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Rallies and Reversals

XSB in your fixed income quiver

The choice of ETF’s in the fixed income arena is continually expanding as we face uncertainty about markets, the economy and interest rates. One thing for sure is that if interest rates rise bond prices will fall and your fixed income portfolio will drop. The question is how will you manage this supposedly secure portion of your portfolio? There are a number of choices, you can adjust duration, shift sectors, ladder your portfolio or trade it. Let’s explore XSB.

The iShares CDN short bond index (XSB) replicates the performance of the DEX Short Term Bond Index and consists of a range of investment grade federal, provincial, municipal and corporate bonds with a term to maturity between one and five years. There are 182 holdings with a weighted average term to maturity of 2.89 years, duration of 2.7 years, a weighted average coupon of 4.25% and a weighted average yield to maturity of 2.24%. This is as of March 12, 2010.

Over the last year XSB has traded anywhere from about $29 (support) to $29.58 (resistance). Although 2% volatility is not a lot to work with, there appears to be a range it is trading within and something to work with from a technical perspective as we move into a changing interest rate and economic environment. Over the last year the current price has traded as many times below the 50-day moving average as above. Today the current price is $29.21which is below the 50-day moving average ($29.28). Both MACD and relative strength indicators are bearish.

Looking forward, we have some arguments that may warrant a closer look at using XSB as a vehicle to trade. The summer is typically a period of seasonal strength for bondholders, as investors sometimes sell in May and go away for the summer. So far XSB has shown some signs of negative correlation to the TSX. Secondly, there is talk of interest rates increasing as early as June or July. You will want to hold shorter-term bonds. XSB has duration of 2.7 years, which means if interest rates rise by 1%, the price of the bond pool will fall by 2.7%. Thirdly, fixed income will be difficult to make money in as interest rates rise. Pimco, the world’s largest bond-fund manager argues that you need to be active. They filed with the Securities and Exchange Commission to roll out six new bond ETF’s. This is an indication to me that they want to offer investors more choice and flexibility in fixed income to address the challenges of managing fixed income portfolios in a rising interest rate environment.

Using XSB can be a double-edged sword. It is an open-ended fund with no fixed maturity like an individual bond so the price can go down for an extended period when interest rates rise. When an individual bond mature you receive your principal plus you have received the coupon while you owned the bond. The positive side of owning XSB is that it is liquid so you will have no problem buying or selling it.

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Posted: Mar 17, 2010 / 5:00 am
Story# 53344  /  Contributed




Reality of real return

In the past 20 years interest rates have fallen and fixed income investors have done well. We are faced with record low interest rates and most economists would agree that the outlook for interest rates is higher. This will have a negative impact on your bond portfolio. The questions are, when will governments raise interest rates and how should you manage your fixed income portfolio in rising interest rate environment? I would say you have a number of choices, however, your approach should be flexible and active. Over the next few weeks I will explore some fixed income choices in a series looking at investing in a rising interest rate environment.

The objectives of iShares CDN Real Return Bond Index Fund (XRB) are to provide income by replicating the performance of the DEX Real Return Bond Index which is a market capitalization index of mostly Canadian federal and provincial real return bonds. It has 13 holdings with a weighted average term of 21.07 years, a coupon of 3.57%, a weighted average yield to maturity and a weighted average duration of 15.77 years. Duration is a measure used to identify the impact that a rise in interest rates would have on the price of a bond or pool of bonds. So for example, with duration of 15.77, a 1% increase would mean a price decline of 15.77%.

Over the last year the XRB has risen in price from a low of about $18 in March 2009 to a recent high of about $20.75 in late January/early February. Since crossing the 50-day moving average in March last year the current price has been steadily increasing, despite the odd dip below the 50-day moving average. On February 8, 2010 the current price broke below the 50-day moving average and then broke below the 100-day moving average on March 5, 2010. Not only is this a technically bearish signal but also relative strength and MACD are also bearish from a technical perspective.

In the past year, XRB appears to be positively correlated to the S&P/TSX. Not the case in the past month. So what has happened? Scotia Capital reported that the bond market sold off as investors had a renewed appetite for risk and equities rallied. Government of Canada bonds weakened on the back of strong corporate earnings and a much better than expected Q4 GDP. XRB may have also been affected by the view that interest rates could rise in Canada in the 2nd half of 2010. It is worth noting that XRB holds mostly government bonds and 98.40% of its holdings mature in greater than 10 years. As mentioned above the duration on XRB is 15.77 years so any news of rising rates would scare off investors. The other variable that will affect this fund is inflation. Real Return bonds have a portion of their value pegged to the inflation rate. This should work in a positive way if we expect inflation to rise. The most recent debate has been whether inflation or deflation will be a problem and I think the jury is still out, however neither seems to be taking the lead. Mixed data has given the governments the ability to message inflation is not a risk at the moment so rates don’t need to rise until later. It is rare that interest rates move higher unless they are accompanied by inflation but it is also possible that rates could rise even without inflation. After assessing this fund, it appears that like the markets there are a number of factors beyond inflation influencing where this fund will go. In a rising interest rate environment it is a legitimate choice for fixed income as long as you are active with it and you understand all of the variables that influence it’s price changes.

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Posted: Mar 10, 2010 / 5:00 am
Story# 53177  /  Contributed



Canadian market: going for gold

After the euphoria of the Olympics, will some of the optimism spill over into the markets? I doubt the correlation between the “Own the Podium” and “Own the Market” will hold based on the fact that the Canadian Olympic team broke records in terms of how many gold medals our athletes won. However, there are some technical and fundamental indicators that point to a gold medal for the markets this year.

The iShares CDN S&P/TSX 60 Index fund (XIU) replicates the performance of the top 60 companies traded on the S&P/TSX in Canada. Since the low for the markets in March 2009 the price of XIU has gone from $11.57 to a high of $17.65 in December and closed on Friday at $17.14. It has generally found support at the 100-day moving average over the last year, however, that trend was broken on January 20, 2010 when the current price dropped below the 100-day moving average. On February 17th, 2010, the current price rose above the 50 and 100 day moving average presenting a buy signal from a moving average perspective. The caution would be that the relative strength and MACD signals are currently positive but have been exhibiting a downward slope. The other significant technical factor is that the S&P/TSX has been trading in an approximate range between $11,000 and $12,000 since last September. The range for XIU is with support at about $16.20 and resistance at about $17.65. The strong uptrends in the moving averages are levelling off. Even though the market is displaying bullish signals right now, it’s not overly bullish.

Fundamentals seem to be strong from a perspective of the latest economic reports. The Globe reported today that the “The Canadian economy expanded by a greater-than-expected 5% in the fourth quarter, raising the likelihood of interest rate hikes later this year…. The Bank of Canada announces its interest-rate decision tomorrow, and while rates are on hold for now, the tone of the announcement could well acknowledge that growth is picking up speed at a faster pace than anticipated.” This poses another question about what will happen when the government raises rates. Not only to the bond market but to the stock market too. Another issue to look at in fundamental analysis is the consumer. Consumer spending is one of the contributors to earnings growth. Earnings growth tends to be one of the major contributors to stock market prices. “Canadians are feeling more positive about the economy. A consumer outlook index, released separately by RBC today, showed growing optimism last month, with 62% now saying they expect the economy to improve the next year.” Despite this, according to Scotia, about a third of the companies have reported earnings so far in Canada and most have missed expectations. Although things look promising for the gold again in Canada, the market will have it’s work cut out for itself.

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Posted: Mar 3, 2010 / 5:00 am
Story# 53020  /  Contributed



The uncertain futures of gold

Recently the price of gold has fallen from its high. The last time I wrote about gold it was in September and it had broken through $1,000 and was trading at $1,023.85. At the time one of the factors at play were speculators holding net long positions in U.S. gold futures for the week ending Sept 15, 2009. In addition, U.S. gold futures for December delivery fell $8.20 an ounce. Interesting dichotomy, telling us how much insight we have into the fate of the price of gold. Since then, Gold rose above $1,200 in December, a lifetime high. Today spot Gold was at about $1,130. U.S. gold futures for April delivery fell $8.40 an ounce to $1113.50. Is this a sign that the shine is coming out of gold or are we in the same position as we were in September?

To gain some insight it is worthwhile understanding what has been driving the price of gold lately. Gold tends to be negatively correlated to the U.S. dollar. In a London Reuters article by Maytaal Angel on Feb 22, 2010 “Gold dips as dollar recovers…” recent gold moves are explained. “A stronger (U.S.) dollar weighs on gold as it dents the metals appeal as an alternative to the U.S. currency. It also makes dollar-priced gold costlier for non-U.S. investors…. Gold, sometimes bought as a safe haven asset has been moving in line with risk appetite and risk assets in recent weeks.”

To get some sense of gold’s reaction to uncertainty we can look at XGD (Barclays iShares S&P/TSX Global gold exchange traded fund), which is made up of gold companies like Barrick, Kinross and GoldCorp. XGD replicates the performance of gold companies, not the bullion itself so they will operate slightly differently than the price of gold, however, when we look at XGD we can see that it did peak in early December at $24.53 and is now trading at $19.95, generally rising and falling with the U.S. dollar. Over the last year the current price has maintained support above the 200-day moving average until January 21st of this year. On Feb 18th the current price bounced against this resistance point and failed to break through. Back in September last year the 200 day moving average was below the current price and served as a support function not a resistance function, like today. From a technical perspective, I would want to see if the current price could break through this point of resistance.

To find out more about the future of Gold and other sectors we will be hosting our 2010 Outlook featuring Gareth Watson, Director Canadian Equities of ScotiaMcLeod, in the 1st week of March. Seating is limited so please call me at 250-868-5525 to reserve your seat.

Recently the price of gold has fallen from its high.  (Chart:  Contributed)
Recently the price of gold has fallen from its high. (Chart: Contributed)
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Posted: Feb 24, 2010 / 5:00 am
Story# 52898  /  Contributed





About the Authors

David Allard David Allard has 16 years experience in the financial services industry. He specializes in creating and managing integrated and comprehensive wealth management solutions for affluent clients. Most recently David was a Portfolio Manager for a leading Canadian investment management and private banking firm. He graduated from the University of Manitoba with a degree in Economics. He also completed an MBA degree. David is a member of the Chartered Financial Analyst (CFA) Institute and a founding member and past president of the Okanagan CFA Society. David resides in the Okanagan with his family. His interests include golf, tennis, mountain biking, skiing and triathlons. Over the years, David has volunteered with the Canadian Cancer Society, United Way and Big Brothers.

Email: david_allard@scotiamcleod.com

Website: http://www.yourlifeyourplan.ca






The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet presents its columns "as is" and does not warrant the contents.



These articles are for information purposes only. It is recommended that individuals consult with a financial advisor before acting on any information contained in this article. The opinions stated are not necessarily those of Scotia Capital Inc. or The Bank of Nova Scotia. ScotiaMcLeod is a division of Scotia Capital Inc., Member CIPF.



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