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Have Silver Prices Reached A Bottom? ETFs In Focus

There is no doubt that silver has taken cues from the recent free fall in gold prices amid concerns of an interest rate hike by the Fed in their December meeting. A rising interest rate environment lowers the appeal for zero-yielding precious metals like silver. Spot silver prices were recovering for most of October but started dropping from the end of the month following the Fed’s hawkish meeting and stellar jobs report. After enjoying a short-term spike in the wake of the gruesome Paris terror attack last Friday, spot silver prices fell again to its three-month low this week and are currently down more than 9% year to date and below the one-year high by 22%. Therefore, it remains a matter of debate whether silver prices are really crashing or have already reached their bottom. There are a number of factors which indicate that silver prices will indeed rebound and that too even strongly. First, although there is a strong chance of an interest rate rise, the most recent Federal Open Market Committee (“FOMC”) meeting hinted that the hike will be soft. This has led to a pullback in the U.S. dollar and again brightened the prospect of precious metals as an investment asset. Second, recent growth forecasts suggested that the global economic slowdown is more pronounced than expected. Recently, the Organization for Economic Co-operation and Development (“OECD”) cut its 2015 global growth forecast to 2.9% from 3% expected earlier. The sluggish growth will largely be due to China, which is projected to grow by 6.8% in 2015, its lowest in 25 years. Precious metals like gold and silver are considered as an excellent economic hedge during a prolonged period of economic downturn, as investors prefer them over riskier assets such as stocks. The present slide in silver prices also presents a good buying opportunity. Finally, since silver is used in a number of key industrial applications, China’s economic slowdown is expected to hurt its demand. However, the white metal is expected to draw leverage from its use as the best metallic conductor in solar panels. About 3 million ounces of silver are required to generate one gigawatt of electricity from solar energy. Increasing government efforts to curb carbon dioxide emissions are boosting the demand for solar panels across the world. Most of the demand is likely to come from China, which is expected to become the world’s largest installer of solar panels this year. Despite the white metal hitting a three-year low price this week, silver mining ETFs rebounded in the last five days (as of November 19, 2015). Investors should closely monitor the movement of these ETFs as the rally is expected to continue in the coming days. Global X Silver Miners ETF (NYSEARCA: SIL ) This ETF follows the price and yield performance of the Solactive Global Silver Miners Index, measuring the performance of the silver mining industry. The fund holds 25 stocks in its basket. Industrias Penoles Cp, Silver Wheaton Corp. (NYSE: SLW ) and Tahoe Resources Inc. (NYSE: TAHO ) are the top three holdings in the fund with allocations of 11.59%, 11.17% and 11.08%, respectively. The top 10 holdings account for 74.24% of the fund’s assets. The ETF is also highly focused on Canadian firms with a 57.96% share, followed by U.S. (12.34%) and Mexico (11.15%). SIL has gathered about $131 million in assets and trades in an average volume of roughly 78,000 shares per day. It charges 65 bps in fees from investors per year. The product lost 29.7% so far this year but was up 4.4% in the past five days. iShares MSCI Global Silver Miners (NYSEARCA: SLVP ) This ETF tracks the price and yield performance of the MSCI ACWI Select Silver Miners Investable Market Index, which provides exposure to companies primarily engaged in the business of silver mining in both developed and emerging markets. The fund holds 30 stocks in its basket. Canadian firms dominate the fund’s portfolio with a 59.49% share, followed by U.K. (13.52%) and the U.S. (9.58%). Silver Wheaton, Fresnillo Plc ( OTCPK:FNLPF ) and Industrias Peñoles occupy the top three positions in the basket with shares of 23.52%, 10.93% and 7.54%, respectively. The top 10 holdings comprise 71.4% of the fund. Notably, the fund also offers some exposure to the broader precious metals and minerals sector (29.72%) and gold (9.23%), apart from silver (60.84%). The product has amassed over $12 million in its asset base and trades in a paltry volume of around 17,000 shares a day. It charges investors 39 bps in fees per year. The fund shed 32.1% in the year-to-date timeframe but returned 2.9% in the last five days. Original Post Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

El Paso Electric: Fairly Valued, No Significant Upside

Summary We initiate coverage on El Paso Electric with a Neutral rating and TP of $40. The TP is based upon company’s future financial performance and historical valuation against industry peers. Current political situation in El Paso may cause challenges in reaching a settlement with the PUCT. Thus, the company would have to face uncertainty related to litigation. PVR anticipates the regulators of Texas and New Mexico to finally allow the significant increase in rate base. However, the current stock price is not including uncertainty related to regulatory. EE would have to apply for relief in rates in challenging jurisdictions as a result of new generation investment. Plain Vanilla Research ((NYSE: PVR )) initiates coverage on El Paso Electric Co. (NYSE: EE ) with a Neutral rating and a target price ((TP)) of $40. Since September, the stock price of El Paso Electric has outperformed the Utilities Sector by 7.28 percentage points (ppts). This is shown in the chart below: (click to enlarge) However, we think that the performance is not sustainable in the future as the company is facing challenges on multiple fronts. This restricts the stock from offering significant upside potential. In addition to that, a dividend yield of only 3% is not very attractive to tempt dividend investors. We will be discussing the challenges below: 1. Political Circumstances In El Paso In the past, proceedings related to change in rate base in El Paso have been engulfed with politics a lot. The company can be anticipated to face an interesting stance from the City Council officials as they will try to create challenges for the company to reach a settlement agreement. Furthermore, the supporters of solar-powered energy have also entered the arena as the publicly-listed corporation is trying to create alterations in rate design, which would cause installers of rooftop solar panels to make a partial requirements fee payment. Instead of reaching a settlement with the City Council authorities, we think the company should play the long game and wait for a decision from the Public Utilities Commission of Texas (PUCT). Although, the road is long and would result in higher uncertainty but it will result in a more favorable decision for the organization. 2. Approval From Texas And New Mexico Regulatory Authorities We anticipate that the regulatory authorities of Texas and New Mexico will allow the significant increase in rate base at the end. However, the current stock price reflects that investors expect the regulatory authorities to allow the increase in rate in any case. We think that slight hindrance in regulatory approval will result in the stock price on a downward trajectory. Texas is responsible for contributing roughly three-fourth to El Paso Electric’s bottom line. Meanwhile, the remaining contribution is from the state of New Mexico. 3. Demand For Rate Relief Requests In Challenging Jurisdictions El Paso has the finished the construction of two peaking units located at the Montana Power Station (MPS). In addition to that, the company will be finished with the construction of the third unit by spring of next year and by year-end, the company intends to complete the construction of the fourth unit. The four units are natural-gas powered and will have a capacity of 352 megawatts ((NYSE: MW )). These units are built to cater the increasing requirement of electricity in El Paso’s service territory. Montana plant and support infrastructure is anticipated to have a cost of $375 million. The company has been lucky to experience an annual growth rate of 1% to 1.5% for the past several years in the service territory. Normally, the industry has been seeing flat or decline in power consumption. Derivation Of Price Objective PVR has based its target price (TP) of $31 at earnings per share ((NYSEARCA: EPS )) of $2.67 along with a forward P/E multiple of 15.39x. The following forecasted income statement reflects as how we have arrived at our 2018 EPS. Currently, El Paso Electric’s stock is exchanging hand at PVR’s forward price-to-earnings (P/E) multiple of 15.44x. In the past three-years, the stock has traded at an average forward P/E multiple of 14.94x. This reflects that the stock is trading at a premium of 6.5% against its three-year average forward P/E multiple of 14.94x. (click to enlarge) Meanwhile, against its peers’ combined forward P/E multiple of 12.23x, El Paso Electric’s stock is presently trading at a premium of 26.2%. In the past three years, the stock has traded at an average premium of 22% against its peers’ combined forward P/E. (click to enlarge) We have arrived at our target forward P/E multiple for El Paso Electric by calculating the three-year average forward P/E multiple of 12.24x for the combined industry peers. After that, we have applied the three-year historical premium of 22% to the historical average peers’ combined forward P/E multiple to reach El Paso Electric’s target forward P/E multiple of 14.93x. We have formulated the peers forward P/E multiple by combining our forward P/E ratios of Consolidated Edison (NYSE: ED ), PG&E Corporation (NYSE: PCG ), PNM Resources Inc (NYSE: PNM ), American Electric Power Company Inc (NYSE: AEP ) and Xcel Energy Inc (NYSE: XEL ) along with El Paso Electric. We have given their respective P/E weight according to their market capitalization.

Asset Class Weekly: Emerging Market Debt

Summary In an effort to help investors discover the broad opportunity set beyond the stock market, I am introducing a new weekly report called The Asset Class Weekly. My priority each week is to explore in depth an asset class that might not be on the radar screen for the average investor. The inaugural Asset Class Weekly will focus on emerging market bonds. When people think of investing, their minds typically turn to the stock market. This perspective is certainly understandable, as the financial media concentrates nearly all of its time discussing the many stocks of companies that people like to own. And when accessing their employee retirement programs, the menu of fund offerings is typically made up stock mutual funds of all styles, sizes and geographies along with token bond and money market offerings thrown in to round out the line up. But capital markets have so much more to offer to investors than just stocks. And these various other asset classes can provide investors with attractive returns opportunities as well as the ability to better control risk through more meaningful portfolio diversification. Introducing The Asset Class Weekly In an effort to help investors discover the broad opportunity set beyond the stock market, I am introducing a new weekly report called The Asset Class Weekly. My priority each week is to explore in depth an asset class that might not be on the radar screen for the average investor. The inaugural Asset Class Weekly will focus on emerging market bonds. More specifically, the analysis will concentrate on the U.S. dollar denominated sovereign debt from emerging markets. Emerging Market Bonds So what exactly are emerging market sovereign bonds? It is debt that is issued by the government of developing economies around the world. The list of countries that make up a measurable part of the emerging market bond universe is vast ranging from Mexico, Brazil and Venezuela in the Americas to Ukraine, Latvia and Hungary in Eastern Europe and China, Indonesia and Malaysia in the Far East. Why the focus on U.S. dollar denominated debt? This is because a large number of bond issuance across the emerging world are done in local currencies. Thus, U.S. dollar denominated debt offerings from emerging market governments helps neutralize for U.S. investors the currency risk that would otherwise come with investing in this category. For example, those with exposures to bonds denominated in local market currencies stand to benefit if the U.S. dollar (NYSEARCA: UUP ) is weakening relative to these local currencies, but will struggle if the U.S. dollar is strengthening versus these same currencies. And in the current market environment where the U.S. Federal Reserve remains determined to raise interest rates while much the rest of the world is intent on easing, the U.S. dollar has been strengthening markedly relative to many of these local emerging market currencies. Hence the focus on the U.S. dollar denominated offerings at least for now instead. Gaining Investment Exposure Three exchange traded funds make up nearly all of the assets in the U.S. dollar denominated emerging market sovereign bond market ETF space. They are the following: iShares JP Morgan USD Emerging Market Bond ETF (NYSEARCA: EMB ) $4.7 billion in total assets 0.68% expense ratio PowerShares Emerging Markets Sovereign Debt Portfolio (NYSEARCA: PCY ) $2.7 billion in total assets 0.50% expense ratio Vanguard Emerging Market Government Bond ETF (NASDAQ: VWOB ) $514 million in total assets 0.34% expense ratio Why Emerging Market Bonds? Emerging market bonds provide measurable risk-adjusted return advantages and portfolio diversification benefits that makes the category worth monitoring for consideration in a diversified asset allocation strategy. First, U.S. dollar denominated emerging market sovereign bonds have a fairly low returns correlation relative to other key asset classes. Over the past eight years, the correlation of its weekly returns relative to the U.S. stock market as measured by the S&P 500 Index (NYSEARCA: SPY ) is a reasonably low +0.52. And when compared to the core U.S. bond market as measured by the iShares Core U.S. Aggregate Bond (NYSEARCA: AGG ), it has an even lower returns correlation of just +0.32. Moreover, it also offers a differentiated returns experience from its emerging market equity (NYSEARCA: EEM ) counterpart with a correlation of just +0.43. In short, emerging market bonds offer a unique returns experience that is measurably differentiated from the primary investment categories as well as emerging market stocks. Second, the category offers a “middle of the road” alternative from a return, risk and income perspective. For example, the S&P 500 Index has a 3-year historical standard deviation of returns, which is a way of thinking about risk in terms of the volatility of returns, at 12.21% along with a yield of 2.0%. The core U.S. bond market, on the other hand, has a far lower standard deviation of returns at 2.95% but also offers a yield to maturity of 2.4% that is not much higher at present than the dividend yield on the stock market. As for emerging market stocks, they are even further out the risk spectrum than U.S. stocks with a standard deviation of 16.65% along with a yield of 2.2%. But emerging market bonds offer investors a middle ground between these options with a standard deviation of 7.17% that is higher than core U.S. bonds but lower than U.S. stocks and a yield to maturity that is meaningfully higher toward 5.7%. Third, U.S. dollar denominated emerging market bonds have held up fairly well in the recent market environment. Since the start of 2014, the ETFs in the category have fallen in the middle of the returns range relative to U.S. stocks and core U.S. bonds. (click to enlarge) The category has also meaningfully outperformed its emerging market equity counterpart. (click to enlarge) And drawing back from a longer term perspective, we see that since the early days of the financial crisis eight years ago at the start of 2008 through today, emerging market debt has delivered a comparable total returns experience to the U.S. stock market with less price volatility along the way. This strikes a stark contrast to emerging market stocks that tracked the S&P 500 Index through the early post crisis years only to have fallen flat over the last four years since the summer of 2011. (click to enlarge) Thus, based on its overall characteristics, there is much to like about the category at any given point in time both from an individual returns and portfolio construction perspective. What Accounts For The Returns Difference Between EMB and PCY? When considering an allocation to U.S. dollar denominated emerging market sovereign bonds, it is important to note that meaningful differences exist between the construction of the iShares JP Morgan USD Emerging Market Bond ETF and the PowerShares Emerging Markets Sovereign Debt Portfolio. First, the EMB much like the smaller VWOB has a far larger number of individual bond holdings relative to the PCY. For while the EMB has 846 holdings, the PCY only has 89. Second, the EMB and PCY will have different effective durations at any given point in time. At present, the EMB has a duration of 7.05 years versus the PCY at 8.21 years. Both of these duration readings are longer than that of the core U.S. bond market as measured by the AGG currently at 5.30 years. Lastly, the country mixes that make up the EMB and PCY portfolios are very different from one another. And unlike EMB, the PCY is designed to maintain equal weights across its emerging market sovereign debt allocations. As a result, the exact nature of the risks driving either portfolio can be entirely different at any given point in time. The following are the top 10 country weights that make up the EMB portfolio as of November 19. Mexico 6.20% Russia 5.61% Turkey 5.41% Indonesia 5.16% Philippines 5.11% Brazil 4.51% China 4.03% Hungary 4.02% Colombia 3.85% Poland 3.71% In contrast, the following are the top 10 country weights that make up the PCY portfolio as of November 20. Ukraine 6.48% Russia 4.26% Venezuela 3.82% Pakistan 3.66% Qatar 3.63% Latvia 3.62% Romania 3.57% Croatia 3.57% Lithuania 3.55% Poland 3.53% In short, these are two very different products from an individual emerging market country exposure perspective. This is a risk element that is important to evaluate closely before making an allocation to either product. Are Emerging Market Bonds Worth An Allocation Today? Despite all of the merits associated with an allocation to emerging market bonds in a diversified asset allocation strategy, I am not recommending an allocation to U.S. dollar denominated emerging market bonds at this time. This does not mean that I am not actively monitoring to potentially make an allocation to the space at some later date in time. But I am inclined to stand away from the category at the present time for the following reasons. To begin, while the option adjusted spread over comparably dated U.S. Treasuries has widened notably from its lows from the summer of 2014, at 349 basis points this yield spread remains somewhat low to average at best from a long-term historical perspective. Perhaps more importantly, this yield spread may not be fully reflecting some of the mounting short-term to intermediate-term risks facing the category at the present time. Many emerging market sovereigns are in the throes of an economic slowdown to varying degrees. A number of these countries are major commodities exporters, and they have suffered mightily from chronically declining prices for materials such as copper and oil amid supply gluts and declining global demand from the likes of China. And with the U.S. dollar strengthening and the Federal Reserve now considered likely to raise interest rates in December, the economic headwinds may become worse before they get better for many of these countries. The recent decision by S&P to demote emerging market giant Brazil to junk status following the recent credit rating downgrade highlights the current challenges facing some of these emerging market nations at the present time. Lastly, despite their solid recent performance, emerging market bonds are not without the risk of a major price decline at any given point in time. For example, back in 1998 during the outbreak of the Asian Crisis, emerging market bonds plunged by -42%. It should be noted, however, that the financial health of many emerging market nations is vastly better today than it was in the late 1990s. In 2008, emerging market bonds dropped by -34%. And the periodic decline of -10% or more like those seen in 2013 and 2014 should not be ruled out at any given point in time. Recommendation U.S. dollar denominated emerging market bonds have a solid long-term track record of risk-adjusted returns performance and are well suited for inclusion in a diversified portfolio allocation. But at the present time, investors may be well served given generally high valuations coupled with currently weakening economic conditions across the emerging market bond space to exercise patience by waiting to make a long-term commitment to the category. History suggests the potential for periods of downside price volatility that would provide a more attractive entry points. Thus, investors are encouraged to actively monitor the asset class for any sustained period of price weakness to reevaluate the possibility of adding U.S. dollar denominated emerging market bonds to a diversified long-term investment portfolio at that time if fundamental conditions are warranted. Disclosure : This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.