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Emerging Market Giants Much Better Risk than California

Economics / Emerging Markets Aug 10, 2009 - 11:49 AM GMT

By: Frank_Holmes

Economics

Best Financial Markets Analysis ArticleThe Battle of the “Bears” - If I told you that an investment in California was riskier than Russia, would that surprise you?

Well according to the current prices for 10-year credit default swaps, Russia is less likely to default on its debt than the state of California.


Credit default swaps are basically credit insurance. As the likelihood that a debtor will default on its debt narrows, so does the cost to insure that debt.

As the chart below shows, it costs 278 basis points of the principal amount to insure State of California debt and 268 basis points to insure sovereign Russian Federation debt.

According to Bloomberg, the cost of credit swaps for 45 developing countries are down almost eight percent in the past five months and this week marks the first time ever the cost of debt for emerging nations is less than their industrialized counterparts.

While developed nations are footing the bill for a bailout of the global financial system the International Monetary Fund (IMF) says could reach $10 trillion, the BRICs (Brazil, Russia, India, China) have accumulated $3 trillion in reserves—43 percent of the worldwide total.

The developing world has learned from past crises and adapted, while California is really just now experiencing and struggling through a significant financial crisis of its own, issuing IOUs, raising taxes and slashing spending to plug a $60 billion deficit. California may be a good proxy for much of the developed world and may be a sign that a significant shift is taking place in the current world order.

This is a very interesting development and should force investors to rethink preconceived notions of risk.

China: Believe the Hype?

China’s stronger-than-expected GDP growth of 7.9 percent in the second quarter has made some market pundits skeptical of the China story. They claim that the ruling party has “massaged” the data in order to project stability.

The most widely cited negative point has been the 3.35 percent annual decline in electrical power generation during the first half of 2009.

However, we believe the decline in power usage is a response to China’s nationwide efforts to increase energy efficiency and reduce greenhouse gas emissions from the country’s power plants and factories. The original goal from five years ago was to cut energy intensity by 20 percent by 2010 so a decline was expected.

The negative correlation between energy intensity and GDP growth isn’t a new one either. Last year, China experienced 9 percent GDP growth while reducing the country’s per capita energy intensity by 5 percent.

In addition, other recent data points suggest economic activity is recovering at a rapid rate.

Adjusted for seasonal factors, China’s overall power generation rose 4.2 percent in July. That’s the fastest growth rate in 2009.

For the first time this year, China’s railroad cargo statistics saw a positive increase on a year-over-year basis. We’ve also seen the price of copper, historically a good barometer of economic growth, recover from significantly depressed levels at the start of the year.

By Frank Holmes, CEO , U.S. Global Investors

Frank Holmes is CEO and chief investment officer at U.S. Global Investors , a Texas-based investment adviser that specializes in natural resources, emerging markets and global infrastructure. The company's 13 mutual funds include the Global Resources Fund (PSPFX) , Gold and Precious Metals Fund (USERX) and Global MegaTrends Fund (MEGAX) .

More timely commentary from Frank Holmes is available in his investment blog, “Frank Talk”: www.usfunds.com/franktalk .

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.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Gold funds may be susceptible to adverse economic, political or regulatory developments due to concentrating in a single theme. The price of gold is 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 or gold stocks. The following securities mentioned in the article were held by one or more of U.S. Global Investors family of funds as of 12-31-07 : streetTRACKS Gold Trust.

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