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Dollar/Yen As A Hedge To Oil Investments

Summary Oil and oil companies seem like attractive bets, however there are many near term risks. In an environment of persistent low oil prices, the BOJ has assured continued QE or increases in QE. The dollar has an inverse correlation to oil, therefore a dollar hedge allows for a pure supply/demand bet on oil. The case for being long oil (NYSEARCA: OIL ) has been made numerous times on this website and others, but I will recap a few of the salient points here for completeness. Oil may be attractive from a supply point of view. Most of the new supply that led to the recent glut came from shale oil wells in the United States. In fact, oil production from other sources of world oil actually declined during the period from 2012 to 2014. Source: Resilience.org Shale oil wells have rapid decline curves compared to conventional wells. Source: oilprice.com As shown above, the production rate is a small fraction of the initial production by years 2-3. Therefore, we ought to expect that roughly two years after oil rig counts began to decline, the supplies of crude oil ought to begin to fall rapidly. However, the timetable for this recovery in oil price has been delayed due to the fact that several E&P companies were slow to stop drilling. In a last ditch effort to produce cash flows from their land, many companies continued to drill even at unfavorable prices. Source: marketrealist.com Though crude began to fall in July of 2014, companies didn’t start reducing rig count until many months later, and rig counts didn’t reach the current lower range until the spring of this year. This led to a situation where US supply didn’t start to roll over until the beginning of this year. Despite the drop in rig counts, the supply coming out of US shale is still higher than it was at the start of the crash in oil prices: Source: QuintoCapital.com This makes for an interesting situation of time arbitrage. The sharp decline in shale wells, combined with a lack of new drilling in the U.S., means that by 2017 (2 years from the peak shale oil supply seen in the above chart) the U.S. supply should be low enough to begin to positively affect oil prices. Investors who are convinced of the above argument may take a long position either in the commodity (via futures) or in specific, cash-rich E&P names that are unlikely to go bankrupt, and wait out the supply-demand imbalance. However, there is a danger in catching a falling knife – commodity speculators are currently riding the trend for lower prices, and stock traders are following suit with oil stocks. In addition, there is a risk that the oil supply/demand mismatch may worsen when Iran brings new production online. A long position in oil or oil stocks could pay off eventually, but lead to disastrous portfolio results in the meantime. Therefore, it is desirable to hedge such a position. The Case for Shorting the Yen ( YCS ) Japan’s central bank, unlike the Federal Reserve, uses a measure of inflation that includes the cost of energy. Thus, the fall in oil prices has set back its goal of ending deflation. Though Haruhiko Kuroda has been insisting that this is a temporary setback, one must consider what would have to happen for an investment in a cash-rich E&P firm to go poorly – namely, we would have to see much lower oil prices before the supply glut ends. Take a look at comments Kuroda made earlier this year (emphasis added): “…however, based on the assumption that crude oil prices are expected to rise moderately from the recent level , the CPI is likely to reach 2 percent in or around fiscal 2015. Needless to say, the Bank maintains its policy stance that it will make adjustments as necessary without hesitation, when there are changes in trend inflation, in order to achieve the price stability target at the earliest possible time. The Bank will not respond to developments in crude oil prices themselves, but in conducting monetary policy, it will closely monitor how they affect inflation expectations — or, in other words, whether conversion of the deflationary mindset will nevertheless proceed.” And, more recently, “The timing of reaching the inflation target depends on oil, he told reporters in Tokyo. Kuroda, 71, reiterated that the BOJ won’t hesitate to adjust policy if necessary.” And “Kuroda said he didn’t see limits to further policy steps, amid concern among private analysts that the BOJ’s campaign — mainly purchases of Japanese government bonds, or JGBs — is running up against constraints. He didn’t think a limit on buying JGBs would come soon.” The latest inflation numbers for September showed inflation at -.1% , a far cry from the 2% goal. While Kuroda stated that the BOJ will not specifically respond to oil prices, lower oil prices are bound to continue to bring down inflation expectations. I take the above comments as basically an assurance that as long as oil prices stay low, the BOJ will continue its QE program, and if oil prices fall further, there is a high likelihood that the BOJ will ramp up its QE program yet again. The Case for Being Long The U.S. Dollar There has been a strong inverse relationship between the dollar (NYSEARCA: UUP ) and oil: Source: quintocapital.com This correlation makes sense: because oil is priced in dollars, the strong dollar has contributed to the fall in oil prices. While Japan has been concentrated on stepping up its QE program, the US Federal Reserve has basically told market participants that it plans to raise rates in December. This divergence in policies is driving the USD/JPY higher, and the oil price lower. So going long the dollar in addition to being long oil provides investors a way to play oil purely for its supply-demand characteristics, rather than its aspect as an alternative currency. A word about China There has been a perception that the crash in Chinese stock prices will lead, or already has led, to weakening oil demand. However, the opposite is actually true – Chinese oil demand is actually up 9.2% year-over-year , as lower prices have stimulated demand. As Stanley Druckenmiller said earlier this year , the cure for high prices is high prices, and the cure for low prices is low prices. Putting it together I think there’s a strong case out there for being long oil right now. However, there is always a risk that the fall in oil could become overdone, and we could see oil prices that are in the $20-$30 range before we see prices in the $60-70 range. In order to hedge this volatility, I think there’s a good case for being long the US dollar, specifically against the yen, which will devalue further if oil either stays low or drops further. Any thoughts are always appreciated.

Socially Responsible Investing: 3 Funds That Are Beating The Market

There’s a powerful trend emerging in the investing world. Investors are building portfolios based on their morals and values. Dubbed “socially responsible investing,” or SRI, these investors align their investments with their values by avoiding companies with poor environmental, social or governance practices. Like their counterparts, sustainable investors also want to earn a good financial return on their investment. They don’t want to sacrifice performance for social impact. And these days, they don’t have to. For the last several years, the returns on socially responsible investments have risen sharply – and many are beating the S&P 500 What’s driving the boom in Socially Responsible Investing? Socially responsible investing funds have been enjoying increasing popularity, largely due to the emergence of “impact investing” – a feel good concept that started in the U.K. The difference between the two is that socially responsible investing avoids investments that are inconsistent with the values of the investors while impact investing actively pursues a specific positive impact. For example, funds that don’t invest in companies that make alcohol, tobacco, gambling and weapons are considered socially responsible investments. A more targeted approach, impact investing addresses specific issues like sustainability, women’s rights, the environment and more. Just how popular is SRI? In 1995, there were only 55 mutual funds that engaged in SRI, with $12 billion in assets. Today there are nearly 500, with assets exceeding $500 billion. What’s In It for Investors? Socially responsible investing looks a lot different than it did just a decade ago. As SRI has evolved, the advantages for investors are numerous: SRI investors now have more investing options, with the number of funds growing rapidly. There is also increased diversification of the investments within the funds themselves, which results in less risk to the investor. Investors can now invest in socially responsible Exchange Traded Funds (ETF). There are funds of various market capitalizations and investors can choose from domestic, foreign and global funds. Investors can select a fund whose strategy and social responsibility agenda are similar to that of their own social and financial objectives. Socially Responsible Investing Is Beating the Market Socially responsible investing no longer means you have to sacrifice returns on your investment. The once meager returns of socially responsible investments have improved considerably, even beating the S&P 500. Consider the following: The Index which tracks the equity performance of socially responsible funds, Focus iShares MSCI USA ESG Select Social Index Fund (NYSEARCA: KLD ), has outperformed the S&P since 1990, with an average annual total return of 10.46% compared with the S&P 500’s 9.93%. Benchmark performance of the MSCI KLD 400 Social Index, which includes firms meeting high Environmental, Social and Governance (ESG) standards, has outperformed the S&P 500 on an annualized basis by 45 basis points since its inception (10.14%, compared to 9.69% for the S&P 500; July 1990-Dec. 2014). Not all SRI funds beat the index, but it is remarkable how closely most of them track the market as a whole. Here are some ways to add socially responsible investing to your portfolio. At the time of this writing, I do not own a position in any of the funds mentioned in this article. Socially Responsible Investing: iShares MSCI KLD 400 Social ETF For investors looking for an easy way to add socially responsible investing to their portfolio, the iShares MSCI KLD 400 Social (NYSEARCA: DSI ) is worth a look. DSI posted a 35.5% return in 2013 – beating the S&P 500. DSI posted a 12.2% return in 2014, underperforming the S&P 500 by less than 2 points. The ETF’s underlying index tracks 99% of all the stocks in the United States and includes firms with a variety of market caps. The socially responsible ETF currently tracks 400 different firms and charges 0.50% in expenses. Technology and health care firms make up the bulk of DSI’s holdings. Socially Responsible Investing: iShares MSCI USA ESG Select ETF Investors wanting to eliminate the volatility of owning smaller firms from their portfolios should consider the iShares MSCI USA ESG Select ETF. The $350 million ETF includes U.S. large-cap and some mid-cap stocks which have been screened for positive SRI characteristics. It currently includes almost a hundred different stocks – with top holdings in 3M (NYSE: MMM ), Microsoft (NASDAQ: MSFT ) and renewable energy utility NextEra Energy (NYSE: NEE ). Expenses for KLD are also 0.5%. The socially responsible investing fund has consistently posted solid returns over the last several years. In 2013, KLD posted a 31% return, which was slightly less than the benchmark index, although KLD had beaten the index for the past 5 years. In 2014, KLD posted a total return of 13.5%. Socially Responsible Investing: Huntington EcoLogical Strategy ETF The often overlooked Huntington EcoLogical Strategy ETF (NYSEARCA: HECO ) focuses on various firms making efforts on environmental issues and sustainability. It’s a well-diversified, moderate risk, capital appreciation fund. HECO focuses on “ecologically focused companies,” firms that have positioned their businesses to respond to increased environmental legislation, cultural shifts toward environmentally conscious consumption and capital investments in environmentally-oriented projects. HECO holds more than 50 different companies including Starbucks (NASDAQ: SBUX ) and Texas Instruments (NASDAQ: TXN ). The returns have been strong. HECO returned nearly 30% in 2013 and narrowly outperformed the benchmark in 2014. Expenses for the ETF are slightly high at 0.95%. Final Thoughts You don’t have to give up performance to invest with your conscience and make a difference. Serious investors interested in socially responsible investing no longer have to sacrifice investment returns for their morals. And the easiest way to add SRI to your portfolio is an Exchange Traded Fund such as the funds mentioned above. The information provided is for informational purposes, not a recommendation. As always, investors should consider their own financial objectives and time horizon when making investment decisions. Diversification and asset allocations are important considerations. Sources: 5 ETFs for the Socially Responsible Investor by Dan Kaplinger Socially Responsible Investing With ETFs by Greg Lessard Socially responsible investing has beaten the S&P 500 for decades by Jennifer Openshaw.

From The Studs Up: Building (And Rebuilding) A Portfolio With MPT

An optimal investment portfolio contains assets intended to show well in the light and in the dark. That means it’s built to suit for your risk tolerance and target time frame, for moments of market clarity and uncertainty. We’re talking about modern portfolio theory (MPT), which aims to optimize potential returns for nearly any given risk. Modern portfolio theory has a fresh-sounding resonance, but it’s a 63-year-old investing model structured on three elements: asset allocation, diversification, and periodic rebalancing . At its roots, MPT is a basic investing model – and by now a fundamental one – that embraces diversification and equilibrium while sticking to a measured regime of the classic buy low/sell high. “The idea is that by sticking to that kind of discipline, you can ride out the down markets by staying diversified, and not making rash moves when the market is going up significantly or pulling back,” says John Bell, director of guidance platforms and tools at TD Ameritrade. For example, asset classes whose prices go sharply higher tend to become overweighted and could warp the balance. “If you’re consistently rebalancing back to a target, in general you will be selling the assets that are most highly valued and overpriced, and buying those things that are undervalued and underpriced,” Bell adds. “Buy low/sell high is what rebalancing allows you to do without attempting to introduce biases into your analysis. The beauty of calendar-based rebalancing is there’s nothing more magical about it other than enforcing some discipline,” he says. Mix of Materials Modern portfolio theory was first penned in 1952 by economist and Nobel Prize laureate Harry Markowitz, who used mathematics to support his theory that you can minimize risk and maximize returns by holding a combination of asset classes that aren’t correlated to each other and that align with your personal appetite for risk as well as your age . In other words, with MPT, you spread the risk among assets that don’t typically behave in the same way. It all boils down to these three components: Asset allocation. Investment products span asset classes that might include stocks, bonds, cash, real estate, international holdings, and emerging markets. Ideally (although this isn’t always the case), each asset class performs differently over time and has different levels of risk. For instance, equities typically have higher risk than fixed-income products, but the return is generally greater over time. Diversification. MPT disciples choose assets that don’t correlate to each other, like oil and food, or technology and apparel, domestic versus foreign, large cap versus small cap, and so on. Rebalancing. Consider regular realignment of a portfolio to the target asset allocation already in place. Certain stocks in your portfolio, for example, might soar and upend your targets. Rebalancing allows you to get back on task and, MPT proponents argue, tends to lower the portfolio’s risk. Check Emotions at the Door Why such lasting power for MPT? Because self-control practiced through rebalancing manages two emotions that typically prompt investors to make bad decisions: greed and fear. “Human behavior sometimes trumps logic and sound thinking,” Bell says. “People tend to buy at the absolute worst time and sell at the absolute worst time. Discipline takes the human emotion part out.” But MPT is not bullet-proof. It’s aimed at helping you dodge what’s called “undiversifiable” risk, or what happens when you have all your investment eggs in one asset-class basket and that class stumbles. If all your money was tied up in stocks in 2008, you likely lost a big chunk of change. Wealth Accumulation MPT also follows a basic school of thought about accumulating and keeping wealth. In your 20s, when you have decades of investing before you, conventional wisdom urges taking more risks, perhaps investing more heavily in equities than fixed income in your portfolio weightings. The assumption is that you have time to recover from a harrowing market event that could wipe out 50% of your portfolio. Remember 2008? But if you’re in your 60s, when time has snuck up on you, MPT says it’s best to protect your wealth by taking a more conservative approach without swaying too far from your goals. Those who ran for the hills and converted equities to cash in 2008 probably missed the bull market that followed. MPT cannot – and does not claim to – eliminate “systematic” risk, or what happens when the entire market takes a tumble. But it can soften the blow. Rather than suffering a 50% loss along with the stock-market crash of 2008, a well-balanced portfolio may have set you back only 25% or sometimes less. “You’ll very rarely ever be at the top or the bottom of a broad group of asset classes, but most likely in the middle. That makes sense, because you have a mix of all the asset classes,” Bell says. Disclaimer: TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. Commentary provided for educational purposes only. Past performance is no guarantee of future results or investment success. Options involve risks and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before investing.