In the feature, “ETFs Provide Cover When Markets Get Crazy,” which ETF does John Schloegel recommend?

Nevertheless, Schloegel likes a variety of ETFs, with exposure to alternative energy, materials, commodities and utilities.

Some of his favorites include: iShares Dow Jones Basic US Materials (IYM) up nearly 12 percent this year and nearly 23 percent over the past 12 months; Poweshares Water (PHO), which tracks domestic water-oriented businesses and is up 11 percent in the past year, and Claymore S&P Global Water (CGW), which is like PHO but is focused internationally.

Scholegel also points to one of the more popular ETFs, the SPDR Gold Shares (GLD) fund, which tracks the commodity’s movement as a good diversification tool. The fund is up about 34 percent over the past 12 months.

Looks like an “all of the above” situation.”

What did Goldman Sachs’ Abby Joseph Cohen call a “pretty good hedge against inflation”?

“We think that equities in general tend to be a pretty good hedge against inflation,” she said. “Equities and shares do well in a period of moderate inflation.”

A comparison of our tax returns would no doubt indicate that Abby’s opinion is more highly valued than mine. Nonetheless, I will give mine here.

First, what does she mean by “moderate inflation?” Stocks have tended to do well over time, and inflation has been moderate over time, so I suppose that is all correct. Meaningless, but correct.

Typically, to be considered an inflation hedge, an asset’s returns should be highly correlated with inflation rates. Alternatively, if the asset returns preserve purchasing power over time it can be considered inflation resistant.

Equities do seem to cover the second criteria. According to Managing Investment Portfolios: A Dynamic Process (CFA Institute Investment Series), “companies’ earnings tend to increase with inflation, whereas payments on conventional bonds are fixed in nominal terms. [However…] corporate income taxes and capital gains tax rates typically are not inflation indexed.” Also, the earnings multiple is inversely related to inflation in the same way that bond prices are (a higher discount rate).

As a result of these conflicting signals, “the very-long run real return on stocks in the United States has been relatively insensitive to realized inflation rates.” (Emphasis added.) Equities are not so much a hedge against inflation as an asset class that does not fare as poorly as some others. Furthermore, they have a negative correlation (ibid p. 526) with unexpected inflation (such as we are seeing today).

Commodities, by contrast, and particularly storable commodities directly related to economic activity, have a positive relation to unexpected inflation. Energy, and to a lesser degree precious metals, are true inflation hedges. Is it then any wonder that such commodities are doing well now, and equities aren’t? Whether this will continue is a function of where inflation goes from here, not a function of equities being a “pretty good hedge against inflation.”

Another asset class that has typically been a good inflation hedge is real estate - and raw land in particular. However, in light of the current economic situation the past may not prove to be a reliable indicator in this case.

Disclosure: At time of publication William Trent is long oil (USO) and gold (GLD) through ETFs.

Disclosure: Author is long STREETTRACKS GOLD (GLD) at time of publication.

Typically, commodity cycles are driven by supply, not demand.

Gold | Economist.com

World gold production fell by 1% in 2007, according to the latest Gold Survey from GFMS. Gold prices have risen to new highs this year, but fresh supply has been held back by a global shortage of mining professionals and equipment. China, where gold output rose by 12% last year, supplanted South Africa as the world’s number-one producer—a position it had held for more than a century.

Although a recession in the US could take a bite out of demand for gold, it won’t help the supply any. Inflation is still higher than the Fed has historically been comfortable with, and that too seems unlikely to change much in a recession. There seems to me to be more inflation risk than is being priced into most assets, so I’m keeping 10% of my own assets in yellow metal.

Disclosure: Long GLD

Disclosure: Author is long STREETTRACKS GOLD (GLD) at time of publication.

Along with other commodities, the basic materials have taken something of a beating recently. The durable goods report suggest that it could be more than just a technical move as shipments, orders and backlog for primary metals all slowed while inventory growth accelerated. It is worth noting that the fundamentals aren’t bad, they are just not quite as good as they were a month ago. Most industries wish they had 15% growth in orders and 25% growth in shipments, and with both growing at a faster rate than inventories it is hard to argue there is a glut. Still, it will be interesting to watch whether the deterioration continues.

Fabricated metal products, which were never as strong as the primary metals to begin with, also show a slowing trend. Here, the fact that inventory growth was faster than order growth and nearly as fast as shipments suggests a higher degree of caution is warranted. Further, with these firms building inventory they are likely to need less of the primary inputs in future months.

Larry Kudlow sees falling commodity prices and bond yields as cause to worry about deflation.

Copper
According to a Bloomberg article, Chinese copper demand is slowing as well.

Copper demand growth in China, the world’s biggest consumer of the metal, may slow to 5.6 percent this year, as record prices prompt makers of cables, wires and air conditioners to switch to cheaper substitutes.

Consumption may be 3.8 million metric tons, Yang Changhua, senior analyst at Beijing Antaike Information Development Co., which advises the government on industry policies, said today at a conference in Nanjing in eastern China. The estimate is lower than his March prediction of consumption of 3.86 million tons and last year’s growth of 9 percent.

Meanwhile, Zambia keeps digging up more of the stuff:

Chamber of Mines of Zambia general manager Fred Bantubonse has said Zambia’s copper production for this year was likely to be at around 600,000 metric tonnes.

In an interview, Bantubonse said this year’s copper production was higher than last year’s which was pegged at 466,000 metric tonnes. “Future prospects of copper production for the year 2009 are likely to about 800,000 metric tonnes all things being equal,” he added.

Nickel
Inco has the right idea: produce less metal but earn more income.

Gold
South African gold production plummeted by 6.1 percent over the three months ended July from the previous three months, according to Statistics SA.

Newmont Sees Lower Gold Production Until 2008

Russia’s gold production down 0.4% in 8 mthsRumors of massive central bank gold selling are still just rumors.

Chemicals
In their latest Investment Survey, Value Line noted significant improvement in ranking for specialty chemicals makers such as Watch List member Sasol (SSL).

The Specialty Chemical Industry is currently ranked 32 out of 97 for year-ahead performance. This is, as noted, in the top half of all industries covered by The Value Line Investment Survey, and a considerable improvement compared with our June report.

Most companies in the specialty chemical sector reported strong bottom-line advances during the June quarter. The earnings outlook for the sector remains relatively favorable for the second half of 2006, as well. Moreover, much of the strength will probably continue into the first half of 2007. This is a disparate group, however, and prospects vary considerably by the product line and market position of each participant. We urge investors to carefully review each stock before making specific investment decisions.

Disclosure: Author is long the Streettracks Gold ETF (GLD)

Disclosure: Author is long STREETTRACKS GOLD (GLD) at time of publication.