It starts with a 100-year perspective. Unlike most American homes that are designed to last only decades, every aspect of this house is built to 100-year standards.

Built through a partnership between Boulder-based Vireo LLC and WeberHaus GmbH & Co. KG, this home was manufactured in Germany to precise tolerances (1/2 inch over a 100-foot span) and then shipped to the U.S. Once it arrived on site, assembly took a matter of days as there was no additional fabrication required.

See video below for a time lapse:

www.youtube.com/watch?v=wFwn4vhPhAo

One of the less obvious benefits of such a short on site build time is cost overruns on typical construction projects due to weather, coordinating large numbers of contractors, and delivery delays in supplies and materials are practically eliminated. Further, construction site waste is cut from an average of 17% to a claimed 2%.

As you might imagine, it has an array of solar photo-voltaic panels, a gray water recycling system and ultra efficient lighting and appliances. It’s also pressure tested to 3 atmospheres so the only air exchange (through an ultra-efficient heat exchanger) is for freshness. As such, it only requires about 18% of the energy of the average home.

To learn more about this unique home, visit the 2002 Alpine website for more information.

Many thanks to David Scott of Colorado Landmark Realtors.

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Roth Conversions in summary

For a primer on Roth IRAs, please click here.

The law currently allows for IRA owners to “convert” up to 100% of their existing tax-deferred accounts (traditional IRAs, rollover IRAs, SEP IRAs, SIMPLE IRAs, etc.) into a tax-free account, also known as a Roth IRA.  Once a regular IRA is converted to a Roth IRA, no taxes will ever be owed on any future investment earnings or distributions.  However, every dollar that is converted will be taxed at today’s ordinary income tax rates.

Anyone with an IRA is eligible for the conversion as there are no restrictions on age, income or marital status.  Conversions are irrevocable, except as noted later in this article.

What’s unique about 2010?

2010 has generated Roth conversion fever for two reasons:

1. Prior to 2010 there was an income restriction where if you had more than $100K in modified adjusted gross income (MAGI), you were ineligible for a Roth conversion.  This restriction has been lifted for 2010 (and future years) and therefore there is a large group of more affluent investors who were previously ineligible to convert.
2. If you convert your IRA to a Roth IRA in 2010, you can split the taxes owed in 2011 and 2012 as opposed to having to pay them all at once.  If you convert in future years, all the taxes are owed by the filing deadline in the following year.

Arguments for conversion:

1. Tax rates are at historical lows

2010 in particular is likely to be one of the last low tax years for the foreseeable future.  Therefore 2010 may be the last chance to convert at these more favorable rates.

2. Spread payment of taxes over two years (if converting in 2010)

You can liken this to an interest free loan from the government.  Rather than pay all the taxes associated with a 2010 conversion by April 15, 2011, you can split the taxes owed between 2011 and 2012.

3. Roth IRAs have no RMDs

Once an IRA investor turns 70.5, he or she must begin to take withdrawals from his or her IRA.  The amount that must be withdrawn is a percentage of the IRA based upon life expectancy tables and this percentage increases every year.

Investors who do not need the money and would rather leave their IRAs to their heirs, a Roth IRA can be a great way to accumulate income tax free.   It is worth noting however that non-spouse beneficiaries who receive a Roth IRA are subject to mandatory distributions.

4. Shift your wealth into a more protected environment

When you convert an IRA to a Roth IRA, taxes will be owed.  Normally it’s most prudent to pay these taxes from non-qualified (non-IRA funds).

For example, an investor has $1 Million in IRAs and $350K in non-IRAs.  If he were to convert his entire $1Million in IRAs to a Roth IRA, he would likely face a tax bill of approximately $350K (although the exact amount owed would depend on his state of residency and other factors).  Therefore post conversion, he would be left with just $1Million in a Roth IRA.

This technique may provide more asset protection by offering greater shelter for the investor’s entire portfolio.  However this argument should be examined carefully with the aid of a competent lawyer as laws will vary from state to state and limits may apply.  Furthermore, as an alternative, an investor, if eligible, may gain greater overall protection by rolling his IRA into a 401(k).

Another item to carefully consider is whether the investor is ever likely to make investments that generate unrelated business taxable income (UBTI) as this type of income may cause the equivalent of double taxation within the IRA. Therefore these types of investments should normally be reserved for investments held outside of any kind of retirement account.

5. Reduce the size of your estate and therefore potentially reduce estate taxes

This benefit applies to more affluent IRA investors although it’s a hard one to nail down at the same time.  2010 currently has no federal estate tax, however most agree it will return in some form in 2011 and beyond.  In fact under current law, in 2011 the amount above which estate taxes are owed (at rates up to 50%) is $1Million.

Therefore a Roth IRA conversion may make sense to lower the overall value of an otherwise taxable estate.

6. Roth IRAs are tax-free

Many investors have seen the value of their IRAs decline since 2008 and although the markets have partially recovered, now may be a particularly good time if you feel your IRA is at a relative low point in terms of value.

This is because you pay income tax on the value of the IRA at the time of conversion.  Therefore if you convert an IRA worth $1 Million in 2010 and it increases to $1.2 Million by the end of the year, you will still only owe taxes on $1 Million.

7. Great tool for deliberately generating taxable income

At Caledonia we had a client who had very little taxable income due to unemployment.  Further, with very little taxable income, he had deductions and credits that would have otherwise gone unused.  By executing a Roth conversion, he was able to convert a significant amount of his rollover IRA while paying almost no income tax in the process.

Another example of when this technique can be appropriately used is when an elderly investor is facing large medical expenses.  Without the significant taxable income that a Roth IRA conversion can generate, large deductions again could be wasted.

8. Beneficiaries are in a high (or higher) income tax bracket

Consider the case where an elderly IRA investor has particularly affluent children he has named as beneficiaries.  It may make sense for him to do a conversion and pay taxes at his lower rate and pass on a Roth IRA to his kids as opposed to leaving the IRAs where the kids will pay tax on IRA distributions at their marginal income tax rates.

9. You have non-deductible IRAs

Non-deductible IRAs are IRAs where there are after-tax contributions.  If they are substantial, this may make sense as there is no income tax to pay on after-tax amounts that are converted to a Roth IRA.  Therefore you are left with the benefit of having converted a tax-deferred account into a tax-free account at no cost.

The potential fly in the ointment with this strategy is that you cannot select to only convert your after-tax contributions.  Instead there is a pro-rata rule that applies.  For example, if you have an IRA worth $100K with a $50K basis (after-tax contributions) and you wish to convert $50K, you will have to pay income tax on $25K or 50% of the converted amount.

Arguments against conversion:

1. Do you really want to stick your head inside the lion’s mouth?

Roth IRAs are supposed to be tax-free.  This means all earnings and any subsequent distributions should be free from income taxes.

However, currently there are trillions of dollars invested in IRAs in America.  What is the likelihood that if a similarly large amount ultimately winds up in Roth IRAs the government will stand by its promise of keeping Roth IRAs tax-free?  Do you really want to take the bet Congress will overlook “millionaires” in the future that aren’t paying any taxes?  Congress didn’t back in the ‘70s and enacted some nasty legislation that lives on today in the form of alternative minimum tax (AMT.).

And it may not just be millionaires that may be ultimately at risk.  Social Security benefits were supposed to be tax-free; at least they were up until 1984 when Congress amended the Social Security Act.  Now up to 85% of a recipient’s benefit amount can be subject to income taxes.

2. Where’s the fire?

Although converting in 2010 may be tempting for some, it’s also worth remembering that one can convert in future years too.  Doing so preserves the ability to do tax-planning year to year, particularly when doing annual partial conversions (discussed below).

3. Conversions are irrevocable

Aside from the limited ability to unconvert (see discussion below), Roth IRA conversions are irrevocable.

4. Ruining a powerful tax opportunity if leaving money to charity

Although you cannot contribute your IRA to a charity while living, you can leave it to charity when you die.  Therefore if you have this intention, a Roth IRA conversion may be disastrous from a tax standpoint.  Since charities have tax-exempt status, there is no reason trigger income tax through a Roth conversion if the money is going to charity anyway.

5. Need the money in five years?

A Roth conversion probably doesn’t make sense in the short-term if you’ll need the money anyway.

6. You will be in a lower tax bracket in the future

This might apply if you’re a baby boomer on the verge of retirement.  Therefore why pay tax at a potentially higher rate now?

7. You don’t have the money to pay the taxes

This is a particular concern for someone under age 59.5.  If you don’t have a separate source of funds and instead make a withdrawal from your IRA to pay for the taxes owed, you’ll be hit with an additional 10% penalty on the withdrawal amount itself.

8. Conversion pushes you into a higher tax bracket

This is a concern because not only are you paying more taxes at the marginal rate, your effective tax rate may also increase due to phaseouts and high thresholds on certain deductions.

Partial Conversions:

Many investors find reasons for and against doing a Roth IRA conversion.  Therefore one approach is to hedge your bet or only partially convert your IRA.  By only converting a portion of your IRA into a Roth IRA, you may benefit from tax diversification if you wish to keep a portion of your portfolio in tax-deferred IRAs.  Alternatively executing partial conversions on an annual basis allow you to control how much income tax you pay from year to year.

Unconversions – for those with buyer’s remorse?

Interestingly, although the deadline for conversion is year end for any particular tax year, you may “unconvert” your conversion, partially or wholly, up until your tax filing deadline plus extensions the following year.

This may be particularly useful if you have underestimated your income and wish you hadn’t converted so much of your IRA.

Tricks:

1. Although the income limitation on Roth conversions has been lifted, there is still an income limitation of $167K (for married filing jointly taxpayers) where your ability to contribute is phased out.  However you can always make a non-deductible contribution to a traditional IRA without regard to income.  Therefore, if you fall into this higher income category, you can make your non-deductible contribution and then immediately convert it to a Roth IRA.  Further you can repeat this strategy every year.  The only important trap to watch out for is the pro-rata rule with respect to non-deductible IRAs (discussed above).
2. Although the deadline for conversion is always year end for any particular tax year, you can unconvert your conversion, partially or wholly, up until your tax filing deadline plus extensions the following year.  This has lead some investors to consider trying to arbitrage their conversion by deciding whether the performance of their investments indicates they should unconvert.  For example, say you have a $1 Million IRA that you convert to a Roth IRA.  You then invest it aggressively and lose 40%.  Provided you are still inside the deadline for unconverting, you could unconvert, and avoid paying income tax on $1 Million.  You could even convert your IRA to a Roth again and this time only pay taxes on $600K.

Traps:

1. If you are subject to a required minimum distribution (RMD), make sure you take it from your IRA before you execute a total Roth conversion.  This is very important because a Roth IRA conversion will not satisfy your annual RMD.
2. Make sure you have separate funds to pay your tax bill if you’re under 59.5.  If you intend to make a withdrawal from your IRA to pay for the extra taxes and you are under 59.5, you’ll be hit with an extra 10% penalty.  And if you don’t have the funds to pay for the 10% penalty, you’ll wind up taking even more from your IRA thus making a bad situation even worse.

Important Dates:

• 12/31/10 – This is the deadline by which you must convert if you wish for your Roth IRA conversion to be effective in tax year 2010.
• 4/15/11 – This is deadline date that 50% of taxes owed due to 2010 conversion are due the IRS.
• 10/15/11 – This is the final date (individual tax filing date plus extensions) by which a conversion for 2010 can be unconverted either partially or wholly.
• 4/15/12 – This is the date by which the other half of taxes are owed for a 2010 conversion.

Summary

Although the financial services industry is marketing the Roth IRA conversion in a push for new business, at Caledonia our general view is that conversions, especially 100% conversions, should be approached cautiously.  Every situation is unique and even in cases where the arguments appear compelling, make sure you are working with an experienced advisor or CPA who can offer you a thorough and balanced analysis.

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A significant difference from the tech decade, however, is that while many of those start-ups were founded on ground breaking technologies, there is more stability within the world of alternative energy.  For one, it is not just start-ups that are pushing the advancement forward.  Large and established companies that have worked in the power industry for decades are recognizing the need to diversify their operations to keep up with the inevitable switch to more sustainable fuel and energy sources. A good example of this has been in the Natural Gas industry.  No matter what your opinion on the fuel as a possible intermediate, cheaper, lower emission substitute (see earlier post), the recent acquisition of a number of natural gas producers by giant oil companies has clearly shown they will not allow the investment opportunity to pass and at worst will make a very safe hedge to their existing operations.  Other firms focused on infrastructure and power delivery see opportunity in improving efficiencies within the distribution markets, not only at the corporate level, but within households and through smart grid system technology.

With so many different ways (and different scales) to invest, it only makes sense that  investment vehicles are growing in number to support the demand and variety of nuances within the marketplace.

Outlined below is a summary of the current key funds in the ETF world and the areas they focus on.

Broad Based Clean Energy Sector ETFs

These funds provide broad based exposure to a wide range of renewable sources.  Many are global in nature providing international exposure as well as diversifying between the various types of power sources.  With the US still to determine the exact scale and direction it will take in pursuing alternative energy, having assets backed by international countries that have already pledged support to comprehensive energy changes is very significant.

PowerShares WilderHill Clean Energy Portfolio (PBW): PBW tracks the WilderHill Clean Energy Index, a benchmark that tracks companies that focus on greener and generally renewable sources of energy and technologies that facilitate cleaner energy. It holds 53 securities and is heavily exposed to companies in the electrical equipment sector.

Market Vectors Global Alternative Energy ETF (GEX): This ETF holds 30 securities and is heavily exposed to firms in the U.S., which make up 44% of the fund’s total assets. GEX is diversified among a variety of alternative power sources; its top holdings are Westas Wind Systems (9.5%) and solar giant First Solar (6.7%).

PowerShares Global Clean Energy Portfolio (PBD): PBD consists of 88 securities and has nearly one-third of its exposure to U.S. firms, the largest single country allocation. Additionally, the fund is heavy on mid and small cap securities; just 14% of the assets are classified as large cap firms.

PowerShares Cleantech Portfolio (PZD): PZD consists of 78 firms which focus on knowledge-based products or services that improve operation, performance, productivity, or efficiency, while reducing costs, inputs, energy consumption, waste, or pollution. PZD’s top holding is Schneider Electric (2.8%).

iShares S&P Global Clean Energy Index Fund (ICLN): This iShares fund allocates its holdings to a wide variety of alternative energy sources. Besides solar and wind, the fund also invests in firms that produce biomass and ethanol and geothermal producers. The top sector is electrical equipment, which makes up about 53% of assets. Independent power producers make up nearly 25% of holdings.

Wind Power ETFs 

Wind power is going from strength to strength across the world.  In the US alone, Texas broke a record in March earlier this year when wind energy supplied 19% of the total grid energy to the state.  Granted, this was a one time event, but it does show how significant a contributor this form of energy production can be in the future.  On a global level, power generated from wind grew by more than 31% in 2009 alone, while China more than doubled its wind power output in the year.

First Trust ISE Global Wind Energy ETF (FAN): FAN offers investors global exposure to the wind industry, allocating 26.2% of its assets to Spanish equities, 16.3% to the U.S. and 14.9% to Germany.

PowerShares Global Wind Energy Portfolio (PWND): This ETF also offers investors global exposure, and is diversified across market capitalization levels with nearly equal allocations to large, mid, and small cap securities.

Nuclear Power ETFs

Nuclear power has become a  debate that splits environmentalist opinion as much as it does members of the general population.  Security fears, as well as catastrophic disasters such as Chernobyl have made this a political battleground regardless of the energy issues it presents.  For countries that have already implemented nuclear power on a large scale, they have benefited a great deal from proven clean energy that can supply almost all of its energy requirements.  France is often heralded as the prime example in this case as it generates almost 80% of its electricity in this way.

iShares S&P Global Nuclear Energy Index Fund (NUCL): NUCL holds 24 securities, maintaining heavy exposure to the electric utilities sector (50.9% of the total assets). Besides the U.S., which makes up 32% of the fund, NUCL offers global exposure by investing 14.6% in Japan, 13.2% in Canada, and 10.1% in France.

iShares S&P Global Nuclear Energy Index Fund (NLR): This fund is well diversified among market capitalization levels with roughly an equal amount in each of large, medium and small cap securities. While other funds in this segment focus on power generation, this fund allocates 36.6% to uranium mining and 4.5% to uranium storage, offering investors exposure to a seldom-tapped segment of the industry.

PowerShares Global Nuclear Portfolio (PKN): This ETF tracks the WNA Nuclear Energy Index, which follows globally-traded companies engaged in the nuclear energy industry. The benchmark represents reactors, utilities, construction, technology, equipment, service providers and fuels. It is heavily focused on large cap firms, which make up roughly two-thirds of the fund’s total assets.

Solar Power ETFs 

Solar PV production costs continue to drop dramatically and many producers are optimistic that price parity may be approaching faster than expected.  The advent of new thin film technologies as well as other game changing technological advances positions solar well in the alternative energy race.  Outside of the technology, there are problems to be resolved at governmental levels where heavy subsidies and changes to tax laws have added significant and unexpected pressures.  The once thriving solar industry in Spain is suffering considerable losses in this regard, and even the global leader, Germany is facing tough policy changes that will impact the industry.

Market Vectors Solar Energy ETF (KWT): This ETF focuses on mid cap securities, which make up more than half of the fund’s total assets. KWT’s top holdings are Renewable Energy Corp. and MEMC Electronic Materials, which combine to make up 22.6% of the fund’s total assets.

Claymore/MAC Global Solar Energy Index ETF (TAN): TAN offers investors a greater level of exposure to small cap securities by investing slightly more than two-thirds of its total assets in small cap firms. Its largest holding is First Solar, which makes up 10% of the fund’s total assets.

Miscellaneous Clean Energy ETFs

These ETFs focus on a specific clean energy niche, and as such do not belong in any of the other categories. The majority of these funds focus on a specific fuel source (such as biomass), or seek to benefit from a greener lifestyle through more progressive transportation or carbon trading programs. These are some of the most targeted ETFs on the market today, and many have relatively low trading volumes.

PowerShares WilderHill Progressive Energy Portfolio (PUW): This ETF takes a unique approach to alternative energy investing by focusing on U.S.-listed companies that are engaged in transitional energy bridge technologies, with an emphasis on improving the use of fossil fuels. PUW offers exposure to sectors that many other clean energy ETFs do not touch, such as auto components (7.8%), chemicals (7.8%), and oil, gas and consumable fuels (17.9%).

PowerShares Global Progressive Transportation Portfolio (PTRP): PTRP focuses on companies that develop and produce cleaner and more efficient means of transportation. This ETF has a heavy focus on industrials (57.7%) with a large allocation to consumer discretionary firms as well (19.3%). Its top holdings include Clean Energy Fuels Corp., which provides natural gas for vehicle use, and Piaggio & C.S.p.A., which is an Italian company focusing on the production of scooters and motorcycles.

iPath Global Carbon ETN (GRN)- This ETN tracks the Barclays Capital Global Carbon Index Total Return which is designed to measure the performance of the most liquid carbon-related credit plans and is designed to be an industry benchmark for carbon investors. The index currently includes two carbon-related credit plans: European Union Emission Trading Scheme or EU ETS Phase II and Kyoto Protocol’s Clean Development Mechanism.

Elements CS Global Warming ETN (GWO): This fund tracks an equally weighted index that consists of 50 companies that have a focus on products that minimize global warming. The fund charges an expense ratio of 0.75% and is up 52% over the past 52 weeks.

First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN): QCLN invests in firms that are engaged in the manufacturing, development and distribution of emerging clean-energy technologies such as solar, photovoltaics and advanced battery technologies. Its top holdings include Cree (8.4%), a leading maker of LED technology.

Disclosure – Caledonia Wealth Management, Ltd. invests in numerous ETF’s centered on the alternative energy sector including some of those listed above.
Thanks goes to Eric Dutram and ETFdb for content help.

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Brazil has the largest economy in South America and ranks as the world’s fifth most populous country and tenth largest economy.  It is uniquely situated in that it shares borders with every country in South America with the exception of Chile and Ecuador.  The country has rebounded strongly since the economic problems of 2007,  driven by domestic demand as rising incomes create a growing, increasingly consumer-oriented middle class .  Brazil is also seeing greater freedom in its export policy, which has led to strong ties with China.  In fact, China surpassed the US in 2009 as the largest trading partner.  While many assume that trade must be one of the biggest drivers of the economy, it actually only represents a small part of Brazil’s GDP and these exports are further diversified geographically with a low dependence on external financing and reserve accumulation.  Incredibly, this has led to Brazil’s international reserves being able to cover the country’s sovereign and private external debt obligations. 

With a growing consumer market that has been supported by government aid, there has been a significant upswing in merger and acquisition activity.  Sectors such as finance, consumer retail and agribusiness are seeing more takeovers, corporate restructuring and ventures.  These pressures are looking likely to result in an increase in rates to a predicted 9% no later than April, as there is some concern that inflation could be a significant risk.  Banks are also getting in on the action, greatly expanding their credit positions while opening hundreds of agencies across the country in 2010.

With a change in Presidency this year not looking to upset the apple cart in terms of economic direction, good things seem to occupy the horizon for a country that will have a chance to show off its growth, development and place in the global economic order in Rio at the 2012 Olympics.  There is also a wave of competent business expertise flowing through the corporate landscape in Brazil.  One example is Eike Batista, predicted to be the worlds richest man in a couple of years due to the enormous wealth he has built in Brazil and beyond.  For a very engaging interview with Batista, watch the Charlie Rose Show online and find the video in the archives on 02/08/2010.

The simplest way to invest and get exposure to the Brazilian markets beyond individual stock selection is through the ETF’s iShares MSCI Brazil Index (EWZ), Market Vectors Brazil Small-Cap (BRF) and a currency option is Wisdom Tree Brazilian Real (BZF).

Click on the above links for more details on these funds, and check back for another post that will profile them in more detail.  Part 2 of this series will take a look at Chile and why it may follow in Brazil’s success as a strong emerging market.

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SeekIng Alpha (SA): In your portfolios currently, how are you allocating among different asset classes?

David McMillan (DM): At the beginning of 2009 our biggest concerns came from a number of directions. We wanted to ensure that if the declines of the previous year continued we would be protected on the downside from further drops in portfolio values. We also needed to ensure that if we saw a dramatic recovery we could participate and generate respectable returns. It was the classic problem of trying to have low risk with solid growth, and in one of the most challenging economic periods of our time. As active managers, it wasn’t enough for us to sit on the sidelines and hope that a recovery would erase some of the losses that 2008 delivered. This led to holding a diverse mix, heavily weighted in fixed income investing, including treasuries, inflation protected bonds, corporate bonds, international bond funds, high yield bonds, commodities, and limited number of domestic and international equities (particularly in the green and clean technology areas). This saw us outperform our market benchmarks with lower risk levels. We had seen numerous opportunities within the fixed income space, and they didn’t fail to deliver. Even the higher risk fixed income investments were more attractive than most equity positions from a risk-return standpoint.

Disclosure:  Caledonia and/or its principals currently hold(s) position(s) in TBT

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Senator Timothy Wirth addresses delegates

On January 14th, Caledonia was proud to be part of a watershed moment in New York at the United Nations headquarters, where institutional investment leaders were present to construct a unified approach to the importance of a low carbon economy within the industry.  Investor groups representing $13 trillion called on US Congress and other global decision makers to “take rapid action” on carbon emission limits, energy efficiency, renewable energy, financing mechanisms and other policies that will accelerate clean energy investment and job creation.

Watch the video below for a summary of the summit.

Download the Investor Statement on Catalyzing Investment in a Low-Carbon Economy.

The message delivered from leading investment houses was clear.  Pursuing investments that play a greater role in reducing the economic effects of climate risk will be a significant part of the economic landscape in coming years.  Even for the skeptics who still doubt the hard evidence provided by the scientific community will be forced to follow this path, if for nothing more than to take out some insurance against the very real changes happening to the Earth’s climate.  What was also apparent is that few financial institutions are not waiting for barriers to be crossed, or policy implemented, before beginning programs and bolstering research and development.  In fact, there was a very real sense from groups like HSBC, Deutsche Bank, Goldman Sachs, CALPERS, CalSTRS and many others that have been significantly underway in their planning for a greater focus on areas of climate change and other environmental risks.

To watch the complete webcast from the event go to the UN site for coverage.

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Interest rate hike:

While there is still a lot of debate (and outright arguing) by the deflation vs inflation camps, it seems that we are seeing more of a swing toward at least one interest rate raise coming during 2010.  The overzealous stock market recovery, a likely (though small) improvement in unemployment numbers, commodity appreciation and a very real need for the government to inflate its way out of the enormous debt burden will all be drivers.

For reference, here is a chart that shows the historical Fed Funds rate since the 1950s and how infrequent the periods of ultra low effective rates are.

Higher Inflation, particularly Stealth Inflation:

There is an interesting push/pull going on with inflationary forces right now that is likely to swing backwards and forward for some time.  With commodity prices on a strong run in 2009 and showing no sign of weakness, we are inevitably going to see the trickle down of price increases into the broader economic landscape.  Supporting this has been an improving stock market, a weakening dollar and gains in corporate credit fundamentals .  The drag is on the demand side with high unemployment numbers, foreclosure rates and consumer spending still being very sluggish overall.  Balancing both sides appears to give the nod toward higher inflation over the short term, and significantly higher inflation over the 5-7yr range.  The spread on the yield curve in the US between long term issues and short term is also growing and is often a sign of inflation to come.  If the government sees consumers put under additional pain through retail price increases, a raise in rates will bring some of this back into check and managing consumer sentiment will be a key priority to keeping things as economically healthy as possible.

Stock Market Increase Followed by Slide:

Perhaps the greatest surprise of 2009 was the scale of the recovery we saw in the stock market.  With no real, fundamental or strong economic news underlying any prospects of a sustainable recovery it is hard to identify the areas of support that will allow this to continue.  This is also not to say that the stock market and economy have to trend together, as there have been many periods when this has not been the case.  It seems likely that we are in a period of multi-year ups and downs that could feasibly continue for another decade and will follow a similar pattern to what we have already seen since the start of the century.

This secular bear market type of activity is extremely difficult for investors to manage due to the rapid (relatively), changes in market performance that make entry and exit points difficult to determine for an active management approach.  Buy and hold strategies also suffer as you risk no appreciation (just look at the last decade) while enduring the gut wrenching roller coaster ride we saw in 2000-01 and 2008 where many converted their paper losses and fled to cash.  Our expectations are for the broader market both domestically and internationally to continue it’s late 2009 trend through the first couple of quarters of 2010.  What then happens may be largely dependent on how bonds react in the first half of the year.  Ironically, the biggest risk to the stock market could be the bond market, as it is likely that the Fed will not hesitate to pull liquidity and crash the stock market if the US continues to have difficulties in selling treasuries.

Long Term Bonds Get Hurt:

If you talk to bond traders right now, the conversation often comes back to the possibility of a bond collapse, particularly on longer duration Treasuries.  With the US Government needing to issue more debt, and also now printing even more money to buy Treasuries (the Fed bought $289million in 2009), the Treasury market is in a very unstable position.  Foreign purchasers have already scaled back their acquisitions greatly as they diversify into other holdings, and this will continue into 2010 and beyond unless we see a rate increase that will make the yields more attractive than they are now to outside investors.  The issue here is that with any type of rate hike (good for long term yields), there will be some significant declines in bond prices.  In fact, shorting long term Treasuries in 2010 and beyond may be the play of this decade.  Many hedge fund managers are already making dramatic changes to their bond portfolios and selling longer duration holdings out of their funds, resulting in an increasing yield and lower prices particularly at the 10year level and longer.  As the world starts to question the ability of US to pay back the money on its debt issuance, interest rates on Treasuries could dramatically increase not to mention the potential threat of the AAA rating the US currently enjoys on its government bonds.

Commodities Continue to Rally:

As mentioned above, there is something of an inextricable link between commodity price appreciation and the inevitable appearance of inflation, particularly when the growth curve has been as steep as we have seen in 2009.  Commodities may also prove to be the stealth inflation factor the government overlooks when it views its CPI figures.  We see the biggest gains to continue in energy, agriculture as well as industrial and to some extent precious metals.  Gold is forever the wild card and while we feel it has a large speculative component to its appreciation, that increases its risk dramatically, it is very possible that we will continue to see new highs.  Assessing whether recent commodity prices have been ‘real’, or largely attributed to currency depreciation is  a key component that needs to be factored in when considering the 2010 commodity landscape.  Even while we expect to see some strengthening of the greenback later in the year, slowing investment gains, commodities should continue to trend upward in 2010.

There you have it.  In very broad brushstrokes an outline of what we see for the rest of 2010.  Please contact us with any questions on the above commentary and to find out more about the services we offer at Caledonia Wealth Management.

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However a closer examination of the study is revealing.  While 2% may sound impressive and further the study highlights how the energy consumed in manufacture is actually less than that of an incandescent, it’s important to understand the assumptions.  While it may be true to say an LED is 35% more efficient to manufacture than an incandescent, this calculation is based upon a 25,000 hour versus a 1,000 hour expected life.  That a factor of 25.

What the study doesn’t explicitly state, although simple math reveals, is that on a per unit basis an LED bulb is actually over 16 times more energy intensive to manufacture than an incandescent.  On reflection this makes sense since the average LED is approximately 50 times more expensive than a regular incandescent bulb (the difference between 50 and 16 is explained by amortization costs associated with R&D and production).

So is this a dealbreaker for the LED?  No, at least not as long as the 25,000 hour lifespan for the LED is bona fide and the technology can be effectively employed for all standard light bulbs (heat dissipation is currently an issue for a 100 watt LED replacement in a standard fixture for instance).  Furthermore, consider the relative infancy of the mass production of LED bulb technology.  Much of the production cost and energy for an LED is encompassed in the unit’s technology itself.  LEDs are essentially solid state devices that use a circuit board.  Advances in this area are brisk to say the least and will inevitably see energy consumption and attendant costs decline as adoption rates increase.

Will LEDs light the way of the future?  Probably.  While the incandescent won’t go down without a fight with talk of substantial recent increases in efficiency on its own, further advances in technology will likely yield another 100% increase in LED efficiency.  Moreover it’s likely we’re fast approaching a tipping point as in 2007 Congress approved a phase-out of incandescent bulbs starting with the 40 watt bulb in 2012 and it’s hard to imagine demand for efficient lighting solutions waning in the face of uncertain energy prices.

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One such example was in the world of international fixed income, particularly at the government bond level.  Domestically, there are a number of fund choices out there that cover the full spectrum of fixed income options such as treasuries, municipal and corporate bonds, high yield bonds etc.  Exposure internationally has been much more limited, particularly for government rated bonds,  a great shame given the yields that some governments are offering on relatively high quality bonds.  Finding a safe haven in the US has been easy, but with yields of treasuries sitting at such low levels, such as the 5 year paying a 2.1% coupon, the gains are very limited.  Compare that to an Australian government 5 year bond offering 6.2% coupon and the rates become much more attractive.

Clearly, care needs to be given to countries that are in a developmental stage, as emerging market bonds have higher risk profiles than stable, established and developed economies and their ratings will reflect this.  That being said, investors turned off by the risks of equity investing may find this to be a nice compromise in offering a middle ground between AAA rated government bonds and traditional domestic and international stock market funds that are higher on the risk spectrum.  Brazil for example is offering coupon rates in excess of 10% on 2 year issues compared to 0.75% here in the US for the same duration, and this is reflected in the BBB-/A-3 rating Brazil currently has for government debt.

With a few new arrivals in the ETF space that fill this gap it is a good time to review the options open to the investor looking for international treasury bonds to help diversify their fixed income portfolio.  Below is a brief outline of 7 International Treasury Bond ETF’s.

International Treasury Bond ETFs

1) SPDR Barclays Capital International Treasury Bond ETF (BWX)
Top 5  Countries – Japan, Italy, Germany, Belgium, France
Exp. Ratio – 0.50%, Inception date – 10/02/2007, Ave credit quality – AA2, Ave Coupon – 4.29%, Ave Maturity-8.32yrs
YTD performance (10/31/09) – 8.60%

2)  iShares S&P/Citi International Treasury Bond ETF (IGOV)
Top 5 Countries – Japan, Germany, Italy, France, Spain
Exp. Ratio – 0.35%, Inception date – 1/21/09, Ave credit quality – AA, Ave Coupon – 3.41%, Ave Maturity – 7.60yrs
YTD performance (09/30/09) – 6.68%

International Short-Term Treasury Bond ETFs

3)  SPDR Barclays Cap Short-Term International Treasury Bond ETF (BWZ)
Top 5 Countries – Japan, Germany, Italy, UK, S Korea.
Exp. Ratio – 0.35%, Inception date – 01/15/2009, Ave credit quality – AA2, Ave Coupon – 4.18%, Ave Maturity -1.90yrs
YTD performance (10/31/09) – 13.04%

4)  iShares S&P/Citi 1-3 Year International Treasury Bond ETF (ISHG)
Top 5 Countries – Japan, Germany, Italy, France UK
Exp. Ratio – 0.35%, Inception date – 1/21/09, Ave credit quality – AA, Ave Coupon – 3.61%, Ave Maturity – 1.83yr
YTD performance (09/30/09) – 11.65%

Inflation Protected International Bond (TIPS) ETFs

5)  SPDR DB International Government Inflation-Protected Bond ETF (WIP)
Top 5 Countries – UK, France, Germany, Mexico, Brazil
Exp. Ratio – 0.50%, Inception date – 03/13/2008, Ave credit quality – AA3, Ave Coupon – 3.10%, Ave Maturity – 11.37yrs
YTD performance (10/31/09) – 19.66%

Emerging Market Bond ETFs

6)  iShares JPMorgan USD Emerging Markets Bond ETF (EMB)
Top 5 Countries – Brazil, Russian Federation, Mexico, Turkey, Philippines
Exp. Ratio – 0.60%, Inception date – 12/17/07, Ave credit quality – BB, Ave Coupon – 6.92%, Ave Maturity – 12.25yrs
YTD Performance (09/30/09) – 14.82%

7)  PowerShares Emerging Markets Sovereign Debt Fund (PCY)
Top 5 Countries – Ukraine, Venezuela, Rep. of Indonesia, Rep. of El Salvador, Rep. of Turkey
Exp. Ratio – 0.50%, Inception date – 10/11/2007, Ave credit quality – Ba1, Ave Coupon – , Ave Maturity – 7.59yrs
YTD performance (09/30/09) 36.94%

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