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Volatility returned to the markets in force as the second quarter drew to a close, prompting additional mid-year adjustments within the BSW Growth Portfolio.  Below please find a summary of these changes and a mid-year update on our positioning and outlook.

All that glitters . . . ***

Today we exited our gold position within growth portfolios. It has been a wild and profitable ride, but after breaking several key technical levels and moving below $1200 for the first time since August 2010, momentum and weak fundamentals seem primed to push gold down further, possibly even below $1000.  Clearly, gold has lost some of its luster, with gold having declined by 35% from its record high of $1,888.

There are several reasons for gold’s downward momentum.  First and foremost, the risk of a global financial catastrophe has lessened dramatically.  Second, gold performs best in high-inflation environments – or where high-inflation is anticipated.  However, despite QE-infinity expanding the money base many fold, the velocity of money has collapsed, with banks hoarding the liquidity in the form of excess reserves. Ongoing private and public de-leveraging has kept global demand for credit below that of supply, while modest global growth and lingering unemployment has kept wages stagnant – and wages are the biggest component of input costs and, thus, the biggest driver of goods inflation.  Finally, because gold provides no income, it is losing its appeal relative to other investment assets, such as real estate, equities, and even bonds.  Previously, with negative real yields, there was no carrying cost “penalty” to holding gold.  Now, with yields rising and indications that the US Fed is poised to begin tapering its asset purchase program, the interest penalty to owning gold is tangible.

2Q13 Mid-year Portfolio Update:

Our exit from Gold comes closely on the heels our exit from High Yield (see prior post here).  As the quarter came to a close, markets reeled following comments from Fed Chairman Bernanke regarding anticipated tapering of quantitative easing (QE) measures, including the Fed’s current purchase of $85 billion of US Treasuries per month.  Emerging Markets were the hardest hit, as fear grew that any Fed tapering may cool global growth further and have a disproportionately large impact on export-driven emerging market economies.

The sell-off in emerging markets was swift and deep and has pushed valuations to notable levels.  The MSCI Emerging Markets Index trades at 11.2 times earnings, 25% below its 10-year average of 14.8 times, while Emerging Asia trades at 11.4 times earnings, 39% below its 10-year average of 18.6.  The majority of our emerging markets exposure is focused on Asia, which is transitioning to a consumer-driven expansion, rather than the commodity exporting regions of Latin America and Russia — which helped mitigate much of the recent downdraft.  More importantly, we believe the downdrafts in emerging markets have become overdone, as these regions (particularly Asia) will be the likely centers of growth in any global expansion.  Consequently, proceeds from our gold sale were transitioned to our Granduer Peak International Opportunities position, an actively managed fund which focuses on non-US small and mid-sized companies. We continue to like Granduer Peak for several reasons, particularly compelling valuations and that the companies owned by the fund, although primarily domiciled in the developed world, derive a significant portion of their revenues from sales to the emerging markets.

Looking Forward:

Despite the hand-wringing of late, risks to the global economy are gradually dissipating rather than increasing — and we hold a constructive, positive outlook for the remainder of 2013.  Europe’s banking system no-longer teeters on the brink, while lingering unemployment is becoming a catalyst for stimulative measures from the European Central Bank.  Emerging markets have weathered a rough patch, present compelling values, and reduced growth expectations should make it easier for companies and countries to surprise to the upside.  Here at home, consumer confidence has reached a six-year high (which is typically very positive for stocks) yet still has tremendous room to climb (see chart below); valuations are neither excessively cheap nor excessively expensive; corporate cash and profits are strong and leverage levels are low.  We are slightly overweight to the US while focusing on specific sectors that are undervalued and poised for growth: energy and technology.

Historical Data Chart

We hope this Update & Commentary provides you with better insight into your BSW Growth Portfolio.  If you would like to discuss these positions or your portfolio in greater detail, please don’t hesitate to contact BSW.  As always, we are happy to help.

– David Wolf, Chief Investment Officer

With the Colorado Shakespeare Festival now in full swing, it’s interesting to note the roots of the popular expression, “All that glitters is not gold.”  It comes from The Merchant of Venice, and actually offers more important advice on life then money — take a read below. Incidentally, the 2013 season offers a great line-up: Macbeth, Richard II, & A Midsummer Night’s Dream; and is one of Boulder’s finest amenities and traditions.

All that glisters is not gold;
Often have you heard that told:
Many a man his life hath sold
But my outside to behold:
Gilded tombs do worms enfold.
Had you been as wise as bold,
Young in limbs, in judgement old
Your answer had not been inscroll’d
Fare you well, your suit is cold.

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