The Case for Natural Resource EquitiesSeptember 24, 2016

by Frank Holmesof U.S. Global Investors

This week I attended the Denver Gold Forum along with three other U.S. Global Investors representatives, including ourresident precious metals expert Ralph Aldis. I was happy to see sentiment for gold way up compared to last year’sconvention, as was turnout. I was also pleased to see Franco-Nevada, Silver Wheaton and Royal Gold in attendance, all ofwhich I’ve written extensively about.

One of the most interesting presentations was held by Northern Star Resources—the third biggest listed gold producer inAustralia, a dividend payer and a longtime holding of USGI. I’ve always appreciated Northern Star’s insistence on being abusiness first, a mining company second. This shareholder-friendly mantra is reflected in its stellar performance.

Compared to other companies in the NYSE ARCA Gold Miners Index (GDM), Northern Star is a sector leader in a numberof factors, including five-year cash flow return on invested capital. Whereas the sector average is negative 1.6 percent overthis period, Northern Star’s is a whopping 27 percent, the most of any other mining company in the GDM.

This has helped it return an amazing 800 percent over the last five years as of September 23. Compare that to the GDM,which returned negative 56 percent over the same period.

Australian gold miners as a whole trade at an impressive discount to North American producers, 5.7 times earnings versus8.3 times earnings, according to Perth-based Doray Minerals.

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Screening for high cash flow returns on invested capital, as you can see, helps give us a competitive advantage anduncovers hidden gems such as Northern Star and others.

Resource Equities Offer Attractive Diversification Benefits

A recent whitepaper published by investment strategist firm GMO makes a very convincing case for natural resourceequities. I urge you to check out the entire piece when you have the time, but there are a few salient points I want to sharewith you here.

In the opinion of Lucas White and Jeremy Grantham, the paper’s authors, “prices of many commodities will rise in thedecades to come due to growing demand and the finite supply of cheap resources,” presenting an attractive investmentopportunity. Over the long-term, resource stocks have traded at a discount and outperformed their underlining metals andenergy by a wide margin.

According to White and Grantham, a portfolio composed of 50 percent energy and metals, 50 percent all other equities, hada standard deviation that’s 35 percent lower than the S&P 500 Index. What’s more, the returns of such a portfoliooutperformed those of the S&P 500, resulting in a risk-adjusted return that’s 50 percent higher than that of the broadermarket.

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Resource equities have also historically shown a low to negative correlation to the broader market, which might appeal tobears. The reason? When metals and energy have risen in price, it’s been a drag on the economy. The reverse has alsobeen true: Low prices have been a boon to the economy.

The thing is, general equities currently do not give investors enough exposure to natural resources. The weight of energyand metals in the S&P 500 has been halved in the last few years as oil and other materials have declined. Considering thediversification benefits, investors should consider a greater allocation to the sector.

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Timing Is Key

There’s mounting evidence that now might be an opportune time to get back into resource stocks. Following the sharpestdecline in crude oil prices in at least a century, as well as a six-year bear market in metals, the global environment could beripe for a commodity rebound. From its January trough, the Bloomberg Commodity Index has rallied 17 percent, suggestingcommodities might be seeking a path to a bull market.

During the down-cycle, many companies managed to bring costs lower, upgrade their asset portfolios and repair theirbalance sheets. As a result, many of them are now free cash flow positive and are in a much better positon to deliver onthe bottom line when commodity prices increase.

I’ve often written about the imbalance between monetary and fiscal policies. My expectation is that unprecedented,expansionary global monetary policy will be followed by fiscal expansion. Consider this: Total assets of major central banks—including those in the U.S., European Union, Japan and China—have skyrocketed to $17.6 trillion dollars as of August2016, up from $6.3 trillion in 2008.

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This expansion is expected to result in significant inflation gains over the next decade, an environment in which naturalresource stocks have historically outperformed the broader market.

Infrastructure Spending About to Increase?

China largely drove the global infrastructure build out over the past decade as rapid economic growth and rising incomesincreased the demand for “advanced” and “quality of life” infrastructure. This resulted in a breathtaking commodities bullmarket.

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Now, other advanced countries, the U.S. especially, are readying to sustain the next cycle to repair its aging anduncompetitive infrastructure.

As you can see, most major economies dramatically cut infrastructure spending after the financial crisis, indicating it mightbe time to put some of that $17.6 trillion to good use.

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According to the Center on Budget and Policy Priorities (CBPP), the U.S. is presently facing a funding gap of $1.7 trillion onroads, bridges and transit alone—to say nothing of electricity, schools, airports and other needs. Meanwhile, state and localinfrastructure spending is at a 30-year low.

If this financing can’t be raised, says the American Society of Civil Engineers (ASCE), each American household could losean estimated $3,400 per year. Inefficient roadways and congested airports lead to longer travel times, and goods becomemore expensive to produce and transport.

Let’s look just at national bridges. After an assessment of bridges last year, the American Road & Transportation BuildersAssociation (ARTBA) found that 58,495, or 10 percent of all bridges in the U.S., are “structurally deficient.” To bring allbridges up to satisfactory levels, the U.S. would currently need to spend more than $106 billion, which is six times whatwas spent nationwide on such projects in 2010.

Fortunately, both U.S. presidential candidates have pledged to boost infrastructure spending—one of the few things theyshare with one another. Hillary Clinton says she will spend $275 billion over a five-year period, while Donald Trump sayshe’ll spend “double” that.

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Trump’s central campaign promise, as you know, is to build a “big, beautiful, powerful wall” along the U.S.-Mexico border,which analysts at investment firm Bernstein estimate could cost anywhere between $15 billion and $25 billion, requiring 7million cubic metres of concrete and 2.4 million tonnes of cement, among other materials.

As I like to say, government policy is a precursor to change. I’ll be listening closely for further details on Trump andClinton’s infrastructure plans this coming Monday during the candidates’ first debate. I hope you’ll watch it too! Mediaexperts are already predicting Super Bowl-sized audiences.

Don’t Count China Out

In the past year, a lot of ink has been devoted to China’s slowdown after its phenomenal spending boom over the lastdecade, but there are signs that spending is perking up—a tailwind for resources. According to the Wall Street Journal,Chinese economic activity rebounded in August, driven by government spending on infrastructure and rising property taxes.

“In the first seven months of 2016,” the WSJ writes, “China invested 962.8 billion yuan ($144.1 billion) in roads andwaterways, an 8.2 percent increase from the previous year.”

The Asian giant still accounts for a large percentage of global trade in important resources such as iron ore, aluminum,copper and coal. This is why we closely monitor the country’s purchasing manager’s index (PMI), which, according to ourown research, has been a reliable indicator of commodity price performance three and six months out.

Let’s Do Lunch!

Next week I’ll be in Toronto speaking at Mines and Money, one of the world’s largest conferences on precious metalsinvesting. It’s regularly attended by some of the most respected metals experts, analysts and investors. I hope to see youthere!

What’s more, I’ll be hosting a special lunch with SmallCap Power on Tuesday, and you could win a seat at the table! Ifyou’re interested in a chance at winning, just send me your investing question, and I’ll pick the best one. Good luck!

Index SummaryThe major market indices finished up this week. The Dow Jones Industrial Average gained 0.76 percent. The S&P500 Stock Index rose 1.19 percent, while the Nasdaq Composite climbed 1.17 percent. The Russell 2000 smallcapitalization index gained 2.44 percent this week.The Hang Seng Composite gained 1.54 percent this week; while Taiwan was up 3.85 percent and the KOSPI rose2.74 percent.The 10-year Treasury bond yield fell 7 basis points to 1.62 percent.

Domestic Equity Market

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Strengths

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The best performing sector for the week was real estate, increasing by 4.25 percent versus an overall increase of1.19 percent for the S&P 500.Health care company Endo International PLC was the best performing stock for the week, increasing 12.18 percent.Paul Campanelli who is the current President of generic and over-the-counter business was elected as thecompany’s new CEO. Analysts noted this move is consistent with corporate shifts toward generics. The stock was upon reaffirmed guidance.Microsoft announced a huge share-buyback program. The tech behemoth said it would buy back $40 billion worth ofstock, or nearly 10 percent of shares outstanding, and raise its quarterly dividend by $0.03 a share to $0.39.

Weaknesses

Energy was the worst performing sector for the week, still up 10 basis points. Oil sold off after Saudi Arabia was saidto dismiss the prospects for a production-freeze agreement in Algiers.Chesapeake Energy was the worst performing stock for the week, falling -9.80 percent.SeaWorld shares fell after the company cut its dividend. The beleaguered theme park company said in a pressrelease on Monday that it is lowering its dividend payout to $0.10 per share from $0.21 per share. Its boardannounced that it will no longer issue a dividend after the payment this quarter. Instead, it would be "opportunisticallyrepurchasing" shares in the open market.

Opportunities

GoPro unveiled three new action cameras and a drone. The Karma drone, retailing at $799, features a removablethree-axis gimbal to stabilize footage captured by a GoPro on the drone itself, in your hands, or when a GoProcamera is mounted on your equipment.Pharma giant Allergan is buying Tobira Therapeutics. Allergan is paying an upfront price of $28.35 per share in cash,and up to $49.84 per share in so-called Contingent Value Rights (CVRs) if two drugs under development make it tomarket. Used together, the drugs under development – Cenicriviroc and Evogliptin – could help to treat NASHdisease, a buildup of fat in the liver that can lead to liver failure.FedEx beat and raised its outlook this week. The courier giant earned $2.90 a share on revenue of $14.7 billion andsaid it saw full-year earnings per share in a range of $10.85 to $11.35, a bit light of analysts' estimates.

Threats

Deutsche Bank is the riskiest bank in the world, at least according to the latest data from the Federal DepositInsurance Corporation.Carl Icahn dumped a bunch of his Chesapeake Energy shares. An SEC filing shows Carl Icahn owned a 4.55 percentstake in the energy explorer as of Monday, down from 9.40 percent on August 4, Reuters reports.UnitedHealth announced it will stop covering some brand-name drugs. The largest U.S. health insurer says it will stopcoverage of Lantus, the main insulin drug sold by Sanofi SA, and Amgen's white-blood-cell-boosting drug Neupogen,Reuters reports.

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5 Reasons Why Active ManagementWorks

The Economy and Bond MarketStrengths

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The National Association of Homebuilders' housing market index, which measures sentiment, rose to an 11-monthhigh of 65 in September. All three components – current sales, sales expectations and traffic of prospective buyers –improved. NAHB members were encouraged by rising household incomes and a steady job market.The number of Americans filing for unemployment benefits unexpectedly fell last week to a two-month low, pointing tolabor market strength. Initial claims for state unemployment benefits declined 8,000 to a seasonally adjusted 252,000for the week ended September 17.Evercore ISI retailer’s company surveys came in much stronger this week at 50.5 versus 47.6 prior.

Weaknesses

The Federal Reserve held steady this week, saying that the case for an increase to the Fed funds rate later this yearhas strengthened. Three FOMC members disagreed with the decision to hold rates. While job gains have been solid,the labor market has not exerted enough upward pressure on inflation, the Fed's statement said.U.S. home resales unexpectedly fell in August, crimped by a shortage of inventory that is boosting home prices fasterthan the pace of wage growth. The National Association of Realtors said on Thursday that existing home salesdeclined 0.9 percent to an annual rate of 5.33 million units. Economists polled by Reuters had forecast sales rising1.1 percent in August to a 5.45 million-unit pace. July's sales pace was also revised lower to 5.38 million units fromthe previously reported 5.39 million units.The Conference Board's Leading Economic Index for the United States declined 0.2 percent in August to 124.1.

Opportunities

The U.S. labor force participation rate is depressed, even relative to where it should be given trends in demographics.It is possible that this represents an extra source of slack, and that continued monetary easing would entice workersback into the labor force.

The final print for second-quarter GDP will be released next Thursday. If the survey of 1.3 percent growth holds, itwould be a boost from the previous 1.1 percent estimate.JPMorgan sees additional near-term upside for the S&P 500 in its latest U.S. strategy note. The report says positiveequity momentum is likely to be bolstered by a better third-quarter earnings season and highlighted support from lowexpectations and stabilizing U.S. dollar and oil prices over last year. The group sees better opportunity in growthstocks.

Threats

According to BCA, if the dollar stays well behaved and the drag from import prices abates, then inflation mightaccelerate quickly alongside an improving labor market. However, as long as global growth divergences persist, anymove toward tighter Fed policy is likely to send the dollar higher, dragging inflation even further below target. Thus,until the global recovery becomes more synchronized, the Fed's ability to tighten policy will be limited by anappreciating dollar.

The Federal Reserve is focusing too narrowly on its so-called dual mandate and damaging basic financialinfrastructure by keeping interest rates low, former Dallas Federal Reserve President Richard Fisher said Monday.Fisher has long raised concerns about funds and businesses that have a hard time making a profit when interest ratesare low, including insurance companies and pensions.

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After the Federal Reserve opted to leave interest rates unchanged Wednesday, Jim Grant told CNBC he believes themarkets are beginning to lose confidence in central banks. "I think the central banks are busy chipping away at theunwarranted faith in their pretense," the founder and editor of Grant's Interest Rate Observer said.

Gold MarketThis week spot gold closed at $1,337.41, up $27.16 per ounce, or 2.09 percent. Gold stocks, as measured by the NYSEArca Gold Miners Index, ended the week higher by 4.71 percent. Junior miners underperformed seniors for the week, asthe S&P/TSX Venture Index climbed just 1.46 percent. The U.S. Trade-Weighted Dollar Index finished lower by 0.66percent.

Date Event SurveyActualPrior

Sep-20U.S. Housing Starts 1190k 1142k 1212k

Sep-21FOMC Rate Decision 0.50% 0.50% 0.50%

Sep-22U.S. Initial Jobless Claims 261k 252k 260k

Sep-26U.S. New Home Sales 600k -- 654k

Sep-27Hong Kong Exports YoY -2.0% -- -5.1%

Sep-27U.S. Consumer ConfidenceIndex

98.8 -- 101.1

Sep-28U.S. Durable Goods Orders -1.4% -- 4.4%

Sep-29Germany CPI YoY 0.6% -- 0.4%

Sep-29U.S. GDP Annualized QoQ 1.3% -- 1.1%

Sep-29U.S. Initial Jobless Claims 260k -- 252k

Sep-29Caixin China PMI Mfg 50.1 -- 50.0

Sep-30U.S. CPI YoY 0.9% -- 0.8%

Strengths

The best performing precious metal for the week was silver, with a gold-inspired lift of 4.80 percent. It is typical forsilver to have a higher beta to gold.Gold is headed for its biggest weekly advance since July, reports Bloomberg, following the Federal Reserve’sdecision this week to leave interest rates unchanged. The 25-percent rally that gold bullion saw in the first half of theyear has sputtered this quarter, partly on concern that the Fed could have raised rates as soon as this week. In asimilar fashion, gold futures gained after the Bank of Japan changed its focus on Wednesday (as traders awaited theFed decision), from expanding the money supply to controlling interest rates.According to the average estimate in a survey of 16 participants at the Denver Gold Forum this week, gold prices willreach $1,385.63 an ounce by year end, reports Bloomberg. This forecast is 4.1 percent higher than Wednesday’sclosing futures prices. As seen in the chart below, investors poured $249 million into gold-backed ETFs over the lastweek, the article continues. This has helped keep holdings near a three-year high.

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Weaknesses

Although gold was the worst performing precious metal for the week, it was a welcome gain none-the-less in light ofworries surrounding a possible rate hike this month. Saxo Bank’s head of commodity strategy Ole Hansen believesthat gold is due for a correction. Hansen recognizes that gold gains have been elusive lately, but says that the“market has become stale” and prices have “struggled to move higher.” He sees the metal falling back to the $1,250per ounce level, but says once the stale longs have been cleared out of the market, gold could rise to $1,375 perounce.According to Bloomberg, a potential interest-rate hike in the U.S. this year is spurring lower gold price expectations inIndia. This has the potential to deter buying, as the dollar strengthens versus the rupee. Interesting enough,estimates from Bloomberg Intelligence show that India’s gold hoarding since 2000 exceeds 12,500 tons (the U.S.reserve holdings come in at 8,133.5 tons during this period and China’s at 10,500 tons).An employee with the Royal Canadian Mint was caught this week for allegedly smuggling around $180,000 worth ofgold from the facility, hiding the metal in his bum. An alert bank teller discovered the alleged theft, reports PostmediaNews, after the man took small circular chunks of gold on multiple occasions to Ottawa Gold Buyers – typicallyreceiving checks in the $6,800 range for pucks that weighed around 210 grams.

Opportunities

Several members of the U.S. Global team attended the Denver Gold Forum this week, where investor attendancewas up 15 percent from last year, with a mood that was a bit more optimistic. According to a recap from BMO, therewere several key themes at this year’s event: 1) Disciplined capital allocation and reductions in costs, 2) Muted M&A,with an emphasis on existing portfolios and development pipelines, and 3) Renewed focus on exploration, andtargeting organic over incremental. In the prior week, the Precious Metals Summit, where many of the explorationand development companies presented their investment merits, had just come to a close. There were numerous minetours scheduled around the events. We attended the Klondex Mines tour of their True North Mine which was acquiredlate last year on very reasonable terms.

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Diego Parilla from Old Mutual Global Investors sees gold entering a long-term bull market, reports Bloomberg, likelysoaring to a record within five years as asset bubbles pop in everything from bonds to credit to equities. “As some ofthe excesses in other asset classes get unwound, gold will perform very strongly,” Parilla said. Similarly, RobertMcEwen (one of the industry’s most unabashed bulls, says Bloomberg) believes gold prices could rise as much as 44percent by year end, trading in a range of $1,700 to $1,900 an ounce. McEwen says gold is a store of value that hasgone for millennia. “The big argument against gold used to be it costs you money to store it,” he said. “Right now, it’scosting you money to store you cash.”According to a recent UBS Evidence Lab consumer survey in India, results show that the country has a relativelystable appetite for gold. When asked about the potential for gold purchases in the coming months, results were moreor less the same, to slightly higher, versus 2015, reports UBS. The research continues by stating that there is a goodpotential for physical offtake in India to improve over the next couple of months.

Threats

Gold mines in South Africa have seen output drop for decades, reports Bloomberg. The country’s largest goldproducer is turning to an overlooked (and potentially cheaper) source of supply: the dump. “It’s easy gold, but theprocessing volumes are enormous,” said Grant Stuart, VP of projects at Westonaria, South African-based Sibanye.According to Bloomberg, once Sibanye’s mines are depleted, the company faces huge cleanup costs at so-calledtailing dams that contain toxic materials like uranium and sulfides, along with traces of the yellow metal. If the tailingscan be reprocessed economically that might ease the burden.Goldman Sachs is calling for an end in capex cuts, according to a note released this week. “Our thesis on capex cutsis that the sector has approached a point where there are limited opportunities to continue cutting capex – essentiallythe sector has ‘hit bone’”, the report reads. “Although the capex trend is still likely to be down year-over-year from2016 levels, as projects roll off, we do not expect to see further cuts in our existing capex profile.” Should the goldprice continue to rise, miners will be hard pressed to contain their spending.Gran Colombia announced this week that it is monitoring the civil situation in Segovia and Remedios in theDepartment of Antioquia, Colombia, where the company’s Segovia Operations are located. A local mining collective(made up mainly of illegal miners) has convened a civil strike to exert pressure on negotiations it’s having withvarious levels of government and Gran Colombia. The discussions are related to the Colombian government’snational program to formalize illegal mining in the country, at issue is Decree 1421 from the Ministry of Mining andEnergy (which became effective on September 1). Earlier in the quarter, the government put an end to illegal miningon Continental Gold’s property.

Energy and Natural Resources MarketStrengths

Gold is set to benefit from a replay of 2015. Macquarie Research suggests there are numerous parallels between thisSeptember’s FOMC rate decision and last year’s. With the Fed all but telegraphing a 25 basis point hike inDecember, we may see gold trade range bound for the next 90 days. However, Macquarie suggests this weakness

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could be a buying opportunity, as gold may rally once the FOMC hikes rates in December.

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The best performing sector for the week was the FTSE 350 Mining Index. The index of major diversified miners rose10.6 percent for the week as strong August macro data from China lifted metals pricesAnglo American PLC, a major South African diversified miner, was the best performing stock in the broader naturalresource space for the week. The London-based company gained 15.8 percent for the week as investors regainedoptimism in China, propelling metals prices higher.

Weaknesses

Oil prices tumbled on Friday, erasing half of the week’s gains as Saudi Arabia dismissed the prospects for an outputagreement at next week’s informal OPEC meeting. Oil has gained ground since August on speculation that OPECand Russia would agree to cap output when they meet on September 28. However, investors are now becomingnervous that no agreement will be reached.The worst performing sector for the week was the S&P 500 Oil & Gas Refining & Marketing Index. The index dropped0.8 percent for the week as capacity increased with the restart of the Colonial Pipeline this week after earlier delays.The worst performing stock for the week in the broader natural resource space was CF Industries Holdings Inc. Thefertilizer producer dropped 5.8 percent as analysts expect the cash crunch to deepen as crop prices continue to drop.The profitability of fertilizer companies is directly tied to higher crop prices that allow farmers to purchase more oftheir products.

Opportunities

China house prices rose sharply in August, reports VTB Capital. Official data shows house prices in China’s 70largest cities rose 9.2 percent compared to August last year, the fastest pace since January 2014. On a monthlybasis, prices surged 1.5 percent, the strongest increase for more than three-and-a-half years, suggesting the PBOChas maintained its expansionary fiscal and monetary policies.

Copper demand is improving in China according to Macquarie Research. End-user copper demand picked up inAugust, driven by sequential order growth in the construction and transportation sectors. A survey of copperfabricators suggests they are planning to raise production for the traditional golden season, which should help toimprove the copper market balance in China.Rio Tinto CEO is “cautiously optimistic in relation to China.” Rio, the world’s second largest mining company, believesthis is an inflection point that will result in improved market conditions in China. Rio bases its views on improvedmacro August data for China as well as more positive meetings with government officials in the country.

Threats

China is set to curb spending on renewable energy after a record boom. A Bloomberg report suggests China’sspending on renewable energy will decline 11 percent next year as electricity demand stagnates along with slowerGDP growth. China provides about a third of the global investment in renewable energy.Steel prices may remain under pressure as weaker demand leads to inventory builds. In spite of a recovering Chinaconstruction sector in August, UBS reports that domestic inventories are up due to weak demand and risingproduction. In addition, Chinese steel exports have declined as a result of stronger competition from Asian peers,worsening the overall supply-demand dynamics.

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Iron ore indicators continue to deteriorate. As Goldman Sachs reports, restocking is back to 2015 levels, driving ironore port inventories to this year’s highs. In addition, there are 50 million tons of capacity coming online in the next 6-9months.

China RegionStrengths

Taiwan’s Weighted Index soared almost 4.3 percent and reached new 52-week highs this week as Taiwan reopenedfollowing last week’s scheduled mid-Autumn holiday closures and on the back of positive iPhone reports andcontinued accommodative central banking policies.

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The Philippines’ Stock Exchange Index returned 2.29 percent for the week, while South Korea’s KOSPI Indexreturned 1.9 percent for the week, and although both indices were handily shown up by Taiwan in that time, both putin strong performances.The South Korean won gained about 2 percent against the U.S. dollar for the week, making the won the strongestgainer in the region in that timeframe.

Weaknesses

The Philippine peso, on the other hand, actually reached new lows for the week against the U.S. dollar, falling about40 basis points to as much as 48.13. The Philippine central bank left key interest rates unchanged this week.The Hang Seng Consumer Services sector fell nearly 2 percent for the week.Indonesia’s Jakarta Composite Index underperformed its regional peers this week, falling almost 40 basis points inthat timeframe, even as the Bank of Indonesia cut rates by 25 basis points and suggested that further cuts couldcome this year if necessary.

Opportunities

Next week investors receive useful data in the form of September Caixin China Manufacturing PMI (expectations arefor a 50.1 print) as well as the official government readings for both Manufacturing PMI (expectations are for a 50.5print) and Non-Manufacturing PMI.

Bloomberg news reports that the Finance Ministry of Indonesia has already received some 48.5 trillion rupiah via itsTax Amnesty Program.

Threats

The Philippines Environment Secretary Gina Lopez continues to talk tough against miners operating in the country,suggesting that audits and recommendations by the government will require full compliance or risk further shutdownsand closures.Chinese mainland visitors to Macau fell 5.5 percent in August even as gaming revenue rose slightly.Both major party U.S. presidential candidates have suggested they will oppose the Trans-Pacific Partnership (TPP)trade pact negotiated between the U.S. and 11 other nations. President Obama seeks to persuade Congress to passthe TPP before he leaves office, but investors may look for more clarity from the candidates to succeed Mr. Obama

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as the first U.S. presidential debate kicks off on Monday evening.

Emerging EuropeStrengths

Turkey was the best performing country this week, gaining 5 percent. The Borsa Istanbul stock exchange ralliedfollowing the Federal Reserve’s decision not to hike rates, along with comments from Moody’s that the coup has notseriously affected anything. The Central Bank of Turkey cut its overnight lending rate by 25 basis points, from 8.5 to8.25 percent.The Russian ruble was the best performing currency this week, gaining 1.5 percent against the U.S. dollar. Russia isplacing another Eurobond sale, worth $1.25 billion. Notes are due by 2026 and are yielding 3.99 percent. The newoffering exhausts Russia’s limit of $3 billion for overseas sales this year.The real estate sector was the best performing sector among Eastern European markets this week. The MSCIupdated its Global Industry Classification Standards and has added the real estate sector from under the financialsector, bringing the number of GICS sectors to 11.

Weaknesses

Hungary was the worst relative performing market this week, gaining 10 basis points. The National Bank of Hungarykept the three-month deposit rate at 0.9 percent as central bankers focus on unconventional easing to avoid furtherrate cuts. The monetary authority is accepting deposits in its benchmark facility once a month starting in August,instead of weekly, and will begin capping deposits in October.The Ukrainian hryvnia was the worst performing currency this week, losing 60 basis points against the U.S. dollar.Economic data is improving. Gross domestic product, retail sales and industrial production were reported aboveestimates; however, the country needs to continue pushing forward with its reform program to boost investors’confidence.The utilities service sector was the worst performing sector among Eastern European markets this week.

Opportunities

The government of the Czech Republic is aiming to sell as much as 80 billion koruna ($3.3 billion) from October toDecember. The borrowing conditions for the Czech Republic have never been better, as investors are buying short-term bonds with negative yields, speculating gains from the koruna after the country’s central bank removes the capon the currency next year.The Federal Reserve did not hike rates during its latest meeting held this week, creating positive sentiment inemerging markets. The decision was in line with the majority of economists, who set the odds of a September ratehike at around 18 percent due to a sluggish economy, with inflation far below the bank’s target of 2 percent. The Fedhas two more meetings this year, on November 1 and December 13. It is widely believed that Fed chair Janet Yellenis unlikely to raise rates just days before the upcoming Presidential election. The U.S. central bank last raised interestrates in December 2015, from 25 basis points to 50 basis points.

S&P credit rating agency upgraded Hungary to investment grade, sending yields on Hungary’s 10-year local currencybonds below Poland. Hungary is now ranked above junk by two agencies, making it possible for funds that can onlybuy investment-grade debt to start accumulating Hungary’s bonds. Poland’s debt is rated at A-, three steps higherthan Hungary, but was downgraded in January by S&P.

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Threats

According to Kommersant, the Russian government is considering extending the higher mineral extraction tax (MET)rate for oil into 2017, and wants to introduce an additional tax burden on gas in the amount of RUB179 billion. Highertaxes could be applied to all Russian producers, not just Gazprom, as previously discussed. The tax proposal is in theearly stages of discussion and may provide some volatility among listed Russian oil and gas companies.S&P raised Russia’s outlook from negative to stable, but an upgrade to an investment grade rating is unlikely in theforeseeable future, according to Christian Esters, senior director for sovereign ratings. The challenges facingRussia’s economy range from its competitiveness to its dependence on the export of commodities. Access to theinternational markets is very limited due to the sanctions imposed on the country over the conflict in Ukraine, andS&P assumes sanctions on Russia will stay in place for the next three years.The European Commission opened an investigation on a new Polish progressive tax imposed September 1 on theretail sector. The Commission says the tax is discriminatory and ordered its suspension. UBS analysts predict a flattax rate will be proposed by the Polish government but with the same sort of tax-free threshold in order to protect thesmaller players. The retail tax was imposed to help the budget gap.

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