By Steven G. Kelman

28-08-03 You have to wonder what Pentagon officials were thinking when they set up and quickly closed down the Policy Analysis Market (PAM) website in late July. It's not that investors ignore political developments in their investment decisions. It's just that Americans weren't ready for a US-agency-supported market that would allow people to speculate, using futures contracts and derivatives, on potential political developments in the Middle East ranging from terrorism to the overthrow of governments.
Touted as "A Market in the Future of the Middle-East", PAM was financed by the Defence Advanced Research Projects Agency (DARPA). Net Exchange developed the PAM trading system while the Economist Intelligence Unit supplied the data on which PAM securities would be based.

The markets are supposed to be leading indicators, and the geniuses behind this initiative thought that PAM would be an early warning system, helping US authorities predict acts of terrorism and other developments in the Middle-East. Traders would be required to put money in their accounts and their profits or losses would reflect their ability to accurately predict future events.
It was kind of like melding technical analysis with a book-making or betting operation. Pentagon analysts would look at price trends on PAM futures contracts, say, on the possible assassination of terrorist leader, and decide whether the contract indicated insider information that someone had "taken out a contract" on that individual. While traders were promised anonymity, it would appear that anyone who developed a track record would in turn be tracked by government analysts, just as top-performing fund managers are tracked by investors.

It also appears that PAM would in fact have had to seize the assets of any known terrorists who opened an account, under United Nations Suppression of Terrorism Regulations. Politicians from both major parties killed the initiative when PAM started to solicit an initial 1,000 PAM traders.The politicians were quick to point out the possible immorality of betting on assassination and the shortcomings of a market that could encourage terrorists to bet on their plans or alternatively bet against their plans to mislead US authorities.
A PAM contract would have been an extreme specialty investment and the antithesis of what would be a suitable choice for a manager of an ethical fund. Still it would likely have found a niche market.

If you are an investor who might have registered to trade on PAM, do not despair. There are alternatives. For instance, if you have information on the potential overthrow of a Middle-Eastern government, particularly a government of an oil producing country, go long oil futures. The chaos that would follow such a development would almost certainly propel oil prices higher and you would profit.
If you are too conservative to play in that market yet think that the government of that oil producing government will in fact be overthrown, hold energy funds or at least fill up your gas tank when the price per litre is 68.9 cents or less. You should also fill up your gas tank if you are an Ontario resident who wants to bet on another power failure stemming from faulty equipment, human error or both on the US side of the border.

PAM and oil apart, most of us give a heavy weighting to political developments in our investment decisions. The proof is in the pudding or at least in the asset mix. The fact that many of us hold 30 % of our RRSPs in foreign property is a reflection of our concerns about the management of the Canadian economy vis-à-vis its American counterpart.
Many people hold foreign securities and foreign bank accounts as a hedge against a falling Canadian dollar and for good reason. Twenty-seven years ago, the Canadian dollar was worth $ 1.03. Anyone who anticipated the election of the Parti Quebecois government on Nov. 15, 1976 and the political uncertainty that it engendered could have profited from the subsequent fall in the Canadian dollar. Of course, anyone who sold the Canadian dollar or switched to US investments once the news was out still profited because the trend continued for decades, although reasons other than separatism, such as falling commodity prices, contributed to the decline in later years.

The ultimate market for playing against political uncertainty is gold. Anticipated disruptions of a region or country often send gold prices higher if those disruptions will have an economic or political impact outside that geographical area. Similarly, gold seems to move inversely with confidence in the US dollar. These, however, are short-term moves and not the dominant forces in the gold market, which mirrors worldwide demand against supply from the mining industry and from central banks through sales and gold loans.
The last word on PAM is that the US Senators responsible for intelligence spending and budget appropriations had recommended that PAM spending be frozen and the project terminated. Of course you can always bet on trends inthe Middle East by delaying or advancing your gasoline purchases.

Steven G. Kelman is an investment counsel and president of Steven G. Kelman & Associates. His company provides specialty publications and training for the mutual fund industries. Steven is the author of several personal finance books and is author or co-author of courses offered by the Investment Funds Institute of Canada, including the Ethical Conduct and Behaviour continuing education course and the Labour-Sponsored Investment Funds course. He received a B.Sc. from McMaster University, an MBA from York University and holds a Chartered Financial Analyst designation.