ETF Market Vital Funds: Nov. 6

U.S. rose on Thursday, clinching the S&P 500′s 37th record finish of 2014, on the heels of an upbeat report on weekly jobless claims in the U.S. and after European Central Bank President Mario Draghi promised a larger stimulus to buttress flagging European economic growth. European shares rose during overseas’ trading hours, but U.S.-listed Europe stock ETFs gave back gains by the end of the American session. Bond prices tilted lower and gold was little changed from its roughly four-year lows.

Daily Performance for the Largest ETFs:

• iShares Russell 2000 ETF (IWM): +0.43%
  
• SPDR S&P 500 ETF Trust (SPY): +0.40%
• PowerShares QQQ (QQQ): +0.32%
• SPDR Gold Shares (GLD): +0.08%
• Vanguard Total Bond Market (BND): -0.23%
• iShares MSCI EAFE ETF (EFA): -0.54%
• iShares 20+ Year Treasury Bond ETF (TLT): -0.65%
• Vanguard FTSE Emerging Markets ETF (VWO): -1.42%

Will the Swiss Referendum Turn Around Gold?

Gold is in free fall. But a Swiss vote later this month might help stoke a rebound in the yellow metal and alter the contours of the gold market for years to come.

Though it sounds farfetched, a referendum in Switzerland on Nov. 30 could force the hand of the Swiss National Bank to buy billions of dollars in gold and never sell.

So far, gold prices have paid little mind to the vote, slumping nearly 13% over the past three months as a rising dollar and diminishing inflation expectations have eroded gold’s appeal.

The SPDR Gold Shares (GLD) inched higher on Thursday from near a four-year low.

Yet Wall Street is gearing up for the possibility, albeit remote, that Swiss bankers might be forced to buy about $60 billion in gold over the next five years.

J.P. Morgan’s Nikolaos Panigirtzoglou, a strategist based in London, said on Thursday:

We feel that the market is overly complacent at a time where a major development could affect demand for gold in the coming months/years.

If passed, this could potentially require the Swiss National Bank to acquire a large amount of gold in the market – possibly $60bn worth of gold within five years if it decided to match the 20% threshold requirement by converting some of the cash holdings in its balance sheet.

At issue is an initiative called “Save Our Swiss Gold,” and it could force the Swiss central bank to hold at least one-fifth of its assets in bullion, up from about 8% now, report Nicholas Larkin and Catherine Bosley at Bloomberg.

Why push this issue? Proponents contend that the SNB’s policy of capping how many Swiss francs it holds brought too many euros onto the balance sheet, reports The Wall Street Journal’s Andrew Morse.

Sebastien Galy, a currencies analyst at Societe Generale, said in a research note last week that a “yes” vote would be a major support for gold:

The new gold rule would be the equivalent of giving a large put to the market. Each time gold collapses, the SNB would automatically buy gold so that the 20% reserves ratio is maintained, and this would presumably be achieved by mostly selling EUR and USD.

Jared Dillian, a former Lehman Brothers Holdings’ ETF trader turned market commenter, agrees.

If Switzerland buys $60 billion worth of gold over a period of 5 years…it is going to have a measurable impact on the price of gold. Will it go catapulting to new highs? Probably not. But if it looks like this referendum is going to pass, I wouldn’t be surprised to see gold creep towards 1400.

The Wall Street Journal’s Chiara Albanese and Ese Erheriene reported last month that normally sleepy currency options on the franc/euro are getting pricey, a sign that traders are already taking flyers on currency protection.

Investors have so far paid the vote little attention, but are now waking up to the risks. This mirrors traders’ last-minute anxiety over Scotland’s referendum over independence from the rest of the U.K. in September.

There are many caveats, and only a small chance that the rule would ever come into effect. The WSJ’s Ms. Albanese and Ms. Erheriene report that Switzerland’s regions and parliament would still have to ratify the move, which sounds unlikely.

Vanguard Already Tops Yearly Flows Record

Vanguard Group‘s asset-gathering juggernaut rolls on.

Charles Stein at Bloomberg reports that Vanguard pulled in $163.4 billion in the first 10 months of 2014, already a full-year record.

October’s $24.5 billion haul was the second-biggest monthly inflow on record, he says.

Vanguard, which unseated Fidelity Investments as the biggest mutual-fund company four years ago, is benefiting from investors’ preference for indexing over active management. Equity mutual funds that track indexes attracted $85.8 billion this year through September, compared with $2.5 billion for funds that pick stocks, according to Chicago-based Morningstar Inc. Stock ETFs, which are almost exclusively passive products, received $87.2 billion in subscriptions.

Bullish ‘Butterflies’ Take Flight in Energy ETF

Bullish options activity is perking up in the Energy Select Sector SPDR Fund (XLE), a sign of traders wagering on a turnaround in hard hit energy stocks.

Susquehanna Financial Group’s derivative strategist, Christopher Jacobson points out that a trio of large, complex options bets on XLE hit the tape on Wednesday. Each profits from a swing higher in the energy ETFs starting in December and running through March.

Crude-oil prices have been drilled in recent months by a surplus of global supply against the backdrop of slowing industrial global demand. A recent move by Saudi Arabia to cut prices for crude it exports to the U.S. recently stoked more worry that a price war could send oil even lower.

Falling crude has hit shares of producers and oilfield-service companies whose businesses are extracting and transporting crude.

The $10 billion XLE had tumbled 21% from its June high to the middle of October, but has since reclaimed about 7% of that decline.

Daily volume in bullish “call” options in XLE on Wednesday jumped to the highest of the year, according to data from Trade Alert. Call options are contracts that give the buyer the right to buy shares for a set price at a predetermined time; buyers of calls generally profit when shares rise.

Wednesday’s big trades employed strategies called “butterflies,” which use a combination of call options (that resemble, vaguely, a body and two wings, hence the name).

“After coming under significant pressure alongside falling crude prices in recent months, the XLE  has rebounded off its mid-October lows and we saw a series of trades yesterday in which investors appeared to be positioning for further upside in the months ahead,” Mr.  Jacobson said.

Why bother with these complex strategies? Mr. Jacobson explains:

It would appear as if the investor(s) was buying the lowest strike call for upside exposure, selling twice as many of the middle strike call to help finance the trade while speculating that a move above there was unlikely, and then buying back the higher strike call to cap risk just in case the move was more dramatic than expected.

Is Junk Lurking in Your Short-Duration Bond Fund?

Investors have marched billions of dollars into short-duration bond funds in anticipation of the interest-rate spike that, so far, hasn’t materialized.

Those short-duration funds that can boost their payouts are clearly most attractive. But Morningstar’s  Director of Personal Finance, Christine Benz, warns that some large and popular funds are heavy in non-investment grade securities, which could be a worry if the market turns.

Here’s the download:

Given that many investors use short-term bond funds to defray near-term income needs, some of these funds could be taking more risk than their shareholders bargained for.

Given the duration of the current rally in lower-quality bonds, it’s a good time to pre-emptively check up on your holdings’ credit-quality exposures. And if a fund has a substantially higher yield than its peers, be sure you understand what it’s doing to generate it.

Ms. Benz points out that three-year Treasury yields are under 1%, while the average expense ratio for short-duration funds is around 0.80%. That’s a narrow window.
One fund that has managed to thread the needle between low expenses and yield is the Vanguard Short-Term Bond Index (VBISX), she points out.

Others, though, appear to be taking on more credit risk to compensate for the lower payouts in short duration. Ms. Benz singles out the BlackRock Low Duration (BFMSX) for having an overweight, 19%, in non-investment-grade bonds, far higher than peers.

Another is the Lord Abbett Short Duration Income (LALDX), which has been a magnet for inflows in recent years. The fund’s yield of nearly 4% is eye-popping in the short-duration universe.

Morningstar is cautious that the fund is relatively heavy in commercial mortgage-backed securities and low-quality bonds to power that yield.

Stocks Zoom on Draghi Presser

For markets, here’s how the script read Thursday morning:

Mario Draghi: “Jump.”

Stocks: “How high?”

Stock futures in the U.S. and shares in Europe are zipping higher after European Central Bank President Mario Draghi said in a post-policy-meeting press conference that ECB officials are “Unanimous in Commitment to Use Unconventional Instruments If Needed,” according to headlines on Dow Jones Newswires.

The collective, all-seeing eye of the market focused on the ECB on Thursday to see whether the central bank might take steps to follow the Federal Reserve and Bank of Japan with additional stimulus measures. The ECB left its main interest rates unchanged at record lows.

From Deutsche Bank‘s Macro Strategist, Jim Reid:

Whilst not many expect concrete action, the success will be judged on how much Draghi hints at much more future action whilst actually probably doing nothing.

Between June and September the ECB seemed like it was catching up with the curve that many feel it is behind.

However last month’s press conference saw many disappointed at Draghi with the feeling he was back-tracking on prior dovishness. Indeed many feel his performance last month contributed to the large falls in markets over the following week so the stakes are fairly high. 

Dow Jones Industrial Average futures raced higher during Mr. Draghi’s press conference. Meanwhile, the STOXX Europe 600 Index up 0.9%.

Peer pressure will ultimately be too much for the ECB not to embark on a broader asset-purchase program, or quantitative easting, says Jennifer McKeown at Capital Economics:

The ECB is unlikely to succumb to pressure for full-blown quantitative easing at today’s press conference , but it will continue to lay the groundwork.

However, we maintain that these policies are unlikely to do enough to get the economy back on its feet or eliminate the threat of deflation. With the business surveys very weak, bank lending continuing to contract and core inflation at a joint record low, the ECB should be increasingly concerned about the economic and inflation outlook.

ETF Market Vital Signs: Nov. 5

U.S. rallied on Wednesday, giving the S&P 500 its 36th record finish of 2014, after Republicans took control of the Senate in Tuesday’s election. Shares of large companies outpaced smaller ones, while energy stocks bounced back after a string of sharp losses. A strong dollar continued to pressure gold and emerging markets who are commodity exporters.

Daily Performance for the Largest ETFs:

• SPDR S&P 500 ETF Trust (SPY): +0.63%
• iShares MSCI EAFE ETF (EFA): +0.19%
• iShares Russell 2000 ETF (IWM): +0.18%
• Vanguard Total Bond Market (BND): +0.12%
• PowerShares QQQ (QQQ): +0.01%
• iShares 20+ Year Treasury Bond ETF (TLT): -0.14%
• Vanguard FTSE Emerging Markets ETF (VWO): -0.59%
• SPDR Gold Shares (GLD): -2.17%

ETF Trading Last Month Was Heaviest Since 2011

Daily trading in exchange-traded funds last month was the heaviest in three years as market players zipped in and out of positions as stocks careened lower, according to Credit Suisse.

Average ETF trading volume in dollar terms last month was nearly $104 billion, the highest since September 2011, according to Victor Lin at Credit Suisse‘s trading strategy unit. And the total proportion of ETFs trading on exchange rose as high as 35% in the middle of last month.

ETFs are diversified baskets of stocks, bonds and other assets that trade in real time, which traders use for easy exposure to broad market segments and to hedge against big moves.

Global stocks tumbled last month on a confluence of lofty valuations, global growth worries and wariness about the fate of the Federal Reserve’s stimulus efforts. Furthermore, anticipation that the Fed could be inching closer to hiking rates helped support a rising dollar, which proved a major speed bump for commodities and ETFs that hold shares in those sectors.

For instance, tumbling crude prices ramped up the trading volume in the Energy Select Sector SPDR Fund (XLE); this broad sector stock ETF generally accounts for about 10% of total sector EFT volume, but surged to 17% last month, trading $2.8 billion per day, nearly double its average.

The same was true for the iPath S&P 500 VIX Short-Term Futures exchange-traded note (VXX), one of the largest products in the market tied to futures on the CBOE Volatility Index, or VIX.

VXX punched above its weight in a big way last month: with $850 million in assets (0.04% of the $1.9 trillion market U.S. ETF market), VXX traded $2.6 billion on an average October day, or 2.5% of total ETF trading.

An IPO ETF for the Internationally Inclined

First Trust on Wednesday launched the more worldly cousin of its initial public offering-focused exchange-traded fund, the First Trust US IPO Index Fund (FPX).

The First Trust International IPO ETF (FPXI) tracks an index of the 50 largest recent IPOs from companies that are headquartered outside the U.S.

These IPO ETFs don’t capture the first-day “pops” sometimes associated with trading debuts. Rather, both aim to scoop up fledgling shares before they are absorbed into broader indexes. Spin-offs are also included.

From the First Trust International IPO ETF‘s fact sheet:

“While the odds may be stacked against investors attempting to select a few winners from this universe, diversified exposure to recent IPOs may be more desirable.”

First Trust’s international iteration of its IPO ETF follows recently found popularity the FPX. That fund launched in 2006 but languished in relative obscurity until the start of 2013. Since then, FPX has taken in nearly $500 million.

It also comes after last month’s launch of the Renaissance International IPO ETF (IPOS) by Renaissance Capital.

Late last year, Renaissance pushed out its Renaissance IPO ETF (IPO), which has since taken in $28 million.

First day trading activity in the First Trust International IPO was virtually non-existent, with just 100 shares changing hands in early afternoon trading. In contrast, the Renaissance IPO ETF saw more than 800,000 shares change hands in its debut back on Oct. 16, 2013.

UPDATE at 2:46 p.m. Eastern: This post has been modified to include last month’s launch of the Renaissance International IPO ETF (IPOS).

Are Miner ETFs Due for Rebound?

Technicians are hitting the charts hard to suss out when to step in and buy precious-metals miner exchange-traded funds, which have nose-dived to multi-year lows.

Jonathan Krinsky, chief technician at MKM Partners, says he might be on to something in the so-called Bollinger Bands of the Market Vectors Gold Miners ETF (GDX).

Bollinger Bands plot how far prices have strayed from their normal trading ranges. These bands widen in volatile markets, when overzealous buyers and sellers push prices to extremes.

Suffice it to say that GDX‘s 17% drop over the past month has been extreme; Mr. Krinsky says that the ETF has closed underneath its lower Bollinger Band for five days in a row for only the third time ever.

After both previous occurrences (2011 and 2013), the GDX traded higher both five and ten days later, he says. 

Mr. Krinsky, in technician-speak: 

With GDX set to gap-down below the lows from the last three days, and thus become even more extremely oversold, we think a countertrend LONG trade is setting up.

To be clear, we are not calling for “THE” bottom, and for longer-term investors we would need to see MUCH more stabilization in both the miners, and the underlying commodities.

Mr. Krinsky says he would bail on the trade should GDX fall below $15.83, but that any bounce would likely rise to the $19-$20 range.

The GDX drops 0.5% to $17.12 in recent trading, a new six-year low. The Market Vectors Junior Gold Miners ETF (GDXJ) declines 4% to $23.54, its lowest price ever.