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This Invast Insights report covered the international exposure and opportunity of exchange traded funds (ETFs) and what made these products interesting for local investors. There was emphasis on caution and research when it came to reviewing Australian listed international ETFs and the emergence of these products based on a synthetic agreement. We also touched on the introduction to Fibonacci analysis, ratio and their uses in technical analysis.
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Invast Insights
Week Commencing October 8, 2013
www.invast.com.au | 1800 468 278
This week we look at the following topics:
1.0 Exchange traded products on the ASX
1.1 International exposure & opportunity
1.2 Caution and research is important
2.0 A closer look at the DAX
2.1 Germany the growth engine of Europe
3.0 Introduction to Fibonacci
4.0 Invast Gold Seminar
4.1 About our guest speaker
4.2 Gold interview worth watching
www.invast.com.au | 1800 468 278
www.invast.com.au | 1800 468 278
1.0 Exchange traded products on the ASX
We’ve had some feedback this week from clients wanting to know more
about exchange traded products and so we start this week’s publication by
outlining these investment tools. One of the best innovations in markets over
the past decade has been the emergence of exchange traded products,
sometimes called exchange traded funds (ETFs). These are basically funds of
money which invest in a certain basket of stocks but with units listed on the
exchange so holders can trade them freely, like they would trade BHP or CBA
shares for example.
Think about investing in a mutual fund twenty or thirty years ago, you would
literally have to write a cheque and send it to the fund manager who will then
use your funds to say, buy the ASX200 index. If you wanted to redeem your
investment you would have typically had to fill out a form and wait until the
fund manager releases your units with an accompanying cheque.
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Today the whole process can literally take two minutes. You could
hypothetically buy the ASX200 index through a security called the STW then
if you change your mind immediately sell and have the money taken care of
through your online stock broking account. Invast does not issue any ETF
products in Australia and we have no other vested interest in them besides
making our clients aware that they do exist and can be one of the ways to
add diversity to your portfolio.
Our Wealth Preservation Portfolio which was reviewed last week contains two
ETF products – the STW and IJP which we included as part of a well diversified
portfolio. The STW is issued by a company called State Street Global Advisors,
it tracks the ASX200 index which basically means you can replicate the whole
market by owning the top 200 stocks through a single trade in ticker STW. The
fund itself holds around $2.184bn of assets in these top 200 companies and
the management fee State Street Global Advisors charges to undertake the
whole exercise is around 0.29%.
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So let’s say you want exposure to the market but don’t have the time or
resources to go out and buy 200 individual companies, yet alone measure the
weighting of each to achieve a performance that replicates the ASX200 index.
The STW does the whole task for you with a management fee of 0.29%
annually. If the market goes up by around 10% a year, you could expect the
value of the STW to rise by 10% less 0.29%. Our $10,000 investment in the
STW in early September generated a return net of fees of around $450 for the
month, as per our report last week.
1.1 International exposure & opportunity
What really makes ETF products interesting for local investors is the ability to
start investing in offshore markets. We also added the IJP to Wealth
Preservation portfolio last month and while the STW adds exposure to the
top 200 companies in Australia, the IJP provides exposure to the top 300
companies in Japan.
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Local investors can either go out and buy individual stocks in Japan or use the
IJP – the latter obviously much easier to administer. There is a cost, the issuer
of the IJP is iShares backed by Blackrock and they charge around 0.53%
annually. Blackrock is one of the largest funds management companies
globally and again has no affiliation with Invast. We are purely stating the
facts here.
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Image: Snapshot of the IJP in terms of top 10 holdings and sector exposure via iShares website
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The image above shows the type of exposure the IJP gives you – companies
like Toyota, Mitsubishi and Softbank. The Australian stock market has no listed
car manufacturers or multinationals of this size outside of mining companies.
While the top 10 companies in Australia represent around 45% of the market,
in Japan the concentration is around half that. It’s not just Japan either, the
growth of ETF products means the type of international exposure available to
Australian investors is now growing on a daily basis. Below is a snapshot of
international ETFs available to local investors via the ASX.
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Table: List of international ETFs listed on the Australia market via ASX website
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1.2 Caution and research is important
Like all things in life, there are risks. Firstly, the funds are managed on behalf
of the unit holders by the custodians of the funds like Blackrock or State
Street and so you need to take that into consideration. When you purchase
BHP or Telstra shares you are entrusting the board and management of each
company to invest your funds wisely and so the same principal needs to be
taken into consideration. We have had some investors recently ask about
counterparty risk in ETFs and this is a very sensible question, so please do
your homework and read the product disclosure statement of each issued
product if you want more information.
The other thing to consider about Australian listed international ETFs is that
most of them are unhedged. You are effectively paying an Australian dollar
dominated price but for a pool of investments that are dominated in another
currency. So if the Australian dollar rises against the Japanese yen for
example, the IJP will see adverse movements all other things being equal.
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There is an opportunity to hedge out your currency risk with Invast’s other
foreign exchange trading products and so this risk can be minimised. The time
might also be ripe for expanding offshore exposure given the strength of the
Australian dollar in recent years. If you are of the view that the Australian
dollar will fall back to say 80 US cents in three of five years, the option is there
to exchange those Australian dollars into other currencies via ETF products
where appropriate.
One of the worst innovations we think over the past few years is the
emergence of ETF products that are based on a synthetic agreement. We have
complete risk aversion towards these types of products. To find out more it
would be wise to visit the website of each ETF product or contact the
representatives of the following two issuers which Invast’s analyst team have
met both in recent months. Nathan Ide from State Street Global Advisors on
02 9240 7675 or [email protected], Paula Boon from Russell Investments
02 9229 5131 or [email protected].
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2.0 A closer look at the DAX
One of the most attractive markets among traders is Germany’s DAX index,
particularly for Asian time zone clients, as the DAX opens in the afternoon
and trades into the night. The DAX is an index based on the top 30 companies
in Germany – the growth engine of the European economy. Like the Dow
Jones Industrial Average, constituents are usually some of the largest global
multinationals. Germany’s GDP is currently trending at around US$3.5bn
which is around three times Australia. Germany is currently the world’s fourth
largest economy behind the USA, China and Japan respectively. It represents
around 22% of the total GDP within the European Union.
Below is a chart summarising the top 10 constituents of the DAX index,
ranking in order of market capitalisation:
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Image: DAX top 10 constituents, share price as of 30 September and index weighting
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Bayer is the largest constituent and specialises in healthcare, agriculture
products and polymers. If you have had a virus over the winter season and
taken anti-biotics, there is a strong chance that they could have been
manufactured by Bayer. The stock is currently trading on a historical price to
earnings ratio of around 25x, but the market sees improvement in earnings
this year with the price to earnings ratio expected to fall to around 15x. The
stock is currently trading at around EUR88 which is not too far from its 52
week high of EUR91. We focus on the largest stocks in an index because they
usually set the tone for direction. BHP Billiton (BHP) is a great example of how
the largest stock in the market can drag down the rest of the index, as was
the case for the ASX200 index for most of 2012.
The second largest stock on the DAX is Siemens – a specialist in engineering
and manufacturing. The stock is trading on a more reasonable historical price
to earnings ratio of 16.8x at the time of writing but the market isn’t expecting
too much growth over the year and so this is unlikely to change. Siemens has
delivered 13% net growth in dividends over the past five years and so it has
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a reasonable sense of stability but isn’t the type of stock to shoot the lights out. If we compare Siemens to 3M listed in the United States, we see the latter trading on a price to earnings ratio of around 18.7x historically and this is expected to trend to 17.8x by the end of the year – so both companies are within similar valuations of each other. 3M has delivered net growth in dividends over the past five years of around 4.7% and so Siemens has somewhat of an edge. Ironically, 3M is trading just shy of its 52 week high of US$122 while Siemens is exactly at its high point for the year at EUR92.
Most of these businesses listed on the DAX though were impacted by the slowdown of the global economy and more importantly, the sovereign debt crisis which gripped Europe last year. While 2013 has been a slightly better year, with the DAX up around 19% over the past year. The index is very much a “real economy” composition with Chemicals, Automobiles & Parts and Industrial Goods and Services combined representing around 54% of total weighting. Banks combined represent around 5.8%, which is in stark contrast to the Australian market where the ASX200 index has around 22% exposure to the top four banks alone. Insurance is also a reasonably large component of the DAX representing around 10.4% as of the end of September this year.
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The DAX is currently trading on a price to earnings ratio of around 14.9x on
this year’s earnings and around 12.9x next year’s earnings. The market is
forecasting earnings growth of around 15% which is not completely out of
the question but very dependent on how Europe overall performs. The
average price to earnings ratio over the past decade has been somewhere
around 15-16x with an extreme high of around 18x in mid-2008 and a low of
around 9.5x in late 2011.
Returns on equity for DAX constituents have been disappointing over the
past five years, barely rising above 10% which is really the key level many
fund managers look at when deciding if something is worthwhile investing in
or not. Perhaps the lower returns on equity are a function of record low
interest rates both in Europe and globally, there is scope for upside towards
15% which was the level experienced between 2005-2008.
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2.1 Germany the growth engine of Europe
As we stated above, Germany is the world’s fourth largest economy with quarterly GDP growth of around 0.7% and inflation under control at 1.4%. There has been a rift between Germany and the rest of the Eurozone members in recent years around how to address the sovereign debt crisis, mainly because Germany is the largest contributor of capital towards the European Central Bank. Quarterly growth of around 0.7% is broadly in line with trend but it has been languishing between 0-0.5% for most of the past two years.
With the DAX trading close to its historical average price to earnings ratio, we think the real upside needs to come from persistent Germany quarterly GDP growth in the order of 1% for at least the next two to three quarters. It’s almost two and a half years since Germany booked a quarterly GDP print above 1%. The unemployment rate is sitting nicely at 6.8% which compares very favourably to the 9% plus levels running into the middle of 2007. With the election now out of the way and the incumbent returning with a solid
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majority, the next six months are crucial in
1. The DAX achieving the 15% earnings growth estimates expected by the market and
2. The Germany economy resuming its economic growth trajectory.
Invast sees support on the chart for the DAX at 8452 through to the end of October, from 8629 as at the time of writing. If that level breaks, the index could slip back towards the 8109 where it should be met with solid support and trade on a price to earnings ratio of around 13.9. Even if earnings are to be revised down by 5% across the board, this level would still see the price to earnings ratio sit at 14.6x which is slightly below the recent historical average.
3.0 Introduction to Fibonacci Analysis
Fibonacci analysis is one of the more popular technical analysis methods amongst traders. Fibonacci analysis is unique as it is predominantly used to determine key levels that market participants deem to be important.
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To understand why this is the case, we first need to look back on the history
of Fibonacci and its importance in our world, not being limited to the
financial markets.
Origins of Fibonacci Ratio
Leonardo Pisano Bigollo – later known as Leonardo Fibonacci, introduced the
western world to the hindu- arabicnumerals and with it the Fibonacci
sequence. Leonardo, contrary to most beliefs out there, did not invent
Fibonacci sequence. Indians in the 6th Century detailed the sequence and
interestingly, Egyptians and Ancient Greeks employed some of the Fibonacci
ratios in their architecture long before it was detailed in the 6th century.
Whether or not Ancient civilisations derived the ratio from the Fibonacci
sequence or from other sources remains a mystery, as there was no recorded
history of Fibonacci from such eras.
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Fibonacci sequence is derived by adding a previous number to obtain the
next number. Resulting in a sequence of numbers like this:
0,1,1,2,3,5,8,13,21,34,55,89,144…
Out of this sequence, a ratio can be determined and these ratios form what is
called the ‘’golden rectangle”.
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Connecting the corners of these rectangles results in the formation of a spiral, often called the “golden spiral” or the “perfect spiral”. These are found all around us in nature. Ferns, eggs, nautilus shell and even the shape of your ears are all formed according to these measurements. Leonardo Davinci’s“Vitruvian Man” is based on the “golden ratio”, and as weird as it may sound the ratio of a human’s fore arm is approximately the same ratio as the golden ratio.
Golden Ratio
So what is the golden ratio? The golden ratio is 61.8% or 0.618; and it is derived by dividing a number in the Fibonacci sequence with the number that comes after it in the sequence (the ratio becomes constant after the number 13). For example 13 divided by 21, 55 divided by 89 will give an approximate to 0.618 or 61.8%. There is also another ratio as important as the golden ratio; it’s 161.8% and is called the “golden ratio conjugate”. This ratio is derived by dividing a number in a sequence with the number that comes before it, such as 34 divided by 21 or 89 divided by 55.
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Other Fibonacci Ratios
Apart from these golden ratios other sequences can also be derived by skipping numbers in the divisions.
•38.2% is derived by skipping one sequence in the division
•Example: 34/89 , 55/144 = 0.382 = 38.2%
•23.6% is derived by skipping two sequence in the division
•Example: 21/89, 34/144 = 0.236 = 23.6%
Or by multiplying and dividing the golden ratios themselves:
•Square root of 0.618 = 0.786 = 78.6%
•Square root of 1.618 = 1.272 = 127.2%
•0.618/1.168 = 0.382 = 38.2%
•0.618 X 0.618 = 0.382 = 38.2%
•1.618/0.618 = 2.618 = 261.8%
•1.618 x 1.618 = 2.618 = 261.8%
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Uses in Technical Analysis
These Fibonacci sequences are used as a method to predict support and
resistance levels in the market. Considering that Fibonacci ratios are found in
nature and the physical world, it also seems to affect the psychology and
sentiment in the market. What is more interesting is how these ratios are
often lined up at key psychological levels or past support/resistance levels.
There are various ways to use Fibonacci as part of technical analysis, but in
this article I will go through 2 of the more commonly used Fibonacci analysis
methods:
• Fibonacci retracement
• Fibonacci extension
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Fibonacci Retracement - Retracement is a common occurrence in the market
and typically happens following a rally or a drop in the market. Some traders
refer to the phenomena as consolidation, correction, pullback or simply
retracement. Fibonacci retracement is a method to predict how far the
pullback or consolidation in the market is going to be. Even though these
levels are used as an approximation, often it can be uncannily precise. This is
partly attributed to the notion of “self-fulfilling prophecy” in technical analysis
where there are a lot of traders focusing on the same level it becomes a real
support or resistance. This is how Fibonacci analysis works in a collective
conscious market.
A healthy retracement or a retracement that does not disrupt the momentum
of the prevailing trend, has to fall around 38.2%, 50% and 61.8% retracement
ratios; in a nutshell it is simply any retracement level between 0% - 100%.
Once the market has retraced to said ratios; the retracement is considered
complete and market participants looking to get into the market focus on
such completion. The illustration below explains how a market typically
moves, from point A to point D.
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Figure 1 Normal Retracement Range
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There are 2 ratios that are still considered within a Fibonacci retracement but
are not as well-known as the 3 above. These are the 23.6% and 78.6%
Fibonacci retracement.These ratios are used to measure momentum following
a correction in the market. A market that retraced to 78.6% often find it hard
to push itself to a new high/low(sometimes just barely), and likewise a 23.6%
correction implies a very strong momentum in the prevailing trend and a
higher probability of the market continuing to push harder.
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Figure 2 Important Fibonacci Range
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Note that 50% is not a Fibonacci sequence, but often used as a retracement level due to psychological reason. We can easily relate to equal division or a perfectly round number.
Fibonacci Extension
Fibonacci Extension is a method to project how far a rally or a drop can reach. In essence, attempting to pinpoint the moment a correction is likely to occur. As such Fibonacci extension is a powerful tool to project future resistances or supports in the market. Fibonacci retracement and Fibonacci extension comes hand in hand as these are simply Fibonacci retracement levels that go beyond 100%.
In the picture above the movement from B to C is a retracement while C to D is the extension following the correction in the market. 127.2% and the golden ratio conjugate 161.8% are the two commonly used extension levels. It is not very often that price move beyond 161.8%, but most traders would employ 200% and 261.8% as a precaution to such possibility.
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Fibonacci retracements and extens ions are normally drawn from left to right.
There is an instance in Elliot Wave analysis where it is drawn from r ight to left
to project wave 3 and 5; but other than that, normal Fibonacci retracements
and extensions are dr awn from left to right from the latest swing high/low.
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Figure 3, Example of how precise a Fibonacci extension can be, projecting support at
127.2% long before mark et gets there
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Figure 4, Combination of Fibonacci Retrace ment and Extension as commonly used by
traders in the market
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4.0 Invast Gold Seminar
The US fiscal situation remains a mess, Europe is in a tight spot and the
Japanese continue to inject huge amounts of cash into their economy. Traders
are all left asking, where the gold price will continue to trend? The yellow
metal has seen huge price volatility over the past twelve months , but has also
recently developed a solid bottom on the charts, prompting many to ask - is
now the time to buy?
Join Invast's analyst team Peter Esho and Vito Henjoto as they run through
their views on the gold market, both the fundamentals and technical outlook.
Invast will also be joined by special guest presenter Garry Lewis, Managing
Director of AS X listed Robust Resources (ROL) which specialises in previous
and base metals exploration and development. Lewis will provide his views
on the cur rent state of the mining industry, the challenges and opportunities
in bringing on more production into the market.
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Jack Kouzi from Vertical Financi al Solutions will be chairing the event, putting you r questions to the expert panel. The event is due to take place on Friday October 25th from 12-2pm at In vast's brand new Sydney offices located on L37 Gateway Building Circular Quay. Seats are strictly limited, so to secure your place call 1800 468 278.
4.1 About our guest speaker
Invast will be joined by Robust Resources Managing Director Gary Lewis. Mr. Lewis is the founding director of Robust Resources and holds a Bachelor of Commerce and Masters of Business & Technology (MBT) from the University of NSW and is a member of the Australian Institute of Company Directors. He has more than 25 years experience in capital markets and business and strategy development in Australia and Asia, having worked in senior management positions in both private and public enterprises in industries as diverse as mining / exploration and pharmaceuticals. In addition to sitting on the Robust Board, Gary is also Chairman of Toronto Stock Exchange (TSX) - listed Reliance Resources Limited.
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Robust Resources (ROL) is an interesting business in itself, based in Australia
but working hard at drilling its Indonesia prospect located on Romang Island.
Robust has two projects on the island, North Romang and Lakuwahi which
has a JORC mineral resource of 1.18 million ounces of gold equivalent. Robust
also recently completed the acquisition of Andash Mining which holds an
80% interest in the Andash Copper and Gold project in the Kyrgyz Republic.
The seminar will give Invast guests an opportunity to hear straight from a
respected industry CEO about the challenges and opportunities in developing
mines around the region. The seminar fits in well with our gold analysis
published in Invast Insights on 30 September.
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4.2 Gold interview worth watching
We also recently came across a very interesting interview published on Kitco
News with Adrian Ash – head of research at a firm called Bullion Vault which is
part-owned by the World Gold Council and is the world's largest online
investment gold service. It manages $2 billion for more than 48,000 users. The
interview was held at the Precious Metals Conference in Rome this week and
Ash presents what we think is a very balanced argument around gold
sentiment at the moment. He discusses movements in speculative money that
was perhaps riding the gold price and the strong demand of physical demand
still in the market – basically reaffirming the view we recently published.
Watch the interview here: http://www.youtube.com/watch?v=eDLpCUgZbD0
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Image: Kitco News speaks to bullionvault.com analyst Adrian Ash.
To watch more informative trading videos, visit our site.
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5.0 Disclaimer
Please note that you are receiving this report complimentary from Invast
Financial Services Pty Ltd (AFSL 438 283). Invast staff members may from time
to time purchase securities which are included in this or future reports. The
authors of this report may or may not be holding a position in the securities
mentioned. Please note that the information contained in this report and
Invast's website is of a general nature only, and does not take into account
your personal circumstances, financial situation or needs. You are strongly
recommended to seek professional advice before opening an account with us.
General Disclaimer: This newsletter contains confidential information and is
intended only for the person who downloaded it. You should not disseminate,
distribute or copy this newsletter. Invast does not accept liability for any
errors or omissions in the contents of this newsletter which arise as a result of
downloading this newsletter. This newsletter is provided for informational
purposes and should not be construed as a solicitation or offer to buy or sell
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any financial product. Invast Financial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).
Risk Warning: It's important for you to read and consider the relevant Product Disclosure Statement, and any other relevant Invast Financial Services Pty Ltd documents before you decide whether or not to acquire any financial products listed in this email. Our Financial Services Guide contains details of our fees and charges. All these documents are available here on our website, or you can call us on +612 8036 7555. CFDs and Foreign Exchange are leveraged products and carry a high level of risk and you can lose more than your initial deposit so you should ensure CFD and Foreign Exchange trading meets your personal circumstances.
General Advice Warning: Being general advice, this newsletter does not take account of your objectives, financial situation or needs. Before acting on this general advice you should therefore consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision.
*Distributed with the permission of Invast.com.au