On the Ground in Brazil

By Frank Holmes
CEO and Chief Investment Officer

If seeing is believing, natural resources and infrastructure opportunities abound in Brazil.

The above photo was snapped by our global strategist Jack Dzierwa at São Paulo’s Guarulhos International Airport as he spent hours trying to board a domestic flight to Rio de Janeiro. Not surprisingly, he didn’t make the flight.

Jack has traveled extensively around the world, and he says he’s never seen anything like the hectic scene at Guarulhos, which just can’t service the rapidly growing number of Brazilians who can now afford to travel by air.

Scenes like this are important for investment managers to experience in order to grasp the significance of what’s taking place in emerging countries like Brazil. You just can’t get the full flavor of the chaos at Guarulhos from an economic data spreadsheet or a research report.

Jack traveled to Brazil to collect some insight on the country’s infrastructure development and the best prospects for investment. His experience at the airport gives him tacit knowledge and a clear understanding that Brazil will have to expand on its domestic infrastructure.

Brian Hicks, who co-manages our Global Resources Fund (PSPFX) has also spent the week in Brazil – he has been doing research and meeting with natural resources companies.

Brazil is a key driver for natural resources and infrastructure markets. It is home to 190 million people, many of them moving into the middle class, and it’s also one of the world’s fastest-growing economies.

Similar to China, this rise of the middle class will increase demand for oil and other commodities, and its expansion will put growing pressure on the country’s inadequate infrastructure.

Just last week a blackout left nearly 60 million people without electricity and another 7 million without water. Traffic in downtown São Paulo is so bad that many businessmen use helicopters as taxis to get around the city. Brazil only has three main international airports, despite that it has 14 cities with at least 1 million residents.

The U.S. Energy Information Administration estimates that Brazil has more than 12 billion barrels of proven oil reserves. That number is certain to grow as we learn more about the large discoveries recently made off its southeastern coast. In addition to vast reserves of oil, it is also a leading producer of iron ore, aluminum, platinum and other industrial metals.

This natural wealth puts Brazil in an enviable position compared to some other large emerging economies. As the domestic demand for resources increases with infrastructure expansion, much of that demand can be met from internal sources. This benefits the economy on both ends and sets the stage for further economic growth.

Index Summary

• The major market indices were mixed this week. The Dow Jones Industrial Index (1) gained 0.46 percent. The S&P 500 Stock Index (2) declined 0.19 percent, while the Nasdaq Composite (3) finished 1.01 percent lower.
• Barra Growth (4) underperformed Barra Value (5) as Barra Value finished 0.11 percent higher while Barra Growth declined 0.46 percent. The Russell 2000 (6) closed the week with a loss of 0.27 percent.
• The Hang Seng Composite (7) finished lower by 0.34 percent; Taiwan (8) gained 0.23 percent, and the Kospi (9) increased 3.09 percent.
• The 10-year Treasury bond yield closed at 3.36 percent, down 6 basis points for the week.

Domestic Equity Market

The figure shows the return on each of the ten sectors in the S&P500 Index for the five trading days through Thursday. The best-performing sectors were materials, healthcare and consumer staples. The worst-performing sectors were financials, utilities and technology.

Materials, the best-performing sector, was up 2.1 percent for the five days. Within that sector, the best-performing stock was Titanium Metals Corp, up 7.7 percent. Other stocks included in the sector’s top performers were Monsanto, Newmont Mining Corp, AK Steel Holding Corp, and US Steel Corp.

Strength

• The wireless telecom services group was the best-performing group for the week, up 9 percent, led by Sprint Nextel Corp. A major brokerage firm upgraded the stock to outperform and raised its target price for the stock, stating that it foresees Sprint’s core business turning up.
• The fertilizer & agricultural chemical group, led by Monsanto, was the second-best performer, rising 8 percent. In advance of an analyst meeting the prior week, the company reconfirmed its commitment to double its 2007 gross profit in 2012. The company said that it expects total-company gross profit in 2012 in the range of $8.6-$8.8 billion, with gross profit contribution from its Seeds and Genomics platform representing $7.3-$7.5 billion of the 2012 target.
• The specialty consumer services group was the third-best performer, up 4 percent, driven by its single member, H&R Block Inc. The large tax services provider estimated that some two million Americans are expected to claim the tax benefit under the extended, expanded homebuyer credit guidelines.

Weakness

• The homebuilding group was the worst-performer, down 7 percent. On Wednesday the U.S. Commerce Department said that October housing starts fell 10.6 percent from the previous month to an annual rate of 529,000, the lowest level in six months. Permits for new home construction, a sign of future construction, fell 4 percent. On Friday, the stock of D.R. Horton Inc. sold off after reporting a quarterly operating loss in excess of the consensus estimate. The company’s chairman said that market conditions in the homebuilding industry are still challenging, characterized by rising foreclosures, high inventory levels of available homes, increasing unemployment, tight credit for homebuyers and weak consumer confidence.
• The construction & engineering group was the second-worst performing group, declining 5 percent. This week Jacobs Engineering Group Inc. reported quarterly earnings below the consensus estimate and provided 2010 earnings guidance below the consensus estimate.

Opportunity

• There may be an opportunity for gain in M&A (merger & acquisition) transactions as we head into 2010.
• The strength in the market since March could be an opportunity to eliminate weaker companies in the portfolio and upgrade to companies with better fundamental outlooks.

Threat

• Should investors’ expectations for an improving economy not come to fruition on a reasonable timeframe, it could be a threat to stock prices.

The Economy and Bond Market

Bonds rallied modestly again this week as weaker economic data and a sanguine inflation outlook allowed bonds to rally. The chart shows how housing starts have rolled over, falling 10.6 percent in October. Housing is viewed as a key sign post to the economic recovery and has suffered recent setbacks suggesting the economy may be weaker than expected. We also had Fed officials downplaying the threat of inflation in addition to PIMCO’s Bill Gross commenting that the Fed would not raise rates to combat rising asset prices while unemployment remained high.

Strength

• Weak economic data and deflation concerns are providing a lift to the bond market.
• Retail sales rose a surprising 1.4 percent in October driven by strength in the auto sector.
• The Index of Leading Economic Indicators hit a two year high in October.

Weakness

• Housing starts fell 10.6 percent in October, well below expectations.
• October industrial production (IP) rose a disappointing 0.1 percent.
• The Federal Housing Administration (FHA) reserves are dwindling while delinquencies and foreclosures continue to rise.

Opportunity

• Expectations continue to build for growth in the U.S. in the current quarter, possibly as much as 4-5 percent. The global economic recovery appears to be taking hold.

Threat

• The threat of future inflation is building as the dollar moves lower and energy and commodity prices move higher.

Gold Market

For the week, spot gold closed at $1,150.50 per ounce up $31.80 or 2.84 percent. Gold equities, as measured by the XAU Gold & Silver Index (10) rose 1.82 percent for the week. The U.S. Trade-Weighted Dollar Index (11) edged up 0.36 percent.

Strengths

• The World Gold Council reported that investment demand for gold bars increased to 81.2 tonnes in the third quarter, compared to just 57.7 tonnes in the previous quarter. The WGC also highlighted that central banks bought 15 tonnes more gold than they sold during the period, another positive for gold.
• Global economic uncertainty has fueled demand and has caused gold coin production at Britain’s Royal Mint to quadruple in the third quarter, having reached 32,735.8 ounces from 7,500 ounces during the same period of 2008.
• The Times of India reported that the African nation of Mauritius has bought two metric tons of gold from the International Monetary Fund (IMF) for nearly $72 million.
• A recent article by the Canadian Press noted India’s gold obsession is a source of strength and national pride. It is estimated that gold held by Indian households and other private groups would amount to about 50,000 tonnes, worth somewhere between $850 billion-$1.7 trillion.

Weaknesses

• South African miners remain under pressure as the nation’s power utility decided to increase tariffs by 31.3 percent and a simultaneous wage hike of about 10 percent demanded by miners. It is estimated South African miners will retrench about 3,000 employees to counter operating losses.
• The Chamber of Mines has said South Africa’s gold production rose nearly 5 percent to about 1.9 million ounces in the third quarter. However, gold production fell 2.9 percent during the comparable period in 2008.
• The White House said that improper payments by the U.S. government to people, firms and contractors rose to $98 billion in fiscal 2009, half the mistakes coming from Medicaid and Medicare payouts. Washington has also said the error rate of improper payouts increased 5 percent from last year, possibly attributable to fraud.

Opportunities

• Adrian Ash, head of research at one of the world’s fastest-growing online gold service for private investors, has said that gold is still under-owned by individual and institutional investors. Gold accounted for almost one-fifth of investable wealth during the Great Depression in the 1930s, yet only makes up about 5 percent of investable wealth today.
• Research analysts at Deutsche Bank suggest the bull market in gold may endure even if inflation never emerges or the U.S. dollar happens to strengthen. They argue that central banks around the world are using the precious metal as a backup “reserve currency.”
• A U.S. Congressional panel approved a measure to open the Federal Reserve’s monetary policy decision to government audits. This is a further slap at the U.S. central bank following a Senate overhaul proposal aimed at stripping the Fed of its regulatory authority. Fed Vice Chairman Donald Kohn said back in July that “history provides numerous examples of non-independent central bankers being forced to finance large government budget deficits. Such episodes invariably lead to high inflation.”

Threats

• President Barack Obama warned about the need to contain rising U.S. deficits and job losses. If incorrectly addressed, the matter could prompt a double-dip recession.
• A recent filing indicated that Warren Buffett is not loading up on gold or precious metals. Although he has expressed his belief that inflation will rise in the coming years, he is much more inclined to invest in companies that are industry leaders and are able to pass on price increases to consumers.
• The Los Angeles Times reported that California’s budget shortfall next year will be much larger than initially forecast. The state faces a budget gap of nearly $21 billion over its current and next fiscal years, despite the governor’s deep spending cuts to counter plunging revenues.

Energy and Natural Resources Market

Strengths

• According to data released by the U.S. International Trade Commission, copper imports in September soared to 56,012 tonnes, up by more than 50 percent compared to August. Although this is only one month’s data, it could indicate U.S. copper demand is picking up.
• Russian crude steel production gained 5 percent month-over-month in October after a 4 percent decline the previous month. The gain pushed the sector’s utilization to 87 percent, the highest reading year-to-date.
• Tokyo Steel will increase prices of some products by up to 4.2 percent because of rising raw material costs. This includes prices for deformed steel bar, wire rod and I-beam by as much as 2,000 yen ($22.30) a tonne for contracts starting next month, it said.

Weaknesses

• Macquarie noted that copper premiums in Europe fell this week to $40-60 per tonne, down from $60-85 per tonne in mid-August. Physical copper premiums in Europe, Japan and the U.S. have generally moderated over the past two months after rallying strongly through much of the second and third quarters of this year. Physical premiums have tended to be a good indicator of physical demand for a particular metal and have been positively correlated with their respective metals prices over time.
• Chinese coal imports fell to 11.1 million tonnes in October, down 1.2 million tonnes month-over-month.

Opportunities

• The Organization of the Petroleum Exporting Countries (OPEC) expects global oil demand to grow to 106 million barrels per day by 2030, an increase of 20 million barrels per day.
• China’s Hebei province, the nation’s largest steelmaking region, will eliminate up to 2 million tons of polluting and outdated steel capacity by the end of 2011, the Ministry of Information Technology said. Hebei aims to form five large mills, each with capacity of more than 5 million tons a year through mergers.
• According to Upstreamonline, around 50 international oil companies have expressed interest in acquiring stakes in Jubilee Oilfield Offshore in Ghana. The company’s reserves are estimated to contain 0.5–1.8 billion barrels of oil equivalent. The names of the prospective companies were not released but the list includes companies from China, Scandinavia and the U.S.
• Aiming to boost domestic gas exploration, the Argentine government is planning to start a new program aiming at providing more incentives to companies who perform exploration and producing activities in this region.
• With a gradual recovery seen in global demand and global economic crisis, Gazprom plans to pump around 530 billion cubic meters of gas in 2010. That’s considerably more than the 450-490 billion cubic meters of gas they pumped in 2009.

Threats

• According to Business News Americas, the Chilean state copper commission, Cochilco, highlighted that if mining companies do not begin to start searching for alternative sources of water now, it is highly likely that there may not be enough water for any new copper mining projects.
• Workers at BHP Billiton’s Spence copper mine invaded the facility and caused a complete halt to production. The invasion occurred as contract negotiations between the company and union workers have broken down.

Emerging Markets

Strength

• Hong Kong’s unemployment rate fell to 5.2 percent in October from 5.3 percent in September, as mainland liquidity continued to leak into Hong Kong boosting sentiment. Personal bankruptcy filings fell to a one-year low in Hong Kong for the same month.
• Thailand’s exports showed the smallest contraction in a year, declining only 3 percent year-over-year in October after an 8.5 percent drop in September. The improvement was thanks to recovering demand for rice, electronics and auto parts.
• Brazilian president Luiz Inacio Lula da Silva said that Brazil’s economy may have expanded at a 9 percent rate in the third quarter. This implies a meaningful reversal from a second quarter decline of 1.2 percent. Lula also cited the creation of 1 million registered jobs in 2009 despite a global crisis.
• Recent industrial output data confirms that the Polish economy is gradually recovering. Although production fell by 1.2 percent year-over-year in October, the scale of decline was smaller than the expected 2 percent. Citigroup projects Poland’s GDP to rise by more than 2 percent in the fourth quarter.

Weakness

• Hong Kong’s consumer price index rose by a higher than expected 2.2 percent year-over-year in October as government subsidies for public housing rentals expired.
• Chile’s economy contracted in the third quarter. Imports were down 21 percent and exports were down 6.5 percent from a year ago. Foreign trading represents 63 percent of the country’s GDP. However, a fourth quarter recovery is expected.
• Brazil began taxing the issuance of depositary receipts in international markets in order to prevent companies from selling shares abroad rather than locally. This new tax policy comes a few weeks after a 2 percent securities tax for foreign investors of Brazilian equity and fixed income securities. These tax policies aimed at reducing the Brazilian currency’s appreciation may negatively impact the country’s capital markets.
• Russian industrial production fell 11.2 percent year-over-year in October, disappointing the market which had been expecting only an 8 percent drop. While there were improvements in mining and utilities, manufacturing growth continued to decline.

Opportunity

• Taiwanese banks may prove a bigger winner from the financial “Memorandum of Understanding” signed between Taiwan and China this week. Because of regulatory barriers, Taiwanese banks could not service the booming Taiwanese manufacturing businesses in mainland China over the past decade. The agreement should help regain lost customers and gives them access to a much larger economy where they can find more opportunities for growth.
• Colombia’s Finance Minister Zuluaga said the government may sell 15 percent of their holdings in Ecopetrol in order to invest in new roads and other projects. This represents approximately $7 billion dollars, or 3 percent of GDP, to be spent on domestic infrastructure.
• Muted inflation and a strengthening ruble allow the Central Bank of Russia to carry on with the easing cycle well into 2010. Russia will likely be the only remaining BRIC country to continue interest rate cuts.

Threats

• Concerns about a Mexican sovereign credit rating downgrade continue after the approval of the 2010 budget plan. The plans approval implies a deficit to GDP gap of 2.75 percent, the widest since 1989 according to JP Morgan Chase & Co.
• Belgian Prime Minister Herman Van Rompuy was chosen this week as the first president of the European Union. In the past, Van Rompuy has spoken out against Turkish membership in the union arguing it would dilute Europe’s Christian heritage.
• Turkey’s chief prosecutor has launched an investigation into phone wiretaps authorized by the Justice Ministry, a step that may result in a court case to outlaw ruling AKP, the Justice and Development Party.

The tables show the performance of major equity and commodity market benchmarks of our family of funds.

Please consider carefully the fund’s investment objectives, risks, charges and expenses. For this and other important information, obtain a fund prospectus by visiting www.usfunds.com or by calling 1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed by U.S. Global Brokerage, Inc.

An investment in a money market fund is neither insured nor guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Past performance does not guarantee future results. Foreign and emerging market investing involves special risks such as currency fluctuation and less public disclosure, as well as economic and political risk. By investing in a specific geographic region, a regional fund’s returns and share price may be more volatile than those of a less concentrated portfolio. The Eastern European Fund invests more than 25% of its investments in companies principally engaged in the oil & gas or banking industries. The risk of concentrating investments in this group of industries will make the fund more susceptible to risk in these industries than funds which do not concentrate their investments in an industry and may make the fund’s performance more volatile. Because the Global Resources Fund concentrates its investments in a specific industry, the fund may be subject to greater risks and fluctuations than a portfolio representing a broader range of industries. Gold, precious metals, and precious minerals funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The prices of gold, precious metals, and precious minerals are subject to substantial price fluctuations over short periods of time and may be affected by unpredicted international monetary and political policies. We suggest investing no more than 5% to 10% of your portfolio in gold, precious metals, precious minerals, or gold, precious metals, or precious minerals stocks. Tax-exempt income is federal income tax free. A portion of this income may be subject to state and local income taxes, and if applicable, may subject certain investors to the Alternative Minimum Tax as well. Each tax free fund may invest up to 20% of its assets in securities that pay taxable interest. Income or fund distributions attributable to capital gains are usually subject to both state and federal income taxes. Bond funds are subject to interest-rate risk; their value declines as interest rates rise.

These market comments were compiled using Bloomberg and Reuters financial news.

Holdings as a percentage of net assets as of 9/30/09:
Titanium Metals Corp: 0.00%
Monsanto: 0.00%
Newmont Mining: 0.00%
AK Steel Holding: 0.00%
US Steel Corp: 0.00%
Sprint-Nextel: 0.00%
H&R Block: 0.00%
D.R. Horton: 0.00%
Jacobs Engineering: 0.00%
Tokyo Steel: 0.00%
Macquarie: 0.00%
Jubilee Oilfield Offshore Ghana: 0.00%
Gazprom: Eastern European Fund (4.41%)
BHP: 0.00%
Ecopetrol: 0.00%

*The above-mentioned indexes are not total returns. These returns reflect simple appreciation only and do not reflect dividend reinvestment.

(1) The Dow Jones Industrial Average is a price-weighted average of 30 blue chip stocks that are generally leaders in their industry.
(2) The S&P 500 Stock Index is a widely recognized capitalization-weighted index of 500 common stock prices in U.S. companies.
(3) The Nasdaq Composite Index is a capitalization-weighted index of all Nasdaq National Market and SmallCap stocks.
(4) The S&P BARRA Growth Index is a capitalization-weighted index of all stocks in the S&P 500 that have high price-to-book ratios.
(5) The S&P BARRA Value Index is a capitalization-weighted index of all stocks in the S&P 500 that have low price-to-book ratios.
(6) The Russell 2000 Index® is a U.S. equity index measuring the performance of the 2,000 smallest companies in the Russell 3000®, a widely recognized small-cap index.
(7) The Hang Seng Composite Index is a market capitalization-weighted index that comprises the top 200 companies listed on Stock Exchange of Hong Kong, based on average market cap for the 12 months.
(8) The Taiwan Stock Exchange Index is a capitalization-weighted index of all listed common shares traded on the Taiwan Stock Exchange.
(9) The Korea Stock Price Index is a capitalization-weighted index of all common shares and preferred shares on the Korean Stock Exchanges.
(10) The Philadelphia Stock Exchange Gold and Silver Index is a capitalization-weighted index that includes the leading companies involved in the mining of gold and silver.
(11) The U.S. Trade Weighted Dollar Index provides a general indication of the international value of the U.S. dollar.
The S&P/TSX Canadian Gold Capped Sector Index is a modified capitalization-weighted index, whose equity weights are capped 25 percent and index constituents are derived from a subset stock pool of S&P/TSX Composite Index stocks.
The S&P 500 Energy Index is a capitalization-weighted index that tracks the companies in the energy sector as a subset of the S&P 500.
The S&P 500 Materials Index is a capitalization-weighted index that tracks the companies in the material sector as a subset of the S&P 500.
The Conference Board index of leading economic indicators is an index published monthly by the Conference Board used to predict the direction of the economy’s movements in the months to come. The index is made up of 10 economic components, whose changes tend to precede changes in the overall economy.