Eric Roseman's Eruptions: Stocks, Global Markets and Commodities BLOG

Fidelity Leads the Way to Lower Bond-Trading Fees

Following the sub-prime shock in July and the resultant waves of illiquidity created by the asset-backed commercial paper market and mortgage-backed securities, I wrote several blogs urging investors to get their money out of supposedly safe money-market funds. The premise here is that your liquidity or safe-haven assets should not be stashed away in money-market mutual funds because most of these products are infested with mortgage-backed garbage and other illiquid short-term securities. Despite the recent turmoil, many funds still hold these securities.

Unless the fund is coined a “Treasury fund or T-bill fund,” investors have no business parking money in these vehicles because there’s no assurance the host fund company will bail you out should the fund’s net asset value fall below $1. Money-market fund NAVs are fixed at $1 per share.

The majority of money-market funds continue to hold short-term commercial paper and while no funds have broken below the buck since July, the next credit crisis will result in a series of failures as parent companies’ are compelled to bail-out investors. That’s no assurance to investors who have entrusted their hard-earned assets to money-market mutual funds.

My solution is to avoid money-market funds altogether and instead, buy short-term U.S. Treasurys or Treasury exchange-traded-funds like SHV and SHY, traded on the NYSE.

Also, Fidelity Investments is leading the way with the online trading revolution reducing bond-trading costs. That’s great news for bond investors, especially those seeking the safety of U.S. Treasurys.

Starting November 9th, Fidelity will introduce No-load (no fee) Treasury trading on the secondary market.

If you want to own Treasurys directly, then Fidelity is your ticket – at no cost. Stick to a maximum 18-month duration and simply rollover your maturities every 18 months as they come due and reinvest the proceeds into the next 18-month Treasury. This simple yet cost-effective strategy will guarantee safety and income without the tribulations of having to worry about the credibility of your money-market fund operator. And another thing worth remembering; even if Fidelity Investments goes bust, Treasury securities are considered off-balance sheet assets and therefore cannot be seized by creditors. That’s not the case with cash sitting on deposit with brokers, which can be seized by creditors.

War Costs will continue to Pressure Dollar Longer Term

Like the Romans and the British, two of the greatest military powers that dominated the global landscape over the last 1,000 years, the United States will eventually exhaust its war-chest over the next decade and beyond as inflation erodes the dollar’s purchasing power and the dollar is relegated to non-reserve currency status.

The United States will probably go down in history as the most formidable military power to dominate the balance of global power. But like all imperialists in history, America’s long-term fortunes are tied to costly military conflicts, which over time, erode the country’s currency. This has been the case since the mid-1960s when the United States accelerated military spending to grow her capabilities in Indo-China, ultimately resulting in the abandonment of the gold standard by August 1971.

Protracted long-term military conflicts exhaust a country’s ability to maintain and grow her funding requirements as interest income expenses eventually consume a larger share of gross revenues. That’s exactly what happened to the Roman Empire; over 100 years after its military peak, Rome regularly chipped coins, or devalued its currency as military expansionism eventually eroded her coffers.

According to the U.S. Congress, the cost of America’s military operations in Iraq and Afghanistan will fetch at least $2.4 trillion dollars over the next ten years – a mighty gargantuan figure. And since this is a government estimate, we also have to assume that figure will be much higher.

There’s no way the United States can budget its books with two wars in the Middle East and a stretched military as far as the eye can see -- not in an era of high oil, the long-term abandonment of the dollar as a reserve currency and massive deficits that will never be repaid. Instead, the U.S. will be forced to eventually monetize its debt as the printing presses are ramped-up to meet escalating interest expenses from foreigners.

The long-term picture for the U.S. dollar is indeed bleak. But my advice now is not to dump dollars at these ultra-low levels if you haven’t already made the switch. At some point over the next 12 months or so, I’m expecting a powerful short-term dollar rally that will cause enormous damage to speculators, including many hedge funds.

The dollar is relegated to the dust-bin, no doubt. But I’m expecting a big cyclical rally to occur in 2008 or 2009 before resuming dollar-dumping. Even during bear markets, reversals can occur and are very powerful. Dollar bears beware.

Surging Oil and Gold will Pressure Markets

Despite a generally strong rally since the mid-month lows two weeks ago, stocks still look shaky as a host of technical indicators continue to deteriorate this fall.

The stock market is looking tired as the advance-decline line breaks down, many more stocks are hitting new lows and buying pressure has flagged. The markets’ breathe just looks tired and set to consolidate. Also, plunging Treasury bond yields is a bad sign for stocks as the ten-year hits the low end of its trading band this week. Bonds are screaming “recession” this fall, though I don’t think that’s going happen.

The main drag on this market remains housing and especially, financial services stocks. The above chart depicts an unfolding horror story for bank stocks in the United States; sub-prime and other mortgage-backed bottlenecks have also infected banks across Europe, Canada and to a lesser extent, Asia. The picture for bank stocks is grim (see chart below). This chart tells investors that we’re still looking for a bottom. Financial services stocks represent a hefty 20% of the S&P 500 Index.

Worse, I think, is the relentless rally in oil and gold since the Fed cut rates on September 18; oil prices have surged more than 25% and gold is up almost 20%. Big market moves like this for the most widely followed commodities eventually won’t be good news for bonds or stocks. At some point, assuming the rally in oil continues, the bulls will step aside and take profits.

In the next issue of The Sovereign Individual, I’ll address stock-market hedging strategies and the excellent trading services we have available to counter the markets’ decline, including currencies and put options. Also, I’ll show you how to easily and cost-effectively hedge against a bear market with foreign currencies, fixed-income, reverse-index funds and other strategies historically providing a negative correlation to equities.

The next great bear market won’t happen just yet. I’m still moderately bullish on global stocks over the next 12 months. On the bright side, foreign economies are much stronger than the United States, are growing bank credit at a faster clip and can probably absorb a soft U.S. recession, if it occurs. The Fed is also doing the right thing by cutting lending rates – not to save Wall Street but to rescue Main Street, bleeding a slow death in housing.

To be sure, volatility is now a prevalent theme since last summer and I urge investors to embrace market risk, otherwise your long-term returns will be dull. The key is to make sure you have a globally diversified portfolio across asset classes, minimize your trading costs and learn to properly hedge your investments.

Trade Winds Shift as Pacific Economies Depend Less on U.S. Imports in Late 2000s

The winds of change are blowing across the Pacific.

In a dramatic shift of trade flows this decade, Pacific economies now export more to Europe and inter-regional markets across Asia than to America. And this dynamic trend is not a recent phenomenon as inter-continental trade between the U.S. and Asia has been slipping since 1990 at the expense of booming inter-regional trade driven largely by China’s incredible economic growth over the last decade.

In September, the European Union overtook the United States as Asia’s primary destination for exports for the first time in history as China and other regional markets logged record trade surpluses with the European Union (EU).

Congressional Bashing: Japan in the 1980s, China in the 2000s

In the 1980s and 1990s, Japan was the target of rising protectionist sentiment in Congress as imports flooded the United States. For years, Japan continued to record massive trade surpluses with America while Japanese imports declined. Today, the winds of protectionist sentiment have changed as Congress grows increasingly frustrated; but unlike twenty years ago when Japan was a hot target, the United States is now vehemently accusing China of unfair trade practices mainly at the expense of a cheap and undervalued yuan currency.

Last week, Japan confirmed the trend in non-U.S. export growth announcing that despite a record trade surplus in September, its exports to the United States tumbled, underscoring the growing importance of regional trade and rising exports to Europe.

In 1990, Japan was the United States' dominant trading partner in the Pacific, and Asia accounted for 38 percent of all American imports. In 2005, China was the dominant Asian trader. Its trade with the United States has risen some 1,200 percent since 1990, even as the Asian share of American imports slipped to 36 percent.

Japan’s trade surplus with the United States shrank by a hefty 13% last month as exports fell 9.2% -- the first decline in five months. But exports to fast-growing Asia surged 59% while rising 26% to Europe.

Indeed, as the Pacific continues to accumulate wealth this decade, the region is relying less on the United States for its exports, a marked shift based on historical trends in the post-WW II period.

China Rules with Cheap and Abundant Labour

From 1990 to 2005, a manufacturing revolution occurred in Asia as China spearheaded an export powerhouse, mainly to the world’s developed economies.

With wages a fraction compared to those in the expensive developed economies, China and other Asian exporters increasingly commanded a greater share of the world’s factory floor, or manufacturing prowess. Although the United States, Germany and Italy, for example, still manufacturer excellent high-end goods, namely machinery, China can produce virtually every low-end item for just pennies on the dollar.

Trade Envy and the War of Words

Like the 1980s, the threat of trade sanctions is simmering as the United States and the European Union continue to increase pressure on China to revalue the yuan and make her currency fully convertible. With the U.S. dollar in a virtual freefall since 2002, China’s currency -- still semi-pegged to the dollar in a trading band since 2005, has benefited enormously from a cheap currency. But the war of words to pressure China to revalue her currency is a vein and flawed effort to correct chronic and irreversible trade imbalances.

In reality, a sharply revalued Chinese yuan won’t cure the trend in global trade imbalances; in an effort to boost margins and reduce labour costs, global multinationals (MNCs) continue to establish a major manufacturing presence in China because unit production costs are simply much cheaper compared to factories in the West. That is a secular event that will last for decades to come until China and other regional manufacturing centers eventually lose their export competitiveness.

Currency Revaluations not the Cure

Instead of targeting and relentlessly blaming China, the United States and the EU should focus the blame on multinationals earnings gargantuan profits in Mainland China.

Governments have distorted the facts as currency misalignment is not the cure. Rather, the problem lies with major American, European and Japanese MNCs, powerhouses that have established major manufacturing operations in China and to a large extent, have created the distortion in trade imbalances. Companies are in business for one reason: profits. And any CEO worth his salt will continue to establish a manufacturing beachhead where labour costs are competitive. That means China.

Until China becomes a mature and expensive manufacturing hub later this century -- similarly to the United States, Germany and other mature economies over the last thirty years, capital will continue to find a home that offers a high return on equity and low input costs. Trade should remain free, currencies should float and big business should seek the highest return on equity regardless of trade imbalances.

Is Worst Over for Bank Stocks?

The extent of U.S. banks’ participation in the sub-prime and collateralized mortgage obligation (CDO) market is truly amazing. What’s even more incredible is how these huge banks created these structured products and since July, can’t price most of these opaque securities because liquidity is thin and buyers basically nowhere to be found.

More red ink continues to flow this month as yet another huge investment bank drops a load on Wall Street.

Merrill Lynch (MER) dropped a bomb yesterday revealing its first quarterly loss since 2001 on the heels of a massive $7.9 billion dollar Q3 write-down on bad bets in sub-prime and CDOs. I’m not sure what Merrill’s board is thinking, but if my CEO loses $8 billion dollars in three months, I’d show him the door. The same goes for Citigroup (C), Wachovia (WB), Washington Mutual (WM) and a host of other CEOs meddling in sub-prime garbage they can’t price or unload onto the market.

Excluding financial services and the smashed-out homebuilder stocks, corporate earnings are actually not bad this quarter. Technology and materials are leading the charge with strong results while other large-caps focused on international sales will also report good numbers later this month as Q3 earnings conclude later in November. Healthcare, one of the worst performing sectors of the market since the bull began in 2003, continues to shed lousy results with Merck the lonely exception. The drugs industry is in the midst of a serious contraction in long-term profits as patent expirations dilute earnings.

But are bank stocks low enough? Many of these companies now pay handsome dividends in excess of 4%.

Financial services are not cheap enough for me to buy – yet. That’s because more sub-prime earnings-related losses are coming our way next year.
Until this artery of sub-prime and CDO paper is cleansed from the books, bank stocks remain vulnerable. The entire mortgage-backed securities market remains largely illiquid even after a big Fed rate cut last month and another reduction coming our way next Wednesday. Despite lower rates, the market is still very worried.

What really irks me is the fact that banks still can’t price these securities. And Treasury Secretary Paulson’s bail-out fund or “superfund” is just a conduit to bury all that garbage under one roof and walk away from the problem when he leaves Washington next November.

Avoid the banks. Financial stocks will bog down the market’s progress to some extent, but eventually, I expect non-financial services earnings to save the day combined with more Fed rate cuts, low bond yields and a weak dollar boosting U.S. overseas sales and trimming the trade deficit. The banks will absorb their sub-prime and CDO losses over the next few quarters but remain vulnerable to more aftershocks in 2008.

I’m more concerned with housing, which shows no signs of a bottom, surging oil prices and the employment rate. These remain the three biggest wildcards for 2008 and are worth monitoring closely.

Hong Kong in No Rush to Let Currency Rally

Despite immense foreign policy pressure from the United States and the European Union over the last three years, most Asian governments refuse to let their currencies meaningfully appreciate versus the U.S. dollar and the euro. Yesterday, the Hong Kong Monetary Authority (HKMA) intervened in foreign exchange markets to support its currency peg to the U.S. dollar as the currency hit the upper target of its band.

Asian units have rallied against the dollar again this year with the HK$ also a major beneficiary of booming foreign direct investment and portfolio inflows (see chart). Since 1983, the HK$ has been pegged to the U.S. dollar.

Most currencies in Asia have increased vis-à-vis the dollar over the last five years, but the gains pale in comparison to the European units. Since 2002, the South Korean won has led the charge, up a cumulative 30%. China, the primary target of growing protectionist sentiment in Congress has seen its yuan currency – still not convertible -- gain a miserly 9.4% since July 2005 when it broke the dollar link. In stark contrast, the euro has skyrocketed more than 60% against the beleaguered buck over the last five years.

Asia is home to the largest war-chest of foreign exchange reserves, bulging trade surpluses and compared to the economic crisis that plagued markets a decade ago, also boasts shrinking debt-to-GDP ratios. In less than ten years, the region has gone from basket-case to exemplary economic titan as foreign direct investment floods South and Northeast Asian markets.

China, which assumed territorial control of Hong Kong from Britain in 1997, will not introduce policy changes under U.S. or European timetables. Rather, the Chinese, highly pragmatic, will only loosen currency bands in a gradual, methodological manner in order to maintain maximum economic growth and avoid a major slowdown caused by the loss of currency export competitiveness.

The yuan and HK$ are still effectively linked to the American dollar, which has sunk like a rock since 2002 making Chinese exports extremely competitive in all markets, particularly in Europe. This explains why Chinese exports to Europe have surged over the last few years and for the first time in history, overtook the U.S. as the largest destination for its manufactured goods in 2007.

The worst possible outcome for free-trade and global economic growth is rising protectionism. The United States, dominated by a democratic Congress, is growing more hawkish by the day seeking to impose punitive tariffs on Chinese imports. Unfortunately, neither China nor the United States is likely to balk as the war of words intensifies.

As U.S. Treasury Secretary Hank Paulson -- pretty chummy with China, eventually exits government next year, relations between the two countries are likely to deteriorate making some sort of trade war imminent in 2008 or 2009. That might be the trigger for the next bear market.

Despite Weight of Financials, Stocks Heading Higher in 2008

Just when investors thought it was safe to go back into the water following the sub-prime attack in July and August, a dose of bearish news poured cold water on Wall Street’s post-August recovery over the last several trading sessions, including its worst daily loss since early August on October 19th.

In addition to horrible earnings, especially for the banks, brokers and home-builders this quarter, $90 oil is a huge headwind for this market to digest. High oil, poor corporate earnings and more warnings from former Fed boss Greenspan on sub-prime bail-outs helped to stir a brutal sell-off in stocks recently.

Although the earnings picture definitely looks dicey at the moment, I would remain invested in stocks over the next 12 months as other companies report better figures over the next few weeks coupled with lower global interest rates in 2008 and a formidably competitive U.S. dollar boosting exports.

Banks and Home-Builders Trample the Bull

Thus far, 22% of companies in the S&P 500 Index reported a 14.8% decline in earnings for the third quarter, according to National City. In addition to the big drop recorded by financials, home-builders have fared even worse suffering a dizzy 77% crash in corporate earnings. And although technology stocks have been the market’s savior until recently, a surprise earnings decline from Sweden’s Ericsson helped trash the stock 29% last week, questioning consensus forecasts for this quarter. Indeed, prior to the sub-prime crisis, analysts had projected 7.1% earnings growth in Q3; that forecast has now been sharply reduced to -3.7% -- the worst quarterly results since 2002.

Major Headwinds Absorbed by Consumers, Markets

Commodity inflation has not stopped companies from growing their bottom line. Although earnings compression has started since 2006 amid high food prices, the majority of companies have successfully raised prices to offset input costs.

Even more impressive is the continued headwind generated from soaring crude oil.

Ninety-dollar oil is a major barrier for any market. I’ve been incredibly impressed by the stock market’s agility over the last several months as crude soared past $80 and then $85 per barrel. The consumer is absorbing the cost of high gas prices. He’s absorbing oil at $90 per barrel and he’ll continue to absorb higher prices well into the future provided employment growth remains benign and wage growth exceeds inflation. The real concern for the economy is housing and when the bear market will form a bottom. And the answer to that question is probably not until 2009, at the earliest.

Despite shocks from high oil, Middle East saber-rattling in Iran, Turkey and the Kurds, more horrendous news on U.S. housing, sub-prime write-downs and a spat of earnings disappointments in the financial sector, the market has actually held up quite well. Over the next 12 months, I continue to believe that stocks will outpace bonds, real estate and most other asset classes, albeit at a much more modest pace compared to the spoiled returns we’ve grown accustomed to since 2003. The “easy money” is over. The sub-prime fiasco will continue to keep the economy bogged down through most of 2008 and provide more fodder for the Fed to cut interest rates in an election year. Though I’m expecting more sub-prime-related shocks next year, a cheap dollar and lower interest rates should act as the tonic supporting corporate earnings.

Lower Rates, Cheap Dollar will Support Earnings in 2008

Financial services stocks, and to a lesser extent, the home-builders, will continue to weigh down the stock market over the next year as the Federal Reserve shifts from fighting inflation to thwarting deflation. But even adjusting for sub-par earnings in financials and housing, stocks should produce at least an 8-10% total return, including dividends, as the Federal Reserve continues to boost liquidity and the European Central Bank and The Bank of England eventually cut rates, too. Emerging markets will continue to outpace major market stocks on the heels of superior earnings growth, lower U.S. rates and an earnings boom mostly predicated on rising commodity prices.

Stocks are embarking on a period of rising volatility after almost four years of exceptionally low risk-adjusted returns. Investors should remain invested in global stocks, especially U.S. large-caps, which will benefit from an extremely competitive currency and generally healthy balance-sheets in the non-financial sector.

The bull market since 2003 is getting grayer by the day, but is not over yet. Continue to own stocks, commodities, gold, foreign currencies, international REITs and avoid most bonds, except ultra-safe Treasurys.

Some Closed-end Funds Offer Value as Bull Market Grays

I adhere closely to Ben Graham’s investment principles, especially buying an asset at a discount to its book-value. There’s a significant margin of safety buying a security valued less than its market price. Coined “value investing,” this style or brand of investment performance has lagged “growth” investing this year as most value stocks enjoyed a big bull market from 2000 to 2004 and then sputtered.

In the United States, closed-end funds went into new issuance hibernation in the late 1990s. But a bull market in IPOs has developed over the last few years, mainly in funds focused on dividend-paying strategies and real estate investment trusts. In London, over 200 investment trusts are available and trade the same way as closed-end funds – at a discount or a premium to their net asset value (NAV). Funds on the London Stock Exchange, however, trade in sterling.

As this bull market ages and eventually dies over the next 12-24 months, if not sooner, investors should stick to heavily discounted closed-end funds for new purchases. Rather than buy an asset or a mutual fund at net asset value, I’d be looking to buy closed-end funds – but only if they trade at a meaningful discount to their NAV. That means buying a closed-end fund when it trades greater than a 10% discount. Never buy a closed-end fund trading above NAV or at a premium.

Many closed-end funds have earned big returns over the last 12 months, especially those products in the global, regional and single-country fund sectors. I’d avoid most of these funds now.

At current prices, a host of global and domestic real estate funds trade at a big discounts to their NAV and sport dividends in excess of 8-10% following a massacre this year in REITs. Also, closed-end funds specializing in convertible securities and preferreds look attractive amid a falling interest rate environment in the United States; some of these hybrid funds trade at 10% discounts or greater, and provide an effective yield in excess of 10%.

But not all closed-end funds look attractive. I’d avoid placing new money into most of Asia, including China and India, Eastern Europe and Latin America following gargantuan rallies over the last four years. Also, avoid closed-end bond funds; most of these funds offer paltry inflation-adjusted yields and unattractive discounts.

One of my favorite closed-end funds since early October is a global mining fund trading at a 13.6% discount to NAV.

The idea of buying a basket of large-cap gold-mining stocks for just $0.86 cents on the dollar is very appealing to me at this stage of the gold bull market where major producers have lagged bullion since 2006. In September, these companies awoke from the abyss and gained more than 25% as gold prices surged above $700 an ounce and established a new floor.

In my Commodity Trend Alert, we’re long this closed-end fund and already up 14% since mid-September on what I would coin a conservative mining investment. There’s much more to come in the way of profits as gold cracks its all-time high of $850 an ounce, probably in 2008.

Oil Bulls Rejoice Ahead of $100 Oil

Here comes $100-plus oil…but first, prices have to consolidate.

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Marked by the tightest supply and demand imbalance in decades, booming consumption and seemingly endless geopolitical tensions in the Middle East, crude oil prices are poised to break their nominal all-time highs reached in 1980.

But before we get to $100 oil, the primary trend is likely to correct following a blistering rally off the lows achieved during the first quarter.

From its 2007 lows, spot crude oil has rallied 56% while the energy-weighted S&P Goldman Sachs Commodity Index (GSCI) has gained 43% from its lows earlier this year. The GSCI continues to break all-time highs almost daily on the heels of a 70% weighting in energy futures – more than any other commodity benchmark.

For oil bulls, the picture couldn’t be any better. That’s because OPEC can’t pump-out additional capacity while saber-rattling continues to threaten supplies in the Middle East, mainly in Northern Iraq and Iran.

Current oil demand stands at 86 million barrels per day against supplies of 85 million barrels – barely enough to satisfy a market that can’t spare any additional capacity at a time when Asian consumption continues to spearhead global economic growth.

But bull markets always run into corrections and oil prices are now heavily overbought.
If the Kurds and Turks can avoid a conflict, oil prices will decline sharply as a risk premium has been built into current prices. Also, despite rising inventories of crude in North America, supplies in Asia and Europe are tight; any positive change in supplies in the latter two regions will cause oil prices to fall. Finally, hedge funds are heavily net long oil futures with leverage as they ride the primary trend for all its got. A decline in oil prices will send hedge funds and other short-term traders to the door in large numbers, probably exacerbating a correction.

The long-term picture for oil remains incredibly bullish as supplies continue to decline. Most oil-producing countries continue to deplete their production, or fail to replace their annual production. Oil is becoming scarcer by the day. But before we head to $100 a barrel, some air has to come out of this rally. When everyone is riding the same trend for an indefinite period, prices usually tend to fall.

The View from Spain: A Modest Property Bust Underway

I’ve been a regular visitor to Spain since I was barely six months old. It’s always a thrill returning to this great country and visiting my family. And over the years, the economic transformation unleashed across the nation has been nothing short of spectacular.

As a child, I remember Spain was largely a backwater – very underdeveloped and extremely inexpensive. Former dictator, Francisco Franco, held an iron fist for decades and stifled Spain’s development. I vividly remember seeing revolutionary guards patrolling my grandparents’ park across the street every night with rifles in-hand.

Roll the clock forward from 1975 to 2007, and things are shockingly different.

The Barcelona Games in 1992 set the course towards rapid economic industrialization, placing this Catalan capital at the forefront of Spanish tourism and booming foreign direct investment. Once Franco died, the shackles of modern capitalist development were unleashed, and Spain has not looked back ever since.

Spain ranks as the eight-largest economy in the world and until recently, was also home to one of the most impressive real estate bull markets in Europe. In Barcelona, property prices have skyrocketed over the last 20 years; if Spain was affordable 25 years ago, it now ranks as one of the greatest real estate bubbles in the world. And real estate is now suffering a bad hangover in this country as supply has finally exceeded demand as buyers look elsewhere in emerging Europe (e.g. Croatia, Romania, Bulgaria) for cheaper real estate deals.

The Spanish real estate market peaked in February following a major contraction of values across the entire spectrum of publicly-listed property companies in Madrid. Several of these companies plunged during the first quarter on fears of excessive supply and waning demand, a logical conclusion following years of incredible development. Many of these companies still trade miles below their all-time high in 2006.

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For the first time in years, bargains are starting to unfold in Costa Brava and parts of Costa del Sol – but still not cheap enough to draw vultures, which are starting to circle in far cheaper markets like Miami and Phoenix.

Spanish cities, including Barcelona, remain largely expensive and for the most part, prices have not declined far enough to attract value investors.

The best real estate values remain inland; Cordoba, Albacete and Jaen offer good values with an average price of €127,000 ($180,000) while the Canary Islands are still affordable fetching an average price of €229,000 ($325,000). Barcelona is the most expensive by far with residential real estate commanding a steep €621,000 ($882,000) average asking price.

The Madrid Stock Exchange continues to offer poor values with the non-bank sector trading at more than twice the European average based on relative p/e ratios. And Spanish banks, though bordering lows for the year following a wave of selling since sub-prime surfaced again in mid-July, remain highly vulnerable to further declines over the next 12 months. It’s too early to buy Spanish banks – more pain lies ahead as most of the sector is heavily exposed to real estate. Until the European Central Bank starts cutting lending rates next year, which I expect, strains across this sector will continue.

The best values in Spain lie in the insurance sector, offering low multiples and attractive dividends compared to comparative Spanish bond yields. Insurance carriers in Europe, including reinsurers, are home to some of the best values today because claims have been sparse and premiums continue to rise in 2007.

I’m not bullish on Spain. It’s still an amazing tourist destination and that will never change. But real estate prices, like most Western European countries, remain extremely expensive, especially compared to the boom underway in the Balkans where prices are far cheaper than Spain.

For value investors, the best bargain in Spain remains something you can consume – Rioja.