Dion Money Management Blog   Money Management for Retirees and Their Families

The JPMorgan Alerian MLP Index ETN (AMJ)(AMJ) offers investors exchange traded exposure to the natural gas marketplace without the problems of United States Natural Gas(UNG).

Although AMJ is less of a “pure play” on natural gas prices than UNG or even First Trust ISE-Revere Natural Gas(FCG), it’s much more predictable over the long term.

AMJ’s investors gain access to the natural gas market through the stocks of companies that store and transport natural gas, many of which are structured as Master Limited Partnerships. While this exchange traded product comes with the risks of exchange traded notes, it is large and liquid, allowing investors to trade in and out of the fund with relative ease.

The companies that AMJ tracks are well diversified businesses involved in natural gas pipeline and storage. According to the fund’s fact sheet, the top five holdings in the fund are Kinder Morgan Energy Partners(KMP), Enterprise Products Partners(EPD), Plains All American Pipeline(PAA), Energy Transfer Partners(ETP)and Energy Transfer Equity(ETE).

These firms are a sort of “tax collector” as natural gas passes through the system, taking a toll even when natural gas prices are low. Natural gas is currently in huge supply at low prices. Eventually this price discrepancy, along with cold weather, hurricanes, or other typical drivers, will push consumers toward natural gas.

UNG’s structure aims to track natural gas prices at the risk of contango , while AMJ tracks MLP’s at the risk of issuer J.P. Morgan. AMJ is a collection of debt notes, rather than equity, which exposes the fund to the credit risk of its issuer. AMJ was originally launched by Bear Stearns under the symbol BSR, but changed its symbol when J.P. Morgan took over and relaunched the index on June 2, 2009.

Rather than having to roll futures contracts month to month like UNG, AMJ is designed for investors seeking income. The MLPs that AMJ tracks are designed to pass on earnings to investors through their dividends. AMJ’s quarterly dividend amounted to 43.6 cents in August. This payout is similar to the dividend that BSR paid in the past, setting AMJ up to yield around 7%.

ETNs are structured for savvy investors, because of the added risk. This risk, however, pales in comparison to the problems over at UNG. As UNG fights to survive regulation and expand, it is exposing investors to increasingly risky derivatives. AMJ is much more suitable for conservative investors looking to make income over time.

Another added benefit for AMJ investors is the tax structure of the fund. MLPs pass their income through to investors, which results in a K-1. Since AMJ is an ETN, it issues a 1099, allowing investors to avoid the K-1. Do-it-yourself tax preparers will appreciate the difference between these two forms.

While UNG, FCG and AMJ offer unique perspectives on the natural gas marketplace, UNG tracks spot prices, FCG tracks producers and AMJ tracks MLPs. Of these funds, AMJ is the most appropriate for savvy income investors. The “toll booth” firms that underlie AMJ will continue to pick off the flow of natural gas and continue to be indispensable participants in the energy marketplace.

Disclaimer

The expansion of the ETF industry could create a haven for “zombie” or low-liquidity ETFs.

Much has been made this past week about the occurrence of these zombie funds, and the tax that they exact on investors. This is a topic that I have covered exhaustively but that is important to return to frequently as more ETFs hit the market.

For every high-liquidity fund like the SDPR S&P 500(SPY) and PowerShares QQQ (QQQQ) that changes hands millions of times a day, there are many low-liquidity funds with little trading volume and unacceptably large spreads.

The ETF’s spread, the difference between the bid and ask, should be reflective of the liquidity of the underlying stocks. ETFs like the SPDR Financial(XLF) contain a portfolio of large liquid companies that are easy to hedge. The ease of this arbitrage should theoretically encourage market makers to keep the spread between the bid and the ask to a minimum.

The problem is that in a free market, you can’t force people to trade your fund. No matter how well intentioned an ETF is, how exotic, how sensible, how well-constructed, you can’t force viability. As they say, you can lead a horse to water.

ETF issuers are encouraged by the structure of ETFs to produce a suite of products in a single stroke and hope that some of the ideas stick. ETFs are premier once again, but in the heyday of launches, ETF issuers would launch as many as 10 products in a single day, knowing that the popularity of a few products could sustain a whole line.

Much has been made this past week about the occurrence of these zombie funds, and the tax that they exact on investors. This is a topic that I have covered exhaustively but that is important to return to frequently as more ETFs hit the market.

For every high-liquidity fund like the SDPR S&P 500(SPY) and PowerShares QQQ (QQQQ) that changes hands millions of times a day, there are many low-liquidity funds with little trading volume and unacceptably large spreads.

The ETF’s spread, the difference between the bid and ask, should be reflective of the liquidity of the underlying stocks. ETFs like the SPDR Financial(XLF) contain a portfolio of large liquid companies that are easy to hedge. The ease of this arbitrage should theoretically encourage market makers to keep the spread between the bid and the ask to a minimum.

The problem is that in a free market, you can’t force people to trade your fund. No matter how well intentioned an ETF is, how exotic, how sensible, how well-constructed, you can’t force viability. As they say, you can lead a horse to water.

ETF issuers are encouraged by the structure of ETFs to produce a suite of products in a single stroke and hope that some of the ideas stick. ETFs are premier once again, but in the heyday of launches, ETF issuers would launch as many as 10 products in a single day, knowing that the popularity of a few products could sustain a whole line.

The truth of the matter is that ETF issuers like to create, not redeem. When ETFs are launched, a primary market maker will exchange underlying securities for shares of the ETF. The ETF will be priced based on the value of the underlying securities plus a cash component. In essence, it only takes two people — the issuer and the market maker — plus a willing exchange, to launch a new product. Doesn’t that sound easier than equities?

ETF issuers try to chase investor demand to grow their product line. Being a first mover in this business is a big deal, and investors will notice that some of the older ETF funds are still the most popular. As the new biggest investing idea takes shape, ETF issuers rush to develop products to match the trend. So while ETF launches reflect investor demand, they are often slightly behind the curve.

Right now, ETF products are extremely popular, and current and potential issuers are filing like crazy to get their products on the market. Currently, more than 500 ETFs are slated for release. As companies like Schwab(SCHW) and Pimco join the ETF race, it will undoubtedly inspire more asset managers to launch their own lines.

What’s the problem with this glut? ETF issuers will overshoot and produce more products than are sustainable. In 2008, nearly 50 ETFs shut their doors because of lack of investor interest, tying up investor funds as they were wound down.

Illiquidity taxes ETF investors. The problem will never be on the buy side, a fact conveniently overlooked by many issuers who promise liquidity. Because ETFs want to get bigger, market makers feel encouraged to create new shares at 50,000 or 100,000 a pop. The problem occurs when the individual ETF investor wants to turn around and sell 100 or 500 of these shares in the open market.

Even investors who were able to get their money’s worth on the buy side may have difficulty selling these shares later on. Redemption, the sound of assets sucking out of a fund, also only happens at 50,000 or 100,000 share-units.

Creation and redemption happen daily in large liquid funds. In illiquid funds, creation will happen at the fund’s inception, and then perhaps stop entirely. Low trading volume reduces the potential for arbitrage, and market makers will compensate for this weakness by widening their spreads. Investors then have to buy and sell funds at premiums and discounts.

The new generation of ETFs, hedge fund-like and life-cycle like, are aimed at the buy-and-hold investor. By definition, these investors will not trade in and out of these products throughout the trading day. This could cause a liquidity drought in even the most conservative product.

ETFs are different from mutual funds in that they have low fees and trade throughout the day on exchanges. A high spread in an ETF can be as bad as a high fee, and if you can’t find anyone to trade with, what’s the point of being able to buy and sell during the day? Investors tempted to buy a low-liquidity ETF may be better off in a mutual fund after all.

Disclaimer

This week on RealMoney, Don Dion blogged on his bullish outlook, Goldman Sachs and emerging-market ETFs.

In the Dip-Buying Camp
Posted 8/27/2009 2:19 p.m. EDT

Doug Kass’ excellent article yesterday continues to generate interest. I don’t foresee a market top here, but if Kass’ call is right, I place myself in the dip-buying camp with Jim Cramer.

Kass says the market has topped for the year, but I’m bullish for the next 12 to 18 months and a dip sometime in the next four months would make me more bullish due to attractive valuations.

Low interest rates and Federal Reserve policies already healed much of the credit market and the Fed remains committed to its low interest rate policy. We’re seeing a surge in home-buying as first-time buyers take advantage of the tax credit, the same way we saw a surge in auto sales. This will accelerate the drawdown of existing housing inventory and lay the ground for a solid recovery.

From speaking with clients and other business owners, the inventory need is real. Panic on Wall Street spread to Main Street and many businesses battened down their hatches. They didn’t just deal with the tough economy; they anticipated the next shoe to drop. As they restock, we’ll see fourth- and first-quarter earnings improvements. Favorable year-over-year earnings comparisons will build confidence and lead to a sustained recovery.

Consumers also increased their savings in anticipation of a worse situation and we’re seeing consumer confidence improve. Savings in the bank are good for confidence and the move to higher savings rates will not move in the almost straight line we’ve seen in the past year, but adjust over years.

Finally, I’d say that if Kass is right about the top, should the ensuing selloff be significant enough to scare the public, concerns over health care and energy bills (and possibly even the deficit) are misplaced. There will be no significant legislation passed by the Democrats because they will face the prospect of losing control of the House of Representatives.

By this time next year, pundits will be discussing a political shift on the scale of 1994. That will either force Obama to the right, as we saw with Clinton, or it will pave the way for a total reversal of the 2006-2008 electoral pattern in 2012.

Recall that in the early 1990s, there were deficit projections as far as the eye could see, but following the Republican takeover, a political stalemate led to balanced budgets. Today’s huge deficits will not materialize because the American people are even more anti-deficit today than they were when Ross Perot received 20% of the vote.

Kass nails all the concerns and trends as they stand today, but I’m looking out to next year and I see a different picture emerging. It takes time for the facts on the ground to work their way into economic statistics and political realignments, and if he’s right on the market, I see it as reinforcing longer-term positive trends, not derailing them.

Goldman Sachs’ Unwanted Attention
8/24/2009 11:12 a.m. EDT

Goldman Sachs(GS) may rue the day it got into bed with the U.S. government if trends in public opinion continue to develop. From a Rolling Stone expose to political pundits and concerns about high-frequency trading, Goldman Sachs’ name keeps turning up.

Now The Wall Street Journal is asking questions about its “trading huddle” where analysts and traders discuss thoughts on the market and, in at least one case, offered meeting advice that differed from a published report.

On the surface, it doesn’t appear that Goldman did anything illegal nor is there clear evidence of unethical behavior. The meetings were focused on short-term trading ideas, not long-term ones found in analyst reports. Furthermore, one might ask why an investor or trader would be a client of Goldman Sachs if it didn’t deliver an edge.

Instead of focusing on this specific incident, which doesn’t show evidence of clear wrong-doing, I’d ask why the Journal ran this story on the front page. I believe the answer is that the public is not happy with financial institutions in general, and certainly not with firms that have benefited directly from cash infusions or indirectly through the selective bankruptcy of the competition and cash infusions that passed through other firms. In addition, Goldman’s close ties to the federal government raise the ire of taxpayers miffed about huge deficits.

The end-result is likely to be tougher-than-expected regulations. As much as corporations are able to lobby Congress for favorable outcomes, they are almost powerless against widespread negative public opinion. Politicians who might normally favor less-stringent changes will not step in front of a runaway train.

President Obama and the Democrats are already looking at large losses in 2010 due to their botched efforts at health care reform. Deficits, climate change, bailouts and the stimulus are all losers for the party heading into next year as things stand today. Financial regulation could be an easy win because Republicans won’t want to be seen as defending financial institutions.

ETF investors need to consider potential new regulations as part of their long-term planning. Commodity and leveraged ETFs have come under attack and regulation could eventually change the way investors access these asset classes. Financial regulation will be even more far-reaching, affecting everything from insurance to mortgages. Public sentiment suggests the industry is about to land in the government’s crosshairs.

Turkish ETF Runs Ahead of the Field
8/25/2009 4:28 p.m. EDT

While several emerging-market ETFs have seen their returns wane in recent weeks, iShares Turkey(TUR) advanced to higher ground.

In the past month, developed markets were some of the best-performing ETFs, with iShares Austria(EWO) up 19.38%, iShares Australia(EWA) up 10.73%, and iShares Belgium(EWK) and iShares Sweden(EWD) close behind.

Market Vectors Russia(RSX) was a strong emerging-market performer, up 8.66%, while iShares Brazil(EWZ) gained 7.29%.

TUR’s 17.28% rally left these funds in the dust. I could cite some economic data, but the Turkish story is not so compelling that it necessitates such a large level of outperformance.

Year to date, TUR is up 86%, right behind RSX’s 87% return, but RSX is up only 11% in the past three months, compared with 40% for TUR.

TUR has strong momentum and will rally as long as current trends persist, but the next closest emerging-market fund over the past three months — with the exception of another outlier, Market Vectors Indonesia(IDX), up 33% — is iShares Thailand(THD), up 21%. That suggests Turkey may have run ahead of itself.

Disclaimer

Here’s a look at my ETF winners and losers for this week.

Winners:

iShares MSCI Austria Investable Market(EWO) +3.4%

iShares MSCI Italy Index Fund(EWI)(EWI) +2.8%

iShares MSCI Spain Index Fund (EWP) +2.1%

iShares MSCI Belgium Investable Market (EWK) +1.8%

iShares MSCI France Index(EWQ) +2.2%

iShares MSCI Germany Index Fund(EWG) +1.2%

The ETFs following the markets of European Union member nations were some of the biggest gainers this week.

This week, the European Commission’s economic sentiment indicator rose to 80.6 points from 76 points in July. The report adds to the growing number of indicators signaling that the global economic crunch is beginning to ease.

Two weeks ago, I reported on France and Germany’s rise from recession. As expected, the ETFs designed to track the markets of these two nations have followed suit. Others, it appears, are also jumping on the bandwagon.

PowerShares Aerospace and Defense(PPA) +2.0%

Dow Jones U.S. Aerospace & Defense Index Fund(ITA) +1.9%

The aerospace and defense sector saw a boost this week as airplane manufacturing giant Boeing released positive information regarding its Dreamliner aircraft. On Thursday, the company announced that the craft, which has seen its fair share of delays, is now expected to see its first flight in 2009.

SPDR S&P Homebuilders(XHB) ETF +3.1%

Reports of a big leap in sales of new homes last month sent homebuilder stocks higher this week. With a stimulus program offering new homebuyers $8,000 towards their purchase, the federal government is taking steps to ensure that the sector has hit bottom. Fears remain, however, over the possibility that this program may simply be sapping future demand.

Losers:

Market Vectors Solar Energy(KWT) -2.0%

PowerShares WilderHill Clean Energy(PBW) -0.2%

PowerShares DB Oil Fund(DBO) -1.5%

First Trust ISE-Revere Natural Gas Index Fund(FCG) -1.6%

Market Vectors Coal(KOL)ETF -3.1%

iPath S&P GSCI Crude Oil Total Return Index ETN(OIL) -1.5%

From coal to clean, much of the energy sector took a beating this past week. Oil managed to bounce back a bit towards the end of the week as the dollar headed back up. However, it was not enough to help black gold recover from the week’s losses. Natural gas continued to spiral downwards. As I stated earlier this week, this trend is likely to continue unless a tragic Katrina-esque event sends prices back up.

Coal, as predicted, headed south this week as Chinese mines reopened and suffocated the commodity’s five month rally.

iShares MSCI Mexico Investable Market Index Fund(EWW) -1.5%

iShares MSCI Brazil Index Fund(EWZ) -3.1%

iShares MSCI Chile Investable Market Index Fund(ECH) -2.6%

ETFs designed to track Mexico and other Latin American nations slumped this week following the uncertainty of the U.S. markets.

UltraShort 20+ Year Treasury(TBT) -5.6%

TBT was the week’s biggest loser as choppy markets sent investors back into the bond markets. As long as the U.S. remains on shaky ground it is likely that this fund will continue to fall as investors lean towards more conservative instruments to protect their investments.

Disclaimer

Last week, I shared a profile of leading growth stock investor, Peter Lynch. Lynch, a former golf caddy, eventually went on to manage one of the best-performing mutual funds of all time. By following a number of personal rules, including know what you own and investing in things that are boring, Lynch helped the Fidelity Magellan Fund (FMAGX) grow from $20 million to $14 billion before he retired.

This week we’ll consider a growth investor who has made a significant mark in the investment world during the past several decades. He has his own approach to stock picking and has influenced many of today’s most successful and promising fund managers — including the top guns at Fidelity: Bill Miller.

Soon after Peter Lynch broke millions of investors’ hearts by retiring from the mutual fund management game, a man named Bill Miller took over sole management of a struggling fund called Legg Mason Value Trust (LMVTX). That was back in November 1990. He then proceeded to outpace the S&P 500 for 14 straight calendar years — thrashing Peter Lynch’s previous record of seven years.

Many investors know Miller as a value investor — so what’s he doing in a series about great growth investors? Well, for one thing, he bought shares of skyrocketing technology stocks such as AOL (TWX) (up 3000% from 1997 to 1999) and Dell (DELL) (up more than 1000% during the same period) during the late ’90s. And unlike many of the so-called growth investors who piled into those stocks 10 years ago, Miller sold them before the tech bubble burst. What’s more, he did so because he understood their business models and prospects better than most of his peers.

Miller laid the intellectual groundwork for his famous technology investments in the early ’90s. Like other value funds, LMVTX had spent the ’80s buying stocks that looked cheap based on traditional measures such as price/earnings ratios.

But Miller noticed that value stocks as a group tended to suffer through long droughts. He investigated and found that most low P/E stocks were shares of cyclical companies with modest long-term returns on capital. Their returns grew during the early stages of an economic recovery, but fell when the economy slowed — and the firm’s stocks fell with them.

In contrast, some firms had business models that could consistently generate superior returns. Buy those stocks cheaply enough, and you might enjoy strong investment results over an entire economic cycle.

The trick was to spot those superior business models before other investors did. Miller’s first big find was Dell, which Value Trust began buying in March 1996. Other value players also liked the stock for its single-digit P/E — the result of concerns that competition would dampen returns for PC makers. But those value investors abandoned Dell once its P/E rose into double-digits. Miller held his shares as the price and P/E skyrocketed — and the value of the fund’s holdings climbed to more than $1 billion.

Miller held on because he believed the company’s business model could generate returns high enough to justify the share price. The company’s direct sales kept overhead down (no stores; low inventory) and profit up. Customers loved Dell’s prices and made-to-order PCs, so revenue was soaring. And the faster Dell grew, the more cash it generated — new customers paid immediately, but Dell didn’t have to pay its bills for months.

Miller reduced Value Trust’s technology stake before the Nasdaq’s big tumble in the spring of 2000. He figured technology stocks were priced to reflect economic growth of 6% or 7% — which wasn’t sustainable. The risk in the stocks had climbed dramatically, so he sold them.

In the early part of the decade, Miller came up with other ways to sustain his fund’s shining record. He has owned, or still owns, shares of growth stocks that he considers undervalued (Google (GOOG) has been a big winner) as well as dirt-cheap shares of neglected or out-of-favor companies such as Tyco International (TYC) and Eastman Kodak (EK). That eclectic mix is testimony to his view that the distinction between growth and value investing is largely artificial. Smart investors, he rightly points out, take a company’s growth prospects as well as its share price into account.

During the most recent global economic downturn, Miller’s choice to hold onto financials proved that even the best investors make mistakes. During the inflation of the financial bubble, Value Trust saw a great deal of growth. However, when that bubble popped, it dragged down Value Trust and Miller along with it.

However, today, with signs that the economy is beginning to heal, the same companies that dealt the damaging blow to Miller, including Goldman Sachs (GS), J.P. Morgan Chase (JPM) and Wells Fargo (WFC), are also the same ones that are helping to assist the fund’s recent resurrection.

These profiles of great stock pickers suggest that labels such as “growth investor” or “value investor” can be useful, but it’s important to look beyond them when you’re examining the methods and performance of any fund manager. We do just that when we’re evaluating the funds in our model portfolios. It’s just possible that some of the managers at those funds will be remembered as great investors in their own right.

Late last year and into early 2009, West Texas Intermediate crude prices entered what was dubbed “super contango.” The spot price for oil was far below the futures price, guaranteeing a huge profit for anyone who bought and stored barrels of oil and sold an offsetting futures contract.

The reason for the extremely low price was because storage was maxed out at the Cushing, Okla., delivery point. Previously high prices led to a demand reduction that was exacerbated by the global financial panic. Oil was “too cheap,” but there was nowhere to store it and that caused prices to crater. Eventually, investors filled supertankers with oil, parked them offshore, demand picked up and prices recovered.

Natural gas may be headed into super contango as well. The spot and near-month futures contracts sell for less than $3 per million BTUs, but October 2010 futures can be sold for $6. Buy the gas today, store it and next year earn a 100% profit less storage fees. One problem –where are you going to store it?

Natural gas storage is 18% above five-year averages and, according to the Energy Information Administration, regional storage may max out. Unlike oil, natural gas is much more of a regional energy source because it still mostly moves from producer to consumer via pipelines. Liquefied natural gas may change that in the future. Local storage facilities may run out of space in another month or two, and then the gas has nowhere to go — unlike the price, which will rapidly drop.

Many people think it’s easy to switch between natural gas and oil, but in fact they serve different markets: 70% of crude oil goes towards transportation, whereas natural gas is split three ways between residential & commercial, industrial and electric generation demand. Switching from one to the other is a lengthy and expensive process and most of the switches have been made.

The international nature of crude oil means if people in Ulan Batur demand more oil, the price may change in New York. But a natural gas shortage in Mongolia will not raise American prices because there’s no easy means to transport it. There were major discoveries of natural gas last year and New York Governor David Patterson is pushing to open up the Marcellus shale to drilling, with environmental concerns taking a backseat to the need for tax revenue.

On top of that, renewable energy currently is aimed at electricity generation, not transportation (though that may also change depending on the popularity of electric cars).

Natural gas has abundant natural reserves, excessive supply and reduced demand and is a competitive threat — it was one of the hottest ETFs in the past three months, based on money flows.

As I warned almost two months ago, the fundamentals pointed to lower natural gas prices. I was right and prices have fallen. I’ve also warned against investing in U.S. Natural Gas(UNG) countless times.

UNG became a slow-moving target in the futures market that allowed savvy speculators to front-run its monthly contract roll. It already created an exacerbated the near-month contango and cost investors money each time it rolled. Now due to concern over pending regulatory changes, UNG ceased issuing new shares and trades at a whopping premium of 17%. The iPath Natural Gas ETN(GAZ) doesn’t offer much advantage; it had an 8% premium at close yesterday.

Ironically, if we see a final super-contango cratering of UNG, it may create the conditions for the next bull market, but that could take months to years to play out, however, and depends on multiple factors. I’ve recommended First Trust ISE-Revere Natural Gas(FCG), which holds the stocks of producers and has outperformed UNG since March, as a better way to play natural gas if that’s your desire. But unless another Katrina rips through the Gulf region, the outlook for natural gas prices is grim.

Disclaimer

Warren Buffett cut through the fog of uncertainty surrounding the healthcare sector and increased his stake in the sector by buying Becton, Dickinson and Company(BDX) and Johnson & Johnson(JNJ).

An Aug. 14 regulatory filing revealed that Buffett’s Berkshire Hathaway(BRK-A) had 1.2 million shares of BDX at the end of the second quarter, and had increased its position in JNJ.

Healthcare reform, a key issue for President Obama, has sputtered to a virtual standstill. The prospect of new legislation has bullied the healthcare sector since before election day, sending everything from healthcare providers to pharmaceuticals on a wild ride. The debate has caught fire in the last few months, and the smoke has obscured significant recovery in healthcare stocks.

It’s been a rocky road for Buffett’s 1.2 million shares of BDX and 36.9 million shares of JNJ. BDX, which climbed 6.1 percent in the three months ended June 30 to $71.31, settled to $69.83 as of yesterday’s close. JNJ has also climbed steadily upward in 2009.

The first commandment of Buffett investing, however, is to buy solid companies at fair prices, and not get mired down in short-term fluctuations. The recent voices in the healthcare debate have reached a roar, and it is tempting for investors to put their hands over their ears and keep their heads down.

The stark reality, however, which Buffett has keenly grasped, is that America is aging. As baby boomers reach retirement and old age, their numbers will affect nearly every sector in the economy. No matter what packaging healthcare assumes, it is certain that we will need more of it.

Buffett’s long-term investment approach has singled out BDX and JNJ with good reason. BDX has held up well during the recession, and its strong revenue stream makes it a predictable pick for the future. While its bioscience business has felt the downward pull of decreased hospital spending, its medical and diagnostic segments have performed well.

Factors like revenue, management and dividends will help BDX in both the long- and short- term, as well as an increased focus on research. Proposed policies should continue to encourage spending on research, and government customers could help to boost BDX’ bottom line.

JNJ is a well-diversified business that is set to perform well over time. The company has many different revenue streams across the health care industry. JNJ is a major presence in the healthcare sector, with cash-flows that should sustain the company even though difficult economic environments.

While Buffett favors the long-term competitive advantages of both JNJ and BDX, he is not bullish on every area of the healthcare sector. Also included in the regulatory filing was the news that Berkshire had cut its holdings in WellPoint(WLP) by 27% and its stake in UnitedHealth Group(UNH) by 24%.

Like Buffett, ETFs are a good way to capture certain sectors of the healthcare industry while avoiding others. JNJ makes up nearly 25% of the Pharmaceutical HOLDRs ETF(PPH), and biotechnology firms, like the ones in iShares Nasdaq Biotechnology(IBB), should continue to provide competitive advantages.

It is easy to get distracted by a short-term debate that startles sectors like health care. Short-term fluctuations should not hinder investors from achieving long-term goals. Like Buffett, we must look at the realities of an aging population.

An increase in coal production in China is expected to put an end to the commodity’s impressive five-month global rally.

Although Market Vectors Coal ETF(KOL Quote) has been able to take advantage of the recent run-up, the expected supply boost may bring down prices, and KOL will likely take a hit.

Recent tragedies in Shanxi, China’s largest coal mining province, caused the government to halt a large number of small mines in order to reassess their safety. These smaller mines, which account for close to a quarter of China’s coal production, were told that they had to merge with larger producers in the nation. Those that were deemed unsafe by the government were shut down.

Currently China uses coal to produce as much as 80% of its electricity. Therefore, with a quarter of the nation’s domestic coal supply halted, China was forced to import a record 48 million metric tons of coal in the first six months of 2009.

However, on Monday news broke that with many new safety upgrades complete, a number of these smaller mines would be reopened in an attempt to bolster China’s economic growth.

The reopening of these mines is expected to boost output in Shanxi 60% in the second half of the year. Analysts believe that the increase in domestic coal production will drive down the price of imported coal from Europe as much as 7%. Seaborne coal producers are also expected to feel the pressure.

I spoke with Glenn Smith, the director of ETF sales at Van Eck, yesterday about the implications of the expected supply boost and subsequent price drop on KOL. He informed me that, while the fund is likely to be negatively affected by the drop in coal prices around the world, coal is not a bad industry.

Smith explained that coal’s performance is almost entirely dependent on supply and demand. While the fact that an increase in supply is expected to drive down prices, the enormous imports piped into China this year illustrate that demand for coal has not let up.

Although the consensus is that KOL will see a dip, it will be interesting to see how drastic it will be. While the largest companies such as Xstrata, Anglo American(AAUK Quote), and Rio Tinto(RTP Quote) will likely be hit hard, none of these companies are listed in KOL’s index. KOL is currently up 94.5% year to date for a period ending August 24.

The fund tracks an index made up of companies from across the globe that are heavily involved in the coal mining industry. Companies from the United States, China and Indonesia make up 45%, 23% and 16% of the index, respectively.

The fund’s top five holdings include: China Shenhua Energy Co Ltd (8%); Alpha Natural Resources(ANR Quote) (7.6%); China Coal Energy (7.5%); Peabody Energy(BTU Quote) (7%) and Joy Global (JOYG Quote) (7%).

Although, coal demand has not been stifled, the nation does appear to be taking steps toward cleaner energy sources. Just last week, Petro China(PTR Quote) and Exxon Mobil(XOM Quote) signed a landmark liquefied natural gas import deal in Australia.

The agreement entitles China to 2.25 million metric tons of LNG per year over the next two decades. If this is a sign of the future for Chinese energy use, now may be a perfect time to dump coal and get into natural gas.

Beside the changing preferences in China, other factors such as the coming hurricane season and cooler temperatures are also making the idea of investing in natural gas look more attractive.

As I’ve explained over and over again, U.S. Natural Gas Fund(UNG Quote), with its current 14% premium, is a terrible way for investors to gain exposure to the commodity. On the other hand, First Trust ISE-Revere Natural Gas Index Fund(FCG Quote) is a great way to take advantage of the expected bump in prices. Year to date for a period ending August 21, UNG is down almost 50% while FCG is up 29%.

Disclaimer

The demand for “physical” commodity ETFs is exploding worldwide.

International fund issuer ETF Securities saw the biggest ever one-day influx of assets into ETFS Physical Gold ETC(PHAU.L) Tuesday in London. This ETC’s bullion holdings increased by 7 percent Tuesday, or 211,500 ounces, to 3.190 million ounces.

In the U.S., investors use funds like SPDR Gold Shares(GLD) and iShares COMEX Gold Trust(IAU) to diversify and hedge against inflation.

Like other “physical” ETFs, GLD and IAU allow investors to gain exposure to the market for physical gold. Each has gold bullion to back its shares. The success of the ETF is dependent on how much people want to pay for physical gold.

ETF Securities has popularized these commodity funds abroad. The issuer launched five new funds on the Tokyo Stock Exchange earlier this week. The new ETFs are Physical Gold, Physical Silver, Physical Platinum, Physical Palladium and a Physical PM Basket ETF.

ETF Securities has also ventured into the U.S. market. On July 24, ETF Securities premiered the ETFS Silver Trust(SIVR) on the NYSE, offering investors exposure to physical silver. SIVR has yet to attract high volume, but is certainly a symbol to watch.

While hard data has yet to back rampant inflation fears, investors continue to protect their portfolio with inflation-fighting ETFs. Physical ETFs are popular in the U.S. and abroad while Treasury Inflation Protection Securities(TIP) grow in demand. The iShares TIPs ETF(TIP) is one of the top asset gatherers for the ETF giant in 2009.

Other issuers have picked up on this profitability and are beginning to capitalize on the fixed income space. PIMCO launched the PIMCO 1-5 Year U.S. TIPS Index Fund (STPZ), the first of three planned TIPs ETFs on Monday. The PIMCO trio , expected to be fully released in September, could steal market share from TIP with its more focused approach.

Investor demand for inflation protection though “physical” and TIPs ETFs should continue to spur the release of new funds. Investors looking to get involved with the “physical” gold play are well served by IAU and GLD. While the latter has more trading volume, both are large liquid funds with essentially identical strategies.

The success of the ETF Securities funds abroad, along with its U.S. debut, suggests that more of these funds may be in the pipeline. The crackdown on futures-based commodity funds like United States Natural Gas(UNG) and United States Oil(USO) could have people running from these funds to physical commodity ETFs like GLD and SIVR.

Physical commodity funds are a good way to diversify your holdings, but they shouldn’t make up the core of your portfolio. The difference between buying gold bars and buying shares of GLD involves management fees that nibble away at your holdings. ETFs like IAU and GLD also have less favorable tax treatment than other ETFs.

Keep an eye out for the expansion of “physical” commodity ETFs and the opportunities they provide. The regulatory crackdown on futures-based ETFs and fears of inflation could spawn a new generation of funds.

Disclaimer

Investors can thank Vanguard Funds for helping to bring low-cost exchange-traded fund alternatives into the marketplace. As the ETF industry expands, Vanguard has become increasingly focused on selling ETFs. ETFs have been a driving force for the mutual fund giant, accounting for roughly 20% of net flows over the past year. The influx of assets has made Vanguard the third-largest ETF manager.

The growth of the ETF industry has spurred two separate phenomena. First, issuers have felt compelled to break new ground. In a bid to grab market share, they have created exotic or niche products. Individual country funds, made popular by iShares as early as 1996, are now common. In the quest to offer investors something different this summer, Van Eck launched the Market Vectors Vietnam ETF(VNM) while Global X debuted its FTSE Nordic 30 ETF(GXF).

ETF issuers also have tried to break new ground by making previously inaccessible markets like commodities and currencies available to the average retail investor. They have also given the average investor the opportunity to use leverage. Funds like the ProShares UltraShort Real Estate(SRS) and United States Oil(USO) give investors the ability to make the kinds of bets that were previously made almost exclusively by large institutions. (These can also expose investors to credit risk.)

The second phenomenon, which has been propelled by Vanguard, is the increasing number of new ETFs that seek to offer trusted strategies at a more affordable price. As ETF issuers lock horns, investors win. To learn how to take advantage of these low-cost strategies, check out my video:

Vanguard has been a pioneer in the low-cost ETF industry, sparking interest from other firms. Fixed-income giant PIMCO recently released two low-cost funds. The PIMCO 1-5 Year U.S. TIPS Index Fund(STPZ) and 1-3 Year U.S. Treasury Index Fund(TUZ) face off against iShares TIPs(TIP) and iShares 1-3 Year U.S. Treasury(SHY).

Asset manager Charles Schwab(SCHW) recently announced the launch of a series of new proprietary funds. The nine initial ETFs planned by Schwab are nearly identical to Vanguard’s core ETFs. This should come as no surprise to investors who have watched Schwab compete with Vanguard in the past: In May, Schwab cut the expense ratio of its Schwab S&P 500 Index fund (SWPIX) to 0.09%, less than that of the Vanguard 500 Index (FVINX) fund.

Vanguard’s success in duplicating popular ETF strategies at a lower cost has been a win-win for both issuer and investor. In an industry where first-mover status has always been important, Vanguard has proven that investors will always seek out a bargain.

The new wave exotic ETF strategies come at high costs to investors, both in a literal and figurative sense. While ETFs have traditionally been sought out as a lower-fee alternative to mutual funds, complex ETF strategies have high management fees.

The ETF industry continues to grow, and is reaching a new audience. New investors should prompt low-cost ETFs and help to increase liquidity. Vanguard has been ahead of the curve.

Disclaimer