But I anticipated a year of consolidation for the markets Silk covers. Therefore, I recommended a relatively conservative approach. See Silk, 2 January 2008, The Year of the Rat.

Russia remains my favorite market as we enter the second half of the year. The energy trade is still strong, and the Russian companies have the most upside potential because they remain on the cheap side in terms of valuation.

Furthermore, the Russian investment story remains intact as the economy prepares for its next step toward structural changes and greater integration into the global economic system. For an in-depth look at Russia’s economic potential, please see Silk, 19 December 2007, Russia: Top 2008 Market.

On the latter front, the US Treasury Secretary Henry Paulson recently held a meeting with Russian President Dmitry Medvedev, Prime Minister Vladimir Putin and Finance Minister Alexei Kudrin in Moscow in an attempt to persuade Congress to waive the Jackson-Vanik amendment, which would allow Russia to enter the World Trade Organization (WTO) this year–a particularly important gesture.

The Jackson-Vanik amendment denies normal trade relations to countries on human rights grounds, and its revocation is a prerequisite for WTO entry. Note that China is thought to be in compliance with the amendment. Paulson remains a strong advocate of global economic cooperation instead of childish political games; after all, cooperation works to everyone’s best interest.

Please note that Silk’s Portfolio is a long-only portfolio that doesn’t hold any cash. I imposed this restriction in order to fairly compare performance against benchmarks because all major market indexes are also long-only. Also note that this performance doesn’t include the Alternative Holdings Portfolio returns or the Permanent Hedges returns.

Although quarterly results aren’t my main concern, the end of the period offers an opportunity to assess performance since the Portfolio’s inception.

Since Silk’s inception 15 February 2006, through the end of the second quarter 2008, the Portfolio is up 39.8 percent. My benchmark–the Morgan Stanley Capital International All Country World Index Total Return (MSCI World Index Total Return), which includes gross dividends–is up 17.1 percent. The S&P 500 is up 4 percent, including dividends, during the same time frame.

Source: Silk, Bloomberg

The three permanent hedges–US Treasury bonds via iShares Lehman 7-10 Year Treasury Fund (AMEX: IEF), streetTRACKS Gold Trust (NYSE: GLD) and the short on Consumer Discretionary SPDR (AMEX: XLY)–continue their respectable contributions to Silk returns. See Silk, 8 March 2006, Hedge Your Bets; Silk, 29 March 2006, Right You Are (If You Think You Are); and Silk, 6 December 2006, The Money Month, respectively.

Bonds are up 18.5 percent since first recommended, gold gained 60.1 percent, and shorting the American consumer turned out a profit of 24 percent. Notice that this last position is a leveraged hedging short to a long-only Asia overweight portfolio and should be viewed as such.

I initiated the bond hedge when many pundits were busy justifying their views regarding why the US 10-year Treasury yield was about to rise to 6 percent and beyond in 2006, a target first revealed at the beginning of that year.

But bonds didn’t collapse, a fact that shouldn’t surprise Silk subscribers. Furthermore, bonds proved a good hedge instrument, holding their own during uncertainty over the past two years.

The latest hedge permanent position I recommended is the iShares Investment Grade Corporate Bond Fund (NYSE: LQD). We’re down 2.4 percent on this investment since recommended here earlier this year. See Silk, 23 January 2008, The Fed is Your Friend.

I still believe that, because corporate credit has been beaten down over the past few years, now’s the time to start buying into it. If you don’t want to commit fresh funds to this hedge, you can do so by taking some profits from the iShares Lehman 7-10 Year Treasury Fund hedge, which has done well for investors who have been invested in it over the long term. I also hold a long-term bullish view on gold.

It’s becoming increasingly obvious that the majority of investors remain uncertain about the final outcome of the Federal Reserve’s moves and the slowdown of the US economy this year. The debate between deflationists and inflationists remains animated.

I anticipate an eventual deflationary outcome (i.e., a de-leveraging of the consumer). However, the only hedge able to cover both is gold.

The yellow metal has been the object of ardor and the target of scorn throughout the centuries, but it’s never been refused as a means of payment. The reason is because gold has no substitutes.

And given the demand for gold we’ve seen during the past three years (from central bank purchases to new gold exchanges and liberalization of trade around the world), it’s become the world’s fourth currency. In today’s world of massive deficit spending and financial imbalances, expect demand for gold to continue to increase.

I first recommended gold as a hedge five years ago (while overseeing a portfolio for another advisory), and the metal remains the ultimate bulwark today. Gold is in a secular bull market that commenced in 1999 and should be expected to rise much higher, easily surpassing previous highs by the end of the decade. I strongly recommend gold as a hedge position for long-only portfolios.

Pay attention to the hedges and see them as they are: protection for the rough patches. Protecting your portfolio is always a good idea.

Five weeks ago, I recommended shorting HSBC Holdings (NYSE: HBC). See Silk, 14 May 2008, The Long and Short of It. The main argument for the trade is that HSBC holds 63 percent of its loans in the US and the UK, and its stock hasn’t suffered nearly as much as the rest of the global banks. The trade has produced a 15 percent gain since recommendation.

I still expect it to be hit harder in the downturn, and it’s a good hedge to our long positions. If you’re in the trade, place your stop at USD87. You can also enter the trade now using the same stop/loss of USD87.

Today I’m revisiting Silk Volatility System (SVS) I introduced couple months ago. See Silk, 16 April 2008, A Bridge Across the Straits.

The SVS is a simple way to identify which Portfolio stocks are more volatile than others. The system is based on beta calculations, and each stock is compared to the market in the region it calls home.

A stock with a beta of “1” or higher is categorized as volatile. A stock with a beta below “1” is less volatile. In the portfolio tables, you’ll see the notation “V” next to each stock with a beta greater than 1.

The most volatile stocks in the Long-Term Portfolio are:

• China Infrastructure Machinery (Hong Kong: 3339, OTC: CIMHF)
• China Mobile (Hong Kong: 941, NYSE: CHL)
• Keppel Corp (OTC: KPELY)
• Mobile TeleSystems (NYSE: MBT)
• Yanzhou Coal (Hong Kong: 1171, NYSE: YZC)
• FTSE Vietnam Index ETF (UK: XFVT)

The most volatile stocks in the Alternative Holdings Portfolio are:

• Alibaba.com (Hong Kong: 1688, OTC: ALBCF)
• Ayala Corp (OTC: AYYLF)
• Lukoil (OTC: LUKOY)
• Melco PBL Entertainment (NSDQ: MPEL)
• Sinopec (Hong Kong: 386, NYSE: SNP)
• Vimpel-Communications (NYSE: VIP)

Cambodia-based Naga Corp (Hong Kong: 3918, OTC: NGCRF) merits special mention. Although Naga has a low beta compared to the rest of the region, it does carry the risk inherent in a truly emerging market.

It’s the only company investors can own in Cambodia, and given this country’s turbulent political past and the fact that it’s still in its early stages of economic development, you should be aware of the risks such as investment entails.

Naga remains the perfect way to get exposure to an exciting, pure emerging market opportunity in which the rewards can be substantial. See Silk, 5 March 2008, Holiday in Cambodia, for an in-depth discussion.

Naga’s advantage is that its focus to the middle of the pack VIP gambler mainly from Malaysia, China, Singapore and Vietnam. Because Naga has spent far less than the other casino operators in Asia (i.e., Macau) in developing its property because of the low prices in Cambodia, it’s in a position to also offer more concessions to its VIP clientele.

The company’s hotel will also be a steady revenue stream when it opens to the non-gambling tourist later this year, as its services and facilities are of international standards for a very reasonable USD120 per night. As I’ve mentioned before, Naga has a major tax advantage with an effective tax rate of around 3 percent, a far cry from what Macau operators are paying. Naga Corp remains a buy.

As always, I prefer the local shares–when we can get them–to the over-the-counter (OTC) listing. And because Hong Kong is easily tradable through serious brokers in the US, I strongly recommend buying the stock locally.

The investment process is constant. If you’d like to add to your positions in portfolio recommendations or allocate new funds in a diversified way, focus on the following markets, in order (for both countries and sectors). Consult the Portfolio tables for details.

• Russia (energy, telecommunications)
• Hong Kong (banking, real estate, infrastructure)
• India (pharmaceuticals)
• Japan (banking, insurance)
• Taiwan (ETF)
• China (consumer, telecommunications, port, machinery, oil, e-commerce, coal)
• Philippines (telecommunications, real estate)
• South Korea (banking)
• Singapore (banking, telecommunications, industrial)
• Vietnam (ETF)
• Cambodia (casino/hotels)
• Macau (casino/hotels)