Follow Ups

No snow but our ISP was out all morning until now.

One reader asked if I thought the contango/backwardation issue would be a big deal with these new ETFs citing USO as an example. Regarding USO, the drop off, relative to oil, has been so steady and so pronounced that I have to wonder if it is all just from contango. If it were contango every single month (or however often it rolls) I would not expect the line to be so smooth, I would expect to see a straight line down each time it rolled. Maybe I am missing something.

The DB funds are allowed to pick any contract they want for the next 13 months in order to minimize contango and take advantage of backwardation when it occurs. The Oil macro shares from Claymore (UCR and DCR) have no exposure to oil they instead replicate exposure. You can read two articles about the mechanics here and here. GLD and I believe SLV hold the actual metal. I know this is the case with GLD and if so with SLV, again this won't be an issue. I have not studied the ETN's yet, any one who has should feel free to comment whether they are susceptible contango. In looking at a chart that compares USO and the iPath Oil ETN (OIL), they are identical so maybe the ETN's do have contango issues but again this is just a casual observation.

I based on what I have studied and what I have merely casually observed it looks as though the concept behind USO might be flawed for an ETF. Commodity pools manage these issues to spare investors of this problem or, depending on the objective, to exploit it.

At every turn I have talked about simplicity with this sort of thing. I have disclosed owning GLD for clients countless times. I have recently disclosed an interest in the Agriculture ETF (personal holding) as a possible candidate for client money. That would be it. Someone on CNBC on Wednesday said that oil (the commodity) has 0.95 correlation to oil stocks. Personally I don't think it is that high but it might be but oils stocks certainly capture a lot of the effect. Obviously some stocks would track closer to oil than some others (part of the research process if you use individual stocks).

A byproduct of the post yesterday about Merriman was the question of how much to allocate to foreign markets. A reader who goes by Macro Man pointed out that most investors weight too heavily to their home country. This is interesting and seems like it would be true even if unverifiable. It is not clear to me that home country bias is absolutely a bad thing. I need to think about that one for a little while to form an opinion.

An easier point to form an opinion on is how much foreign to have. This sort of number lends itself to a lot of black box science and maybe a little voodoo. I do not think there is a precisely right number. At different times we should have more than we do now and at other times, less. There is a fluidity to it. I seem to hover in the mid-thirties as a percentage. I could see that number being much higher ten years from now as a few emerging markets "arrive" and as a few frontier markets move up to emerging status.

My own thought is that I want my portfolio and the portfolios I manage to get to where I need my account to be and where my clients need their portfolios to be. This is a long term view of course, very long term. My thought about the best way to do that with the smoothest ride is with a lot of foreign exposure. Plenty of other people think otherwise and some believe in capturing foreign with US multinationals. This quickly moves into the realm of no wrong answers. I do it my way, you do it your way and so on.

This leads to a final reader comment asking what is happening with world markets. "I own some well rated international funds and all have been whacked in the last week," the reader writes.

If there are ten funds that invest in Paraguay (making this up as an example) and two of them are five star, six of them are three star and the last two are four star; none of them will be immune from a 30% one day crash. In the last week foreign, especially emerging and commodity related have corrected, even Australia corrected by 3%.

The reader asked why. Why is subject to opinion that may or may not be correct, like maybe it started in Thailand, maybe it is a capital flow thing, maybe it is an ongoing oil correction dominoing to other places. I actually don't think why matters in this case. This is obviously a wide spread trade out of a lot of different things. There is nothing new about this. These types of corrections have happened countless times before, as recently as last spring and last spring was much worse (look at a chart of EEM), and I promise there will be many more in future.

Other than Venezuela, the fundamentals for any story you likely care about have not changed unless you were betting on a cold winter as a catalyst for energy. Many corrections start for no reason at all and then turn up for no reason. This just flat out goes with the territory and you will have to think in time frames of longer than a week or two or you will drive yourself crazy.