Bear Market's Aces Nearly All Played

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Frank Holmes

NEW YORK ( U.S. Global Investors) -- Right now, there are planes full of travelers heading to Vegas with dreams of striking it rich.

These starry-eyed gamblers would greatly improve their odds by learning how to count cards.

Yet, as we learned in the movie 21, where six MIT students team with Micky Rosa to become expert card counters and "bring down the house," this highly illegal technique carries dire consequences.

You may not be able to count cards at the blackjack table, but counting historical trends of the stock market and discovering inflection points are not only legal strategies, they are essential to successful investing.

One "card" worth counting is the Purchasing Managers Index (PMI), which measures the manufacturing strength of any given country. A rising PMI indicates a growing economy and is considered a leading indicator.

There are three different types of indicators: coincident, lagging and leading. PMI is considered a leading indicator, meaning its movement historically occurs three to six months before the market reacts.

In China, the PMI just crossed above the three-month moving average. Historically, there's a 67% probability that Hong Kong and China stocks, as measured by the Hang Seng Composite Index, will trade higher over the following three months when this happens.

As of Oct. 21, the index is up 3.2%, and if this historical trend is sustained, we should see continued positive performance.

This could be an "ace in the hole" for investors after a dismal September that saw emerging markets decline 17% and U.S. equities fall 7%, according to ISI.

We also saw the largest amount of money pulled from emerging markets since the fourth quarter of 2008, according to UBS. For the first time in several months, the monthly change in foreign exchange reserves declined by double digits.

Three sectors -- financials, materials and oil & gas -- were primarily responsible for the dismal returns, say Bijal Shah and Stan Shipley from ISI, with emerging markets feeling the brunt of this downturn. That's because many emerging-market indices primarily consist of these three sectors.

In Russia, 88% of companies are in these three areas of the market, with 52% in the oil & gas industry, 21% in materials and 15% in the financials industry. Poland, Brazil and Hong Kong all have 70% or more of their companies in these three sectors. Only two markets -- Mexico and the Czech Republic -- have 20% or less in financials, materials and oil & gas.

It's a much different story in the U.S. where these three sectors make up less than one-third of the market. As investors shunned these stocks, emerging-market countries were punished more severely.

Although the ongoing European crisis was the primary driver for exiting equities, ISI notes that emerging market banks have "negligible exposure to euro area sovereigns." Nonetheless, the banks in these developing countries declined considerably based on the counterparty risk that follows if European countries default on their bonds.

The ongoing crisis in Europe has not only affected emerging markets, it has also negatively influenced the price of many commodities.

UBS states that an "escalating bank funding stress in Europe is forcing a profound deleveraging process."

As U.S. money markets have been forced to pull their funds out of Europe, the short-term financing markets, which include commercial paper and trade finance, have been stressed and have weakened industrial and commercial credits.

Companies involved in the trading and movement of commodities have had to run their businesses for cash, resulting in the disruption of commodity shipments.

This is clearly a negative for commodity prices in the short term, but we believe the effects have already been priced into the market.

Also, UBS indicates that this has pushed commodity inventories to "unsustainably low levels" and once credit conditions improve, demand should increase.

Imports of major metals to China are already running low, says Credit Suisse. While the year-over-year change in iron-ore imports is at the same level as last year, copper imports are at an 11-year low, based on its year-over-year percent change.

So, if you're counting the market's cards, you can see that nearly all of the bear market's aces have been played. Now that China's PMI has turned upward, along with the potential for China's monetary policy easing, it's possible we'll see a run in commodities through Chinese New Year.

U.S. Global Investors, Inc. is an investment management firm specializing in gold, natural resources, emerging markets and global infrastructure opportunities around the world. The company, headquartered in San Antonio, Texas, manages 13 no-load mutual funds in the U.S. Global Investors fund family, as well as funds for international clients.

For more updates on global investing from Frank and the rest of the U.S. Global Investors team, follow us on Twitter at www.twitter.com/USFunds or like us on Facebook at www.facebook.com/USFunds. You can also watch exclusive videos on what our research overseas has turned up on our YouTube channel at www.youtube.com/USFunds.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.