When researching ETFs you invariably run into articles stating that they’re “nothing you buy and hold” or even that they’re outright fraud, designed to relieve the unfortunate investor of some of his cash. That you should “check performance yourself” is also a common comment.

Well let’s do just that then.

We start with the doubly leveraged SSO that should follow the movement of the S&P multiplied by two. If the index tanks 2% the SSO tanks 4 and vice versa. This performance is only guaranteed on a daily basis in the prospectus, but what does it look like over longer periods?

Take a look at a 5 year chart of the S&P.

In 2 years there’s been a decline of 13% where the last year has seen an increase of 78%. So first a steep decline and then a recovery.

Now let’s look at a 5 year chart of the SSO.

In two years it’s 47% lower, clearly a lot more than 26%. In the last year it’s up 233%, that is also more than 78%.

The conclusion here is that the SSO displays an “overperformance” if you will during longer periods than a day and the longer the period the longer the discrepancy. This is especially true during times of high volatility. If you’re looking to play the broader US stock market with this one you can’t start out with suffering a 2008 style panic from the get go, then you’ll never get your money back. Backing out before losses get out of hand is a good idea here,

Now lets move over to a leveraged currency ETF, the EUO. Lately the USD/EUR pair has also seen some high volatility with some big up and downs. Similar to the S&P above.

First a chart of the currency pair.

In two years the EUR is up 9.6% against the USD, however during the last year it’s down 5%.

And now a chart of the EUO which is short the EUR by a factor of 2.

In two years we have -19% and during the last year we have an increase of 9.5%. An uneducated guess here would be that the currency market doesn’t display the same volatility as the stock market so the ETF doesn’t “tear” and therefore performs more accurately.

To sum up these findings: the more volatile the tracked index the less accurate the ETF will be, it will tend to increase/decrease more than advertised which needs to be accounted for. With that in mind the advice to stay away from leveraged ETFs all together seems like an overreaction. The often repeated admonition to compare the performance of the underlying with that of the ETF, like we’ve done here seems like good advice though. I will think twice before buying the SSO.

As it happens I’m starting to rack up some significant savings, well at least Penn adjusted for my current location. Once upon a time not much effort was required to manage money, interest rates were high enough that the extra effort required, if you weren’t investing in safe debt, was simply not worth it for many and I would probably have been one of them.

Those days are long gone in these times of no-interest and I’m not about to hand over my money to some idiot who just tracks an index while charging me 1% of the invested capital per year for the privilege of basically doing nothing. In this time of unprecedented diversity and proliferation of financial instruments it’s best to manage your own money and I have some thoughts on how to do that in 2011 but the picture is a little bit foggy in my head as to the details of the plans and the backup plans.

Sometimes it helps to clear one’s mind by writing about it. It focuses your mental activity and makes the picture clearer as well as provides a record so you don’t forget, so here we go, by region and asset classes.

The US

Let’s begin with the US, many interesting currency bets are short the currency in question versus the USD. Therefore it pays to try and figure out what could happen in the US that would be negative or positive for the USD. A lot of people currently believe that the US will do pretty well this year, decent GDP growth and so on. That should be good for the USD.

On the other hand, pretend we get some unpleasant surprises so that the growth forecast is revised downwards to perhaps as little as 1% or so. What would that do to the currency, how bad would it be? It sure as hell would make the place less interesting place to invest in which means less capital inflows which is bad for the USD. Think stock sell-off and a reinvigorated carry trade.

As it happens I believe there will be disappointments, not as bad as 1% but worse than current consensus. The continuing crappy employment situation has a lot to do with that, as well as inventory dynamics.

A lot has been said about - and signs are starting to show of - coming troubles in the US muni bond market, I get the feeling though that since we already have Harrisburg and more on the “fait accompli list”. And more obvious cases on the “failures to come” list, the market should have priced in quite a lot of negative news here so I don’t expect this to matter much if it we get a moderate amount of negatives.

All in all, this makes my outlook on the USD at best neutral, probably somewhat negative. However, everything is relative in the currency world so let’s not pass judgment yet. But it behoves to say it again and again; the main weakness of my current setup is the US, it can’t withstand a disaster there. If the US can steer clear of any major ice bergs in 2011 I will probably have a good year, possibly great.

A big threat here would be a QEIII which would reinforce the already ingrained notion that the FED is trying to debase the US out of all its debt problems. However, as has been stated enough times, it would be political suicide for the republicans in the house to allow it.

Europe

In my opinion, the chance/risk of unanticipated negative developments in this area is higher than is seen in the current price of the EUR. Ireland could for instance reject the current austerity plan and default, my feeling is that such a development, or even a slight possibility of such an event, is not by far being currently reflected in the price of the EUR. Neither is the high possibility of further troubles in Greece, Portugal and Spain.

Take a look at this graph and ask yourself this: what the hell happened between 02 and 11 that warranted that development? Up until the whole PIIGS sovereign debt crap hit the fan last year a lot of people (me included) would probably have a lot of answers to that question but at the moment I don’t have squat, it’s a mystery to me. Apart from the fact that a lot of sovereigns have balanced their reserves to include the EUR but that should have run it’s course by now.

I also have to disclose that I get paid in EUR for my work so betting on the EUR tanking is not just speculative but a hedge in my case. My costs are in THB which is ostensibly free floating but displays an uncanny ability to follow the USD.

Now apart from all this, only the German part of the EUR population actually enjoys working as much as the typical American. Add to this ridiculous benefits like retiring at 52 and extremely inflexible labor markets and so on and you probably get the productivity picture. All in all, compared to the US the EUR region doesn’t have a lot going for it which should be reflected in the currencies sooner or later.

Currency wise one thing is a big threat to all this bearishness; the relatively sky high interest rates of the PIIGS bonds, believe it or not they are attracting for instance the Chinese wealth fund and Japanese pension funds. I don’t know, they would have to be a lot higher to attract me, think 20%+. But maybe that is coming…

China

So by now you’ve all heard the stories about abandoned malls and ghost towns, yes even that food and housing is more expensive than American equivalents. Also keeping people employed and getting provincial tax revenues by building malls and cities that no one wants doesn’t seem like a sustainable situation to me. All these real estate and infrastructure investments are of course using up enormous amounts of commodities like iron and copper and you don’t have to be an Einstein to realize that the day this little construction party ends the price of commodities will go down.

The question is when and the answer might very well be 2011. The inflation ghost is already rearing its ugly head in China and the Chinese gov. can either kill it or the construction party.

Commodities extractors

In any case, when the China implosion happens it will also hurt Australia, Russia, Canada and South Africa. Apart from that threat, it seems like the Australian housing market have peaked which in itself is a negative for the AUD. I’ve also heard the situation is similar in Canada. Hence a bearish AUD/CAD position might have a higher probability to succeed this year than for instance a bearish copper position.

Japan

As long as the Japanese savings rate is above 0% all will be well but what happens when it reaches zero and people want to cash out (read sell their JGBs)? Who will buy, will you buy the 30 year at 2%?

Something has got to give but timing here is almost impossible (more on this later).

Another pertinent question is what happens when it does blow up? Will they throw their baby boomers over a cliff or will their robots be up to the task of changing diapers by then? Some have stated that when the Japanese gov. defaults it will be game over for real for the whole global financial system but I’m not so sure as almost the whole hit will be absorbed by the Japanese themselves.

So a directional bet against the JPY and that Japanese interest rates will go up seems to be a no-brainer.

Emerging Markets

This is the only type of market I currently own stocks in (specifically the Thai market but the story is often same same). Dividends are good and prices are fairly low, sure they’ve gone up a lot the last two years but a gold nugget here and there can still be found. Lately I have gone 50% cash and a few bear bets on a Chinese meltdown have the double role of hedging my EM portfolio.

One thing to watch here is real estate what is the situation like in the country of your choice? Is it overheated or not? If not what does the valuation on real estate companies look like? Here in Thailand there is an ingrained fear of these companies more than ten years after their real estate crash in 97. This makes valuations really appetizing since the earlier mentioned psychological trait makes the Thais avoid building ghost towns and empty malls.

Commodities

I’m not willing to bet against agriculturals at this point, but neither am I very bullish so I will simply stay away from them. The very real dislocation that lower wheat yields results in might for instance not result in much higher wheat prices since it’s easy to substitute as animal feed for instance. The result could be that corn gets a run instead. It’s all very complex and fluid and I don’t have enough knowledge of the whole picture and the industry to feel comfortable.

Metals though should be hit, and hit hard when China slows down, not much to add here. Lower construction activity will pull them down, period.

I will also stay away from energy, the picture is simply too fractured. There are simply too many positives and negatives at the same time for me to feel comfortable making a bet here.

The Securities

With all the above in mind the following securities might be on your purchasing list: BOM (note that it’s an ETN), YCS, SAU3, EUO, YXI, FXP.

The big risk here is if the USD tanks badly. Mainly because a lot of the bets needs it to keep its ground but the bets are also denominated in USD so hedging that with some out of the money options that expires in 9 months or so on securities that track the USD or Gold is pertinent, examples are UDN, UUP, GLD and UGL.

Apart from Thai stocks I currently own BOM, YCS calls (stupid, should’ve bought the underlying security instead) and EUO.