PowerShares

PowerShares: Bottoms Up!
by Dan Denning
The Rude Awakening
Wall Street, New York
Thursday, January 5, 2006

Dan Denning discusses a new way to invest in water: The PowerShares Water Resources Portfolio.

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[Joel's Note: Yesterday, Rude favorite, Chris Mayer, bought
you his 'Blue Gold' missive on the water shortage in China
and the growing demand for this precious resource. Keeping
with the aqua-theme, Dan Denning has some interesting ways
you can turn this blue liquid into something greener,
something Scrooge McDuck was more comfortable swimming
around in.

Read on below for a few plays that will have you shouting
bottoms up!

--- Investment Opportunity ---

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tell everyone was thinking the same thing – "Is this guy
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It was that good...

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Bottoms Up!
By Dan Denning
Edited by Eric Fry

A "watershed moment" has arrived!...Literally. One of the
most dynamic and profitable themes for the rest of this
decade will be investing in water. Purifying, filtering,
transporting, storing and bottling water will become
increasingly important global businesses.

Three months ago I wrote to you from Colorado, on the edge
of the Great American Desert. This month, I'm writing to
you from another arid region, Australia. Yes, there's water
in the tropical north. But most of the Australian landscape
is as dry as Carry Nation.

Clean, fresh water is not nearly as plentiful as most
Americans seem to believe. We often take it for granted.
But most of the world's residents do not...and for good
reason. 97% of the world's water is non-potable salt water,
which leaves only 3% that could be consumed by humans...and
most of that "water" is trapped in glaciers and icecaps.

PowerShares: Fewer Water Exports

In mid-December, the premiers of Quebec and Ontario, along
with the governors of eight U.S. states, signed a pact that
will ban all large-scale water diversions from the Great
Lakes basin. That will prevent fully 20% of the total fresh
surface water of the Earth being exported by pipeline to
thirsty states like California, Arizona, or Nevada. The
eight states that border the Great Lakes - Illinois,
Indiana, Michigan, Minnesota, New York, Ohio, Pennsylvania,
and Wisconsin - have seen the future. And the future is
that fresh surface water is going to be more and more
valuable as it gets more and more scarce.

Investing in water has never been particularly easy. But it
just got a little easier.

PowerShares has come out with a new exchange-trade fund
(ETF) based on water stocks. It's called the PowerShares
Water Resources Portfolio (PHO). According to the
prospectus, "The index seeks to identify a group of
companies that focus on the provision of potable water, the
treatment of water, and the technology and service that are
directly related to water consumption."

There are a couple of things you should know about
PowerShares ETFs that make them different from other ETFs
on the market. But since my friend Dr. Steve Sjuggerud beat
me to the punch on the virtues of PowerShares compared with
other ETFs, I'll let him explain:

"PowerShares actually started out by asking, 'What would
the customer want?'

"As the customer, I want broad exposure to a sector (maybe
30 stocks). Don't mess with it too much, please. But if you
must mess with it, please kick out the 'dogs' every once in
a while, and don't just passively sit by and watch them go
to zero.

"And please don't load up on overpriced stocks simply
because the market value of these stocks has gone up. I
don't want the fund to buy more and more of what's already
become super expensive. PowerShares fulfill both of these
objectives...

"Each PowerShares sector ETF actually contains 30 stocks.
And most importantly to me, no stock can make up more than
5% of the portfolio. So the biotech PowerShares, for
example, couldn't possibly have two stocks make up two-
thirds of the assets. Simple stuff. But great stuff.

"Thankfully, the dogs can also be kicked out... stocks that
appear attractive (based on quantitative measures) can be
let in...and the super-expensive stocks will still never
make it to more than 5% of the portfolio. That's because
instead of holding a fixed portfolio, the PowerShares
portfolio changes quarterly based on dynamic underlying
indexes, called 'Intellidexes.'

"PowerShares allow me to invest in sectors the way I
want...where all 30 stocks in the fund actually affect the
performance, which is exactly the diversification I expect
from investing in exchange-traded funds."

PowerShares: Many Advantages, One Drawback

Steve makes all the important points. You get the
diversification of an ETF across a basket of stocks. But
you also get a little more active management from the
changes that the PowerShares team makes in the index. The
dogs are ditched. And with no stock making up more than 5%
of the basket of stocks, you are not vulnerable to an index
crash prompted by the decline of a single stock.

The only drawback of the PowerShares method is that you
will incur higher brokerage costs and taxable gains because
the fund is actively managed. But for the better
diversification and performance, your total return on the
fund should be much higher, even after the additional
costs.

And if there's a downside to the diversification, it's that
you'll end up owning small pieces of stocks that seem only
peripherally related to the water theme. For example,
General Electric (GE) makes up 0.85% of the index. But a
full slate of water utilities are also included among the
holdings, with other water treatment and service companies
rounding out the rest of it.

The intrepid investor may prefer to review each of the 35
particular holdings and construct a smaller portfolio of
key water stocks to own for the next 10 years. But for the
simplest way to be "long water" in 2006, this is it. The
stock just launched in mid-December.

By the end of 2006, water will not only be a major
geopolitical theme, but also a major investment
theme...Drink up!

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Did You Notice: A "One-Stop" Energy Stock
By Dan Denning

The folks at Powershares have also created a very nifty ETF
of energy stocks, but not just any energy stocks. This ETF
contains the sorts of oil and gas stocks that might be very
attractive acquisition targets. The fund is called the
PowerShares Dynamic Energy Exploration & Production
Portfolio (PXE).

If, as I suspect, the acquisition game in the oil industry
is only just beginning, PXE could provide a "one-stop"
opportunity to profit from the consolidation in the oil
sector. Conoco's $31 billion bid for Burlington Resources
will not be the last attempt by an oil major t A) spend
profits before Congress can steal them and; B) acquire new
reserves and production by purchasing the smaller fish in
the oil patch.

Like other Powershare ETFs, PXE is rebalanced four times a
year through a quantitative set of tools. Sixty-three
percent of PXE's portfolio is in oil and gas exploration
and production stocks. One of them is even Burlington
Resources, the same company being pursued by Conoco. The
largest single holding is Valero (VLO).

Valero makes up 6.3% of PXE. That's slightly more than what
PXE aims for. But it's not so much that Valero comes
anywhere close to dominating the index, or exposing you to
a lot of risk, should Valero fall steeply from its high.
What's more, there are several other holdings that I would
love to have recommended individually if the prices were
right, including Anadarko (APC), Noble (NBL), and Amerada
Hess (AHC).

I like PXE, both as a broad play on the energy bull market,
and as a more focused play on M&A activity in the oil
patch.

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And the Markets...