the Asian currencies shadow the US dollar, the greater the odds that policy-makers will inadvertently inflate a domestic asset price bubble, be it in real estate, stock markets and even domestic art works.

Real exchange rates are, therefore, propelled upwards by faster productivity y growth. The jump in emerging market productivity,

perhaps unsurprisingly, coincided with the Fall of the Berlin Wall in 1989 and the subsequent unshackling of their economies. The Capitalist labour force more than tripled in size as some 3-4 billion new workers became economically enfranchised. Moreover, rapid integration with the Western production system was encouraged by their dramatically lower wage rates, which often stood at fractions of the prevailing Western levels. Even today Chinese manufacturing labour is paid a measly 88 cents per hour, compared to the equivalent of some US$51/ hour in Germany: a stark difference of some 60 times. The EM’s subsequent economic ‘catch-up’ has thus become virtually unstoppable. Their faster productivity growth, at annual rates of 4-6%, is more than double the West’s prevailing circa 2% productivity trend. In short, differential productivity has demanded an appreciating real exchange rate, and to date much of this rise has occurred through asset markets because local policy-makers have targeted specific US dollar parities. China, for example, has long been a key advocate of ‘stable’ nominal exchange rates.

Concerned by the so-called Asian ‘savings glut’ and spurred by the latest economic downturn, US policy-makers are already pressurising China to allow the RMB to rise more significantly. Indeed, the recent slide in the US dollar might even be viewed as an unsubtle attempt to raise the tempo of the debate. But, pace a minor appreciation against the greenback, the RMB has largely matched the dollar’s fall against other currencies. This, in turn, has and likely will cause further rounds of competitive currency devaluation. And, as one unit after another tries to leapfrog its rival, the only winner will be the gold price.

Looking ahead, perhaps, there are really only two things that investors need to know: • Chinese policy-makers misinterpret Japan’s experience

with the Yen • China has ‘stated’ a desire to match America’s gold

holdings in Fort Knox.

China is still ‘consulted to’ by Robert Mundell, the 1999 Nobel Prize winner, architect of the Euro and long-time devotee of fixed-exchange rates. Under Mundell’s tutelage, Chinese analysts point to Japan’s bubble-economy experiences to counter current demands that she too allow her currency to rise against the US dollar. They argue convincingly that by yielding to American hectoring and letting the Yen appreciate, the Japanese devastated their domestic economy, punishing it with two decades of economic malaise.

Dangerously, this view contains partial truths. After extensive retooling following the early 1970s oil crises, Japanese industry came into the new decade leaner, meaner and with a much-envied productivity performance. See Figure 1. Unquestionably, the ‘strong’ Yen was a deliberate response to this industrial success and it proved a major

CrossBorder Capital – Why has Currency Volatility Jumped? – Page 29


contributor to deflation from the early 1990s onwards. But, paradoxically, it cannot be blamed for earlier economic failures in the 1980s. Rather, the decision not to allow the Yen to appreciate faster during the early 1980s directly contributed to Japan’s ‘bubble economy’.

Japan’s woes did not start with a strong Yen, although undeniably the strengthening Yen through the 1990s prevented the Japanese economy from recovering from the bubble and so allowed economic difficulties to persist. In other words, criticising Japan’s strong Yen policy misses the point.

Paradoxically, an earlier and larger rise in the Yen from the mid-1980s might have prevented the bubble from inflating in the first place. But worried that their exporters might lose trade competitiveness, Japanese policy-makers struggled to dampen the Yen’s rise. They bought large amounts of US Treasuries, both directly and via Japanese institutions, and chased trophy assets, such as Pebble Beach golf course, CBS and New York’s Rockefeller Center.

These actions to re-cycle dollars not only heightened the pace of domestic monetization, but by holding down the nominal exchange rate, they added to the pressure behind rising domestic prices. Because many Japanese high street prices were either ‘controlled’, such as the dominant rice price, or else not open to foreign competition, the burden of adjustment switched to the asset markets. Stocks and real estate soared, while the skyrocketing price of golf club memberships and the worth of the land area of Tokyo’s Imperial Palace became global symbols of the asset mania. Therefore, it would seem that China faces the curse of history, where those that do not learn lessons are slated to make the same mistakes. Because many emerging markets are themselves likely closet-targeting the parity of the RMB as much as they are the US dollar, these concerns generally apply across the entire EM sector. Thus, the resolution of fast-productivity growth largely comes through rapid asset price appreciation. In short, the more that EM policy-makers resist the necessary rise in their nominal exchange rates, the more we will see asset price bubbles in EM.

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Already, as we noted, EM policy-makers are being ‘forced’ to monetize large US dollar inflows. Figure 2 highlights the jump in their estimated holdings of US Treasuries since the latest US dollar slide from late-summer 2010. This monetization has helped to propel domestic credit growth forward. EM credit is now barrelling along at a near-20% clip, compared to negative loan growth in the West. See Figure 3.

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Yet lately, cross-border financial flows into EM have dipped sharply, notably during the first half of 2010 when a risk ‘off’ investment psychology became widespread. See Figure 4. Interestingly, this recent exit of foreign capital failed to dent EM stock markets probably because cash-rich (or credit-fuelled) domestic investors took up the slack. Many may recall a similar pattern in Japan around the mid-1980s when the build-up of domestic liquidity led to domestic Japanese institutions taking over the reins and driving the Tokyo stock market, often to the surprise of once-powerful foreign investors.

High on the wish list of EM policy-makers are the controls necessary to halt these potentially damaging volatile foreign inflows. Already we have witnessed token gestures from Brazil and Thailand. Others will likely also try. But

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the reality is that, by definition, EM do not possess either the range of policy instruments or the depth of domestic financial markets necessary to counter these inflows.

Ironically, the most effective monetary policy tool is a rising nominal exchange rate. What’s more, imposing capital restrictions flies in the face of parallel demands for trade openness. Why should the West welcome EM imports if EM close the door to Western capital?

Increasing Demand for Gold and Increasing Supply of Paper Monies We have been emphasizing the high importance of currency choice in asset allocation decisions. Which currency to hold wealth in has become the central question for investors? Two weeks ago in an article in the People’s Daily, an ‘official’ stated China’s desire to emulate the size of America’s gold stock. It is already on its way.

In 2000, China owned 395 tonnes of gold but has since increa sed holdings to 1,054 tonnes, admittedly a still tiny 1.5% of her whopping forex reserves by value. This gold stockpile looks even smaller set against America’s 8,134-tonne gold mountain. If China attains her aspiration, she will absorb the equivalent of t he entire World gold production for three years. Other EM may copy this appetite for gold, either directly or indirectly, by increasingly holding RMBs in their reserves.

It looks as though the price of gold could be heading further upwards simply for EM demand reasons alone. However, there are other factors, namely the need for the West to ‘print money’, that are also driving gold higher. Separately, we figure that for developed economies to purge themselves of this crisis, the nominal gold price must double. In short, global QE will benefit gold.

Does Capitalism allow all regions of the World to grow rich together, or does history confirm that one region often

becomes very rich despite, or at the expense of another becoming absolutely poorer? Whichever is correct, Western economies are unquestionably following a slower absolute growth path. Many contemporary commentators feared that this fact came as early as the 1970s, but others argue that it occurred from the early 1990s, perhaps as the direct counterpart to (i.e.’cost’ of) the Emerging Market boom?

For years this slower industrial trend was hidden by the rapid secular expansion of credit and debt, pumped into economies in a vain attempt to lever returns and bolster growth.

Our long-held thesis is that the collapse in the marginal productivity of Western industry crunched new capital expenditure and forced down global interest rates. Although this fact was obvious to bond investors through falling long-term interest rates, it was hidden from equity investors by accounting conventions that simply report average rather than marginal returns on capital. In other words, often aggressive cost-cutting was the truth behind buoyant cash flows, rather than prosperous new investments.

Whatever the source of this cash-flow, it lay un-invested in new plant and instead accumulated in short-term money markets. Rapacious Western banks eager and able to expand their balance sheets hoovered up these cheap and abundant funds from the fat, swollen wholesale markets. Underlying returns were skinny and borrowers often questionable, but performance was flattered by extensive leverage. The crunch occurred because banks and their highly leveraged subsidiaries could not roll-over their financings. The headlines for the 2007-08 financial crisis were written about ugly investment bankers and festering sub-prime loans, but the reality is that this was a classic refinancing crisis borne of skidding industrial profitability. These sliding profits had their roots in heightened

It looks as though the price of gold could be heading further upwards simply for EM demand reasons alone. However, there are other factors, namely the need for the West to ‘print money’, that are also driving gold higher.


competition from EM. The West can no longer so easily compete and is now forced to share World markets.

Staring into the eyes of history, we realise that we have been here before. The 1930s saw a similar transition as economic power shifted from Europe to the USA. The associated wealth transfer largely occurred through the conduit of exchange rates. The American dollar was the big winner over the following decades. In much the same way, the British pound sterling was the big winner after the Napoleonic Wars, at the start of the nineteenth century. The economic record of the nineteenth century, and more ominously the military record of the twentieth century, is testimony to what can go wrong.

The fiscal lesson from the nineteenth century was the high frequency of debt defaults. Even the USA defaulted on its European borrowings. It was admonished by Europe’s bankers who promised: ‘...they will never borrow another dollar, not a dollar.’ Debt default was hastened by the proximity of so-called debt traps. These curse economies whenever the growth of tax revenues falls below the cost of debt service. In other words, when the real interest rate exceeds the pace of GDP growth.

Many remain blind to this threat because the bulk of post -war experience featured GDP growth rates that exceeded real interest rates. Yet the longer span of history confirms that this positive gap is indeed a rare event. More often high real interest rates are the bogey. What is more, it seems reasonable to suggest that increasingly the level of global real interest rates will be set by the ‘high’ marginal return on capital in the EM. If true, this would load huge pressure on Western borrowers to quickly reduce their debt burdens. Faced by a similar problem in the early nineteenth century, Britain engaged in a radical downsizing of her then ‘small’ State; a policy that many now dub laissez-faire.

Other countries could not make the appropriate sized cuts and defaulted on their debts. Then, the Gold Standard meant that currency devaluation was not an option. Default was the only course. Today, currency devaluation is a real option for many. But what do they devalue against? One obvious candidate is gold; another is the EM currencies. By implication, rising gold prices usually mean rising commodity prices, so we should also include the resource-based currencies in this group.

Figure 5 shows the US debt/GDP ratio since the early -1920s. In our opinion, this needs to roughly halve from circa 300%-plus to a figure nearer, say, 150%. Another way to measure this debt burden is to express it in gold terms. This is shown in Figure 6. The recent surge in the nominal gold price has already helped to inflate balance sheets

sufficiently to significantly lower this real debt burden. However, there is plainly more to go, and our estimate of a necessary further doubling of the US dollar gold price from current levels appears to be in the right ‘ball park’.

In other words, Western governments will likely be forced to engage in further doses of QE to deliberately weaken their exchange rates. This action need not lead to faster consumer inflation as many fear. High street inflation tends to result from excessive debt, and explicitly from too much ‘unproductive’ debt. This, in turn, is typically the result of excessive consumer and government debt. Printing money does not necessarily add to debt, but it does almost certainly change the average maturity and duration of debt because the State is issuing more short-term liabilities. A forced shortening in asset duration is unlikely to have any implications for faster high street inflation, but it will have significant implications for asset price inflation.

If investors in aggregate are forced to hold shorter duration assets than they desire, they will react by trying to exchange these for longer duration assets, such as commodities and equities, thereby driving up their prices. This was the experience of America in the mid-1930s, in the wake of the Depression. Figure 7 highlights what then happened to asset


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prices following a liquidity expansion. The big winners then, like now, were commodity prices. Financial asset prices, stocks and bonds, performed well. Real estate delivered a more modest, but still positive performance. Consumer prices were essentially flat. A similar performance ranking colours our latest experience following QE1.

on from currency war towards a more divisive trade war, as in the 1930s. The modern World may also reach a third state: commodity war. If policy-makers are forced to fall-back on monetary policy and ever-greater doses of QE, we know from experience that commodity prices could sky -rocket in price. Thus, using an average gold/oil ratio of 13 times, our target gold price of US$2,500/oz. would be consistent with an oil price of close to US$200/bbl. Similar projections might apply to other commodities. Taking a broad picture, such significant jumps in commodity wealth could spur nationalist spirits to monopolise these resources, so deliberately limiting the access of foreign mining and processing companies.

Already, Venezuela is nationalising strategic assets and China has restricted the export of rare earth metals. This economic imperialism previously featured in the lead-up to WW2. For example, the increasingly militaristic regime in Japan realised that it had to shift away from near-80% dependency on US oil supply. Its designs on the then Dutch East Indies (Indonesia) led to America freezing Japanese bank accounts in the US to contain its further purchases of US oil. Japan retaliated by attacking the US Pacific fleet that had recently moved to Pearl Harbor in order to anticipate a Japanese attack on the East Indies. So began the Pacific War.

Conclusion The current backdrop for EM looks eerily similar to that faced by Japan in the mid-1980s. These parallels are worth spelling out because in our view we are again travelling this same bubble-path. Japan then, like EM now, enjoyed more rapid productivity growth than the US (or indeed the entire West).

Two facts underscore the current relevance of this model. First, emerging markets today are collectively even more ‘trade focused’, and therefore probably even more worried about maintaining their exchange rate competitiveness, than Japan was twenty-five years ago. Second, the increasingly pivotal Chinese economy has allegedly ‘learnt’ from Japan’s sufferings that the strong Yen ultimately destroyed Japanese prosperity. The first statement is irrefutable. The second is a dangerous misinterpretation.

A legacy of the 1930s is the perception that economies that were among the first to devalue became the first to emerge from recession. If this encourages a greater willingness to devalue, then the desire of the fast-productivity economies to match these moves warns that paper currencies will spiral downwards in value as national governments try to leapfrog each other to gain a competitive edge. Gold is the unequivocal winner from this process.

We firmly believe that had a Gold Standard, or its equivalent, been operating, many of our recent

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The other feature evident today that parallels the 1930s is heightened paper currency volatility. 2010 will likely suffer the highest currency volatility since the 1970s; itself a post -1930s peak. See Figure 8. The reasons are similar. First, spurred to gain an edge through competitive devaluation, QEs are occurring sequentially. Second, nagging solvency concerns come-and-go, without ever being resolved. Thus, the renewed doubts about the integrity of peripheral European debt are again debilitating the Euro.

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Today debt worries are being addressed everywhere in the same way: governments are slashing deficits and households are rebuilding their savings. Taken together, in a flow of funds context, these twin directives will push all economies towards positions of trade surplus.

Clearly, for the World in aggregate this is impossible. Therefore, it is likely that trade tensions will emerge, leading


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problems, such as excess credit growth and whopping debt burdens, may never have happened. The Gold Standard, however, has a bad reputation among economists and policy-makers who both misinterpret the 1920s and 1930s experience of gold, and more generally fail to understand the basic principle that money circulates because it has value, it does not have value because it circulates. This is more than a pleasing paradox. It goes to the heart of what we dub the quality theory of money. Avoidance of the problems associated

with the earlier Gold Standard is plainly not an excuse for having unstable money.

Figure 9 shows the US dollar gold price under the regimes of four Fed Chairmen. It is plain that America’s policy goals have flipped many times. Despite a short-lived period of stable money in the early 1990s, the Fed has promoted periods of crushing monetary deflation, e.g. ahead of the 1997 Asian Crisis, and cynical monetary inflation, particularly under incumbent Chairman Bernanke.

Part of the solution to our long-term problems might, therefore, involve some return to a Gold Standard and stable money. However, not only is this alone insufficient, but it would be a singularly inappropriate policy to enact just now, before Western nations have purged themselves of the excessive debts built up in the previous crisis.

Once debt levels have been reduced to manageable levels, new monetary arrangements can be forged. Some guarantee against monetary inflation is needed. But if this ultimately takes the form of gold, the rules of the game need to be modified to ensure that fast-productivity growth economies agree to appreciate their currencies. Previous monetary arrangements have failed whenever the weak deficit economies are forced to undertake the burden of adjustment. It is the strong who must take up this challenge if future World monetary arrangements are to survive. In the meantime, investors should substantially raise their exposure to gold, commodities, resource-based currencies and general emerging market assets. History teaches us many lessons, but the over-riding one is the importance of getting the currency decision correct.

Major wealth transfers typically always occur through the conduit of fast -changing currency parities. Thus, Australians have lately become the World’s richest people per capita. Holders of the British pound and the former Hungarian pengo have suffered the other side of the coin, i.e. falling wealth. With China muscling forward, it can only be a matter of time before the RMB becomes a major World currency, and alongside Chinese wealth levels will leap.

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Is There an Alternative to Gold?Many investors believe that the combination of cost deflation and monetary inflation is going to combine to bring about a sizeable increase in currency volatility, citing a similar period between the end of the depression and the start of the Second World War. It was a time where investor sentiment towards sovereign bonds swung dramatically as investors balanced whether governments would be able to afford the dramatic increases in debt required for government social welfare programmes. This was reflected by volatility in the foreign exchange markets.

Could the recent increase in currency volatility that we are now seeing be an echo from the past? If so are the traditional “normal” key asset allocation decisions, such as the relative weightings of bonds to equities, going to be swept aside by massive currency swings?

To mitigate these swings many commentators advocate investors should move at least some portion of their assets

into Gold and treat it as a currency. This may be a partial solution, and certainly the growth and popularity of gold market access products is to be welcomed, but buying and holding gold can never be a complete solution. That is because the gold market is a relatively small when compared to the many trillions of US$ traded every day in the foreign exchange markets. If gold did become “just like any other currency” it could easily be overwhelmed in a real panic.

Peter O’Neil Donnellon – Is There an Alternative to Gold? – Page 035

Page 36 – Is There an Alternative to Gold? – Peter O’Neil Donnellon

If currency volatility is going to be a major headache for asset allocators then the obvious solution is in the currency options market, where commodity producers and suppliers have traditionally insulated themselves from the worst of any currency movements. However hedging predictable future shipments of commodities or goods is one thing, applying the same strategy in the fast moving world of financial services another.

The financial funds industry has a reputation of being somewhat reactive rather than proactive when it comes to launching new products. This year’s launches tends to have been last year’s “hot theme”, (anyone seen any good new “green fund” launches recently?), here at least it has the chance to get on the front foot. Existing currency ETFs tend to be mostly directional pairs, long dollar, short euro etc. There are some notable exceptions particularly DB’s Currency Harvest product, launched at a time when global interest rates were much higher and the “carry trade” characteristics much more persistent, it has struggled in the new low interest environment.

There are a couple of existing currency volatility indices out there that could easily be adapted to provide a hedge against unexpected spikes in currency volatility and profit from it. Intriguingly one is even designed to be “short vol” and would have to be inverted but they both tell a similar story. Prior to the financial crisis forex volatility was

persistently low and fairly predictable but since the crises volatility has been increasing.

The Barclays Capital FX Volatility Index family consists of three indices. Each index uses a different quantitative and systematic underlying strategy and is composed of 12 cash settled forward volatility agreements on the main currency pairs. In the AlphaVol strategy a systematic mean optimiser model is run to determine the weights of each of the forward volatility agreements in the index. The model generates buy or sell signals, allocating greater weight to forward volatility agreements with a higher expected return.

The BetaVol strategy uses a systematic ranking model that generates buy or sell signals based on the expected return of each asset. The allocation takes long positions in the assets with the highest return and short positions in those with the lowest return. The allocation takes no position in assets that rank in the middle. However, the Beta Volatility index is always net long volatility. The SBetaVol strategy is similar but uses optimised component weightings.

The DBIQ ImpAct FX Volatility Index was designed some time ago to track a bearish currency volatility view so it is systematically short volatility swaps across the six currency pairs with the highest turnover in the FX options market. This subset of currency pairs accounts for approximately 70% of the total market turnover, and the behaviour of implied and historical volatilities is highly correlated to that of indices that include more currencies.

None of these products are in a useful investor friendly form, and DB would have to invert its short vol view but as the risk of currency volatility increases there will be increasing demand for these products. The choice for international investors is stark: either find some strategy to mitigate increased foreign exchange volatility risk or reduce their international capital allocations.

The financial funds industry has a reputation of being somewhat reactive rather than proactive when it comes to launching new products. This year’s launches tends to have been last year’s “hot theme”, (anyone seen any good new “green fund” launches recently?), here at least it has the chance to get on the front foot.

Page 38 – China Wealth Management Forum

China Wealth Management Forum 2010The Forum was a great success and was the largest gathering of wealth managers ever held in China. We had over 130 guests from 31 local banks attending. During the morning session we explored the current state of wealth management in China, and discussed its future direction with the advent of more banks launching private banking operations.

The discussions were lively and gave the guests a unique insight into how successful wealth managers are operating in China and their experiences on what has worked, and what their clients want in the future. The afternoon session took a different tack. The focus during this session was on foreign experts providing the guests with some insights into practices and strategies that have worked overseas and are most likely resonate in China. The quality of the presentations was incredibly high, and the speakers went to a lot of effort to give the guests some really useful tips.

There were three key themes emanating from the day, namely:1. The wealth management market in China is, and shall

remain, unique for a number of reasons beyond simply parochialism;

2. The offshore unregulated investment market is larger than the onshore funds markets, and is set to expand greatly as high net worth investors, not just companies, become participants;

3. China will become the largest wealth management market in Asia over the next 5-10 years, and their exposure to foreign assets will increase as the QD system is slowly phased out over this period.

China is uniquely ChineseThe theme that was repeated throughout the day was that China is a unique wealth management market. And

just because a bank or service model has worked in Hong Kong or Singapore does not mean it will be applicable locally. In China, wealth management is far closer to the Australian service model in which structuring the clients affairs to navigate a variety of tax and accounting issues and the Swiss model of client service and relationship management. Merely providing access to unique investment products, offering leverage, inviting guests to VIP events or having swanky offices will not work. Successful wealth management in China is a service oriented business in which structuring the clients affairs is paramount.

Why? Clients have a higher degree of loyalty to their banks. And the banks seek to offer wealth management services for their clients to enhance their existing relationships, not just to milk more revenue from them. The whole wealth management model in China is based on this premise as the banks truly seek to assist their

The Race to Find Offshore ProductThe unregulated investment market now stands at around US$400 billion and is growing quickly according Robert Agnew from Matrix Services who presented in the afternoon. Impressive as this figure is, this is only one half of the potential pie and that the onshore funds market is around US$330 billion. With the advent of a myriad of new taxes, many high net worth investors are looking to increasingly invest offshore outside of the QDII scheme via the unregulated market using trusts. Under the current regulations, professional investors in China have significantly more investment flexibility than retail investors - and are looking to access unregulated fund structures to invest offshore. Joe Field from the respected English law firm, Withers, explained to the attendees the options available to them and the rationale for pursuing the trust route during his talk. Then Nick Kalikajaris, the ex-Head of Credit Suisse Private Banking in Australia, explained how the banks in Australia had

clients in a challenging financial environment. China is a complex legal and tax environment, and the complexity is only increasing as the regulatory environment develops. Clients are looking to their banks to assist them in navigating this landscape, both on a personal level and for their corporate interests.

The now imminent enacting of an inheritance tax over the next 2-3 years has acted as a lightning rod for many high net worth investors to carefully plan their financial affairs. The banks are trying to address this quickly to meet their client demands by offering more comprehensive services, such as estate planning.

All in all one salient point came out of the morning session, China will be a unique wealth management market. So don’t be arrogant and assume that success overseas can easily be transferred to China. This is both ignorant and a pathway to disappointment.

China Wealth Management Forum – Page 39

Page 040 – From the Editor / Contents Page 40 – China Wealth Management Forum

dealt with similar issues for their clients using more complex trust structures to invest. And Emmanuel Roulin from Swiss-based private bank, Lombard Odier explained how the maturity of a client relationship by providing complex structuring advice is integral to providing superior client service.

The consensus amongst the attendees was that there would be a rush of their clients looking to shield their assets from tax changes or to provide more efficient family-centric estate planning mechanism over the next 9 to 24 months. They also said that the unregulated investment market was going to be the channel they would use for these clients. And that their bias would be towards co-mingled or fund products, not direct equities (which they have been for most offshore company based investments). The general opinion was that the investment behaviour of their clients offshore will more closely reflect their onshore portfolios, i.e. they will lean more towards a conservative or moderately aggressive strategic asset allocation.

However, the challenge for most of the banks is to determine which investment managers to use offshore. They have built up a good working knowledge of the local firms, but are not knowledgeable about their offshore counterparts. So there is a massive opportunity, circa US$300 billion over the next 3-4 years, here for foreign fund managers to build large long-term flows if they approach this market correctly.

However, the challenge for most of the banks is to determine which investment managers to use offshore. They have built up a good working knowledge of the local firms, but are not knowledgeable about their offshore counterparts. So there is a massive opportunity, circa US$300 billion over the next 3-4 years, here for foreign fund managers to build large long-term flows if they approach this market correctly. According to both Robert Agnew from Matrix and Zhang Houqi from China AMC, the banks will remain the dominant sales channel for these flows in the future.

Wealth management is growing at a rapid paceThere are conflicting reports by a number of researchers including Bain, Boston Consulting Group, McKinsey, Cap Gemini et al, on the size of the wealth management market in China. Anecdotally, the evidence from the attendees suggests it’s inclined towards the high side of these reports. With the changes to property investing, the volatility of local markets and the lack of investment opportunities for most high net worth investors, clients are stockpiling significant cash-focussed portfolios with the banks.

Also a number of banks have not segmented their clients yet, or find it difficult to aggregate accounts under a specific name to determine their clients combined financial position.

So the data is pretty opaque at best, except for probably the top 10-15 banks. However, a number of attendees talked about their banks client assets in the Mass Affluent (CNY1 to CNY5 million) and above segments, and the sheer number of these accounts is astonishing. With a little extrapolation you can quite easily determine that the size of the wealth management market easily exceeds USD750 billion. Boston Consulting Group estimate there are in excess of 700,000 households with financial wealth in excess of US$1 million (this accounts for nearly US$700billion alone and doesn’t include the Mass Affluent segment). Based on the attendees, this estimate is correct.

As banks better streamline their wealth management operations, we expect this number to increase by around 25% to 30% (approximately the market share of the smaller 20-30 banks) - this does not include the growth rates which are estimated to be around 20%+ per annum in net inflows (the Chinese have one of the highest savings ratios globally).

A number of attendees also suggested that they anticipate the QDII system to become watered down over the next 5 years as regulations relax the flow of capital offshore. Suffice to say, this presents a massive opportunity for offshore product manufacturers to capture a slice of the pie.


The United States economy grew at a sluggish annual rate of 2 percent in the third quarter, the Commerce Department reported last Friday. On the bright side, the economy is growing faster than the 1.7 percent growth in the second quarter and has registered the fifth straight quarter of expansion.

From Quantitative Easing to Stagflation?

But here comes the dark side – the growth rate is far from sufficient to impact jobs. And the most disturbing piece of information is that the U.S. economy is still smaller than it was when the recession began–more than a year after the recession officially ended, which makes even a “jobless recovery” seem uncertain. QE – The Silver Bullet?Doubts about the scale and effectiveness of an expected Federal Reserve second quantitative easing (QE2) has roiled financial markets of late. So, the latest dismal GDP data probably will cement an official kick-off of Fed’s buying long-term U.S. Treasury debt when they meet on Nov. 3.However, will the long awaited QE2 be the silver bullet as the market expects?

90% Debt-to-GDP Threshold: as of October 10, 2010, the total public debt outstanding reached 94 percent of the annual GDP, and will be larger than U.S. GDP, around $14.2 trillion a year, in 2012, according to the International Monetary Fund (IMF).

Obviously, the U.S. debt level has already crossed the ominous 90% GDP threshold–part of the findings of a recent study published by C.M. Reinhart and Kenneth Rogoff. The two economists’ study on the relationship between debt and growth finds that when public debt exceeds the 90% threshold, a country’s growth is significantly less–4% on average–than its lower debt counterparts.

That suggests the debt level of the United States seems to have reached a saturation point where more monetary easing would have very limited effect, and could even retard growth.

QE Unlikely to Cure Credit CrunchAsset purchases by the central bank theoretically would push down real long-term interest rates and spur more lending, boost stock prices, and business confidence thus fueling growth.

Written by Dian L. Chu

However, we have learned from the first round of QE – record-low interest rates, and $2.05 trillion in securities holdings on Fed’s balance sheet, while benefiting the biggest U.S. companies, aren’t trickling down to the smaller business—i.e. no spending, no hiring.

In the 12 months through August, banks pared commercial and industrial lending—loans typically used by companies without access to the bond market—by 11.3 percent. It is still under debate whether the decline is driven by the supply issue–the balance sheet constraints of lenders, or from the demand side–simply the lack of it.

Regardless, I believe the private lending decline seems mostly a manifestation–from both the supply and demand side–of business confidence lost, and the uncertainty over new regulatory rules, which QE2 along is unlikely to rectify, and thus would have limited positive impacts on the economy.

Where’s The Inflation?There’s also a distinct risk of inflation associated with back-to-back QE’s on a global scale. I think the prevailing deflation fear is quite misguided, and the Fed could be caught ill-prepared when inflation erupts.

As the liquidity works through the system, the time lag between the increase in the money supply and inflation rate is generally 12 to 18 months. Typically, the following are two instances where more money printing would not turn into rampant consumer inflation.

When the liquidity goes into creating asset bubble(s) (e.g. the Dot Com bubble, and the current U.S. bond bubble). Able to buy cheap imported goods to essentially export inflation.In addition, as describe in the previous “credit crunch” section,

Dian L. Chu – From Quantitative Easing to Stagflation? – Page 41

Page 42 – From Quantitative Easing To Stagflation? – Dian L. Chu

there’s a lot of the cash being held at banks to shore up their balance sheet, and corporations are also hoarding cash as ‘safety net” due to the gloomy and uncertain business climate.

So, these are some of the reasons that the U.S. has not seen much inflation spilling over to the consumer side yet, to the point that the policy makers are even having high anxiety over deflation.

Ripe for StagflationWell, heads up, Mr. Bernanke.

With wages rising in almost all low-cost exporting countries, it will become more difficult for the U.S. to contain inflation via cheap imports. Then, as more quantitative easing could further dilute the value of the dollar, pushing up the commodity prices, the system could be pushed beyond its limit into a possible “Demand-pull stagflation” scenario.

Stagflation is an economic situation when both the inflation rate and the unemployment rate are high. The demand-pull stagflation theory was first proposed in 1999 by Eduardo Loyo of Harvard University’s John F. Kennedy School of Government.

This theory posits stagflation can result exclusively from monetary shocks, and describes a scenario where stagflation can occur following a period of monetary policy implementations that cause inflation.

Of course, there is also a scenario where high commodity prices, such as crude oil, tend to raise inflation while slow the economy, which is entirely plausible as well, based on the recent run-up of commodities.

A G20 Currency ShowdownThe dollar-QE-induced inflation could also have global ramifications since China and many of the emerging and developing countries’ growth is highly dependent upon turning raw material into exportable goods.

China’s already on alert with newspapers quoting trade minister Chen Deming as saying “Uncontrolled printing of dollars and rising international prices for commodities are causing an imported inflationary ’shock’ for China and are a key factor behind increasing uncertainty.”

And since dollar is still the major global reserve currency, QE2 could also decrease value of other countries’ foreign reserves.

As China most likely is not the only country sees the potential threat of QE2 coming out of the U.S., a big currency showdown in Seoul seems inevitable (resolution not expected) when the finance ministers from the G20 nations meet this month.

Regarding Government InterventionAmerican business and people are resilient, tends to adapt and learn from mistakes fairly quickly, and probably could have worked its way out of this recession sooner without so much government intervention. That is–let the chips fall where they may–as capitalism mostly guarantees that nothing motivates and accelerates business changes more than losing billions of dollars.

Undeniably, government aid could help speed up a recovery after a massive crisis if it is done with proper priorities and implementations. For instance, many have criticized China’s overbuilding “ghost towns” and asset bubbles in the aftermath of financial crisis. However, my observation is that Beijing most likely is putting a priority on averting a nasty and prolonged recession by turning the entire nation into a gigantic construction site.

From that perspective, China probably has done a better job than the U.S. although it is now left facing some of the consequences including escalating inflation, which ironically is part of what the Fed is trying to achieve through QE2.

Past U.S. StagflationUnfortunately, due to misguided policies and priorities, the U.S. has little to show for it despite a skyrocketing debt level after the crisis. And from what we discussed here, inflation through the printing press most likely will not translate into growth or jobs, and instead, has increased the odds of stagflation.

In case you are wondering when the last stagflation in the U.S. took place, the answer is the 1973–75 recession, inclusive of a stock market crash and the subsequent bear phase from 1973 to 1974. Inflation remained extremely high for the rest of the decade, while low economic growth characterized the next 20 years.

Investing for StagflationIn this environment, hard assets/commodities (agriculture, energy, base metals, etc.) and commodity producers are likely to reign supreme. Equities in emerging economies would be the next best category.

Many ETFs such as the PowerShares DB Agriculture (NYSE:DBA), and Market Vectors Global Agribusiness (NYSE:MOO) should give investors a broad range of selections in this category. Investment vehicles such as PIMCO Commodity RealReturn Strategy Fund that combine income and price appreciation also could protect from inflation with potential higher returns.

Meanwhile, gold bugs should send red roses to President Obama and Mr. Bernanke.


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Page 44 – Market Data – Lucas Weatherill

Macro Monthly November 2010Macro Back DropNovember was a tough month for long only investors.Equities were flat to down, treasuries sold off and credit spreads widened. With the exception of gold and the US dollar (and currency hedged Japanese equities) there weren’t many asset classes that provided positive returns.

US macro data generally surprised on the positive side with the Citigroup Economic Surprise Index rising from 1.7 to 22.4 (but promptly fell to -12.1 in the first few days of December) and the ECRI Weekly Leading Index growth rate improving from -6.4 to -2.4 (where a number around about 2-3 is the average over many decades). The European data surprise index drifted slightly lower, but remains quite high, while the trend of weaker data in Emerging Markets continued with the index posting its lowest level since April 2009. Given the market’s desire for the emerging

economies to save the developed world, this is likely to become problematic for investor positioning some time quite soon.

Overall, portfolios are relatively neutrally positioned with very small betas to both risk and treasury assets, partly reflecting the difficulty in digesting the recent data flow and market reaction. We continue to believe that markets will drift higher into the holiday period but will need to be closely watched. Our central economic view remains that the US is structurally weak and will disappoint on the key data releases over coming months but the fight with the wall of liquidity that could be unleashed by multiple doses of quantitative easing will test market reactions. While we have moderate conviction in our relative value positions in the portfolio, we do not see this as the right time for heroicbets on risk assets in either direction.

Written by Lucas Weatherill ([email protected])

1 Month 3 Months YTD 1 Year 3 Years (pa)

US Government Bonds -0.7% -0.8% 7.7% 4.9% 5.7%

US Aggregate Bonds -0.6% -0.1% 7.7% 6.0% 6.4%

Emerging Market Bonds (USD) -3.4% 0.1% 12.6% 12.8% 8.8%

US High Yield Bonds -1.1% 4.3% 13.2% 16.7% 9.6%

Gold Bullion 2.8% 11.1% 26.4% 17.6% 21.0%

FTSE/NAREIT Global REIT Index (USD) -4.2% 8.5% 13.3% 17.4% -8.1%

CRB Commodity Index 0.3% 14.1% 6.5% 8.8% -3.3%

US Dollar Index 5.1% -2.4% 4.3% 8.4% 2.2%

MSCI World (USD) -0.3% 9.8% 4.6% 8.5% -6.8%

S&P 500 0.0% 13.1% 7.9% 9.9% -5.1%

MSCI Europe ex UK (USD) -8.9% 6.7% -6.0% -5.0% -11.9%

MSCI Japan 6.2% 8.8% -3.4% 5.3% -16.2%

MSCI UK -2.4% 6.3% 5.1% 9.7% -1.2%

MSCI Asia ex Japan (USD) -1.5% 12.6% 13.6% 18.6% -2.3%

MSCI Emerging Markets (USD) -2.6% 11.3% 11.2% 15.7% -2.2%

MSCI Pacific ex Japan Small Caps (USD) -1.3% 18.6% 16.3% 21.0% -3.8%

US Government Bonds : CGBI WGBI US All Maturities, US Aggregate Bonds : Lehman US Aggregate Bond Index, Emerging Market Bonds :JPM EMBI+ Composite, US High Yield Bonds : BOFA ML US High Yield Master II. All data sourced from Datastream.

Equity MarketsRecent very poor performance of equity markets in Europe and the value this is creating has registered on our radar screens. Spanish equities in particular are looking like some of the cheapest in the developed world and show up on numerous of our screens. At the end of November we took a small position in this asset class (currency hedged), which we will add to if the market continues to fall further. Our moderately long standing position in Italy has continued to (unfortunately) perform poorly enough to have moved higher up the valuation rankings. We will continue to watch this position closely with the expectation of increasing on further weakness as well.

We maintain our exposure to China A shares, but have reduced exposure to HK growth stocks slightly as this market has performed exceptionally well over the past few months. We are still big believers in the structural theme but believe that this market has become slightly overextended recently. We have also maintained our exposure to emerging market small caps dividend weighted (our only holding in the space). While the asset has substantially outperformed their larger market weight cousins we still like the valuation and high beta exposure to the theme.

Japanese small caps (again dividend weighted) also form a small part of the portfolio – completely based on valuation grounds. While predicting catalysts for the re-rating of the Japanese equity market has fill pages from Japan watches over the years we really remain confident that in the end, value will win out. The collection of stocks in this space

trades at a price to book of 0.75 and a dividend yield of 2.6% - more than double the Japanese government 10 year bond rate.

In long / short portfolios we are still short US small cap stocks – primarily on valuation grounds - and slightly short the broad US and European market. Our net position remains modestly overweight in both developed and less developed markets but we maintain our interest in adding to short positions when the opportunity presents itself.

Bond MarketsThe US bond market continued its sell-off in November with 10 year yields finishing at 2.8%, 2 year bonds moved higher by 11 bp to 0.46%, and 30 year bonds peaked at over 4.4% mid-month before finishing at 4.11%. We used the mid-month sell off to add to our exposure at the long end of the yield curve. The other surprisingly large move in the AAA space was in the Singapore government 10 year bond space with yields finishing the month at 2.29% - rising by over 30bp in the month. We liked this market at 2% and love it at the nearly 2.5% yield it is trading at in the first week of December.

Emerging market debt spreads moved substantially higher over November as did US high yield bonds (but both reversed most of this in the first few days of December). We still see both offering decent value, though the spread movement in the emerging market index hides the relative performance of countries. With the exception of Venezuela, Argentina and the Ukraine, no market is trading in excess of 500bp over treasuries with all but one below

Lucas Weatherill – Market Data – Page 45

150bp margin. Further spread contraction from here will be a signal to down-weight the index further.

We also maintain our short to TIPs believing that 10 year inflation expectations remain too high at close to 2.2%.

Page 46 – Market Data – Lucas Weatherill

Current PositionsConfidence Level 70%

While we remain cautious on the longer term inflation impact of the succession of QE announcements we expect to happen over the coming few years, the reason for the announcements (ie high unemployment, low growth and a stagnant money supply) should provide nominal bonds withsome support.

AlternativesNovember saw the introduction of dividend futures on the Hang Seng China Enterprises Index, with expectations for a 4.5% p.a. increase in dividends over the next two years. Given the potential for currency appreciation of the RMB, the likely inflation rate in China and the history of dividend rises of the companies in the index we see this as one of the great bargains available in financial markets at thistime and have taken a substantial position (it is likely to be a very low volatility asset).

We have also taken advantage of the poor performance of agricultural commodities to increase the weight slightly (at the expense of the commodity carry hedge fund strategy). We continue to see this, along with gold, as good emerging market inflation hedges.

With the VIX falling back to the lowest levels of the past 6 months in the first week in December we also have slightly increased the position in volatility as a hedge against our generally long exposure to equity markets and risk assets.

Overall, portfolios are relatively neutrally positioned with very small betas to both risk and treasury assets, partly reflecting the difficulty in digesting the recent data flow and market reaction. We continue to believe that markets will drift higher into the holiday period but will need to be closely watched.

Unconstrained portfolios have the following positions:

Developed Market Equities

Asian Equities

Emerging Market Equities

Hang Seng Call Options

High Yield Bonds

Emerging Market Bonds

Convertible Bonds

REITs

Hedge Fund Strategies

Gold Equities

Agricultural Commodities

Volatility

HSCEI Dec 2012 Dividend Futures

Government Bonds

TIPS

Cash

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* Source: Bloomberg, 30 April 2010.SPDR® Gold Trust is currently listed on The Stock Exchange of Hong Kong Limited (“SEHK”) and Singapore Exchange Limited (“SGX”). Nothing contained herein constitutes investment advice and should not be relied upon as such. The value of SPDR® Gold Shares (the “Shares”) of the SPDR® Gold Trust (the “Trust”) may fall or rise. An investment in Shares is subject to investment risks, including the possible loss of the principal amount invested. Past performance of the Trust or of the gold market is not necessarily indicative of its future performance. The Shares are expected to reflect the price of gold, therefore the price of the Shares will be as unpredictable as the price of gold has historically been. Redemption of Shares can only be executed in substantial size through authorized participants. Listing of Shares on SEHK and SGX do not guarantee a liquid market for Shares, and Shares may be delisted from SEHK and SGX. The Prospectus in respect of the Hong Kong and Singapore offer of the shares in the Trust is available and may be obtained upon request from State Street Global Advisors Asia Limited and State Street Global Advisors Singapore Limited (Co. Reg. No: 200002719D) respectively. Investors should read the Trust’s prospectus including the risk factors carefully before investing. Shares in the Trust are not obligations of, deposits in, or guaranteed by, World Gold Trust Services, LLC, State Street Global Advisors or any of their affiliates.The “SPDR®” trademark is used under license from The McGraw-Hill Companies, Inc. (“McGraw-Hill”). No financial product offered by State Street Global Advisors, a division of State Street Bank and Trust Company, or its affiliates is sponsored, endorsed, sold or promoted by McGraw-Hill.This advertisement is issued by State Street Global Advisors Asia Limited and has not been reviewed by the Securities and Futures Commission.

• SPDR®GoldTrustisanExchangeTradedFunddesignedtotrackthepriceofgold(netofTrustexpenses).• Investment involvesrisks, inparticular, investing inonesinglecommodityassetclass.Fluctuation in thepriceofgoldmaymaterially

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