ETF Portfolio: Sticking With Taiwan

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 |  Includes: DBA, EPI, EPOL, EWH, EWT, EWW, EWY, EWZ, FEZ, FXA, FXE, FXI, FXY, GLD, IXC, IXG, RSX, SPY, TLT, TUR, XPH
by: John Crossman

This week the market was less than kind to the portfolio, taking a 3.24% bite, leaving us just a hair over 5% down over the 10 week period since we started.

If you look at the ranking, Market Vectors Russia RSX just pips out iShares MSCI Taiwan Index EWT to squeeze into the top 3. Normally that would precipitate a switch trade but since RSX was one of the assets I had targeted for replacement at the quarterly review in two weeks, I am comfortable hanging onto EWT as long as it can maintain its #4 position or better.

Why am I comfortable with Taiwan?

The main index (which can be found on Yahoo as ^TWII) has been trying for almost a year to break through the 9,000 mark. It has now breached the mark a few times this year and although the follow through has been a bit lackluster, I would not be surprised if we saw a bit of a post-Chinese New Year (Feb 2-4) rally that could take the index to new heights (as momentum driven local investors climb on board). The real medium action on EWT is the Global IT Supply Chain which, thanks to some stronger than expected results, appears to be in rude health although that could just be due to a reasonably strong holiday sales season. Corporate IT budgets for 2011 will start to be spent so the next few quarters will either confirm or refute the trend.

Why replace RSX?

I included RSX in my universes several years ago because it was part of the then trendy BRIC investment theme pumped by sell side brokers and enthusiastically picked up by fund managers around the globe. Chindia (China and India) was the big theme of 2005/6 just prior to BRICs. The popularization of these themes tends to push a lot of spare investment funds into relatively small emerging markets. Efficient Market Hypothesis breaks down under the wave of cash and solid trends can be exploited when certain emerging markets become “flavor of the month.”

Russia is primarily a resource play with massive oil and gas reserves. The EU's largest and most dynamic economy, Germany, has been moving closer politically with Russia in no small part due to the massive amounts of Russian gas that is piped to Germany. When oil and gas prices are rising, RSX is a “go to” investment (Oil and Gas make up 38% of the ETF holdings).

The reason we see RSX moving into the top 3 is the same reason we saw Energy IXC move two weeks ago. Energy prices are firming up and while the U.S. is unlikely to dash forward with 6 or 7% GDP growth this year, 3-4% is very likely. Europe’s overall growth may not be inspiring but the average for the EU masks a big disparity between the core (Germany and close neighbors) and the peripheral states that have dominated the bond market news over the past few months. India, China and other emerging markets look poised to grow and with their relatively energy thirsty economies (higher energy input per dollar of GDP than the developed countries), the demand for energy looks set to stay strong.

So, I should be excited about doubling up on energy this week. But, taking the longer term view, I would like to see if there isn’t a more promising long term place to invest. The ugly demographic picture has kept Japan out of my universe and I am afraid that Russia’s demographic profile looks no more promising (the big difference is that the Japanese are already rich on a per capita GDP basis). When comparing Russia’s demographic profile to the other BRICs, Russia is the odd one out. China may get there in a decade or two but that is over my investment horizon. So, I will maintain my interest in Brazil EWZ, India EPI and China FXI, but, since I have IXC to pick up positive vibes in the energy market, I think it is time to find a better play for RSX.

Could Poland be the next big thing?

The market that I am considering is Poland, which is another one of Stratfor’s long term picks for the next century. I will be looking at the various options in the ETF range but so far, I am leaning towards EPOL. In terms of correlation with RSX, I doubt I will be missing much as one can see from this Yahoo Finance Chart. One of my issues is the relative youth of the ETF. The other is the heavy weighting in financials (44%) which means that interest rates and by extension exchange rates need to be watched closely (part of what haunted me with Turkey TUR).

On the positive side, Poland looks set to become an important economy in Europe over the next 10 years. More research will need to be done to see if the time is right or if this can wait another three months.

Disclosure: I am long EWT, EWW, IXC.