Critical update on the euro crisis...

Critical update on the euro crisis... Learning to profit in a bear market... Why my oldest subscriber isn't reading the Digest anymore... 'It's hard to tell if you are more pigheaded or ignorant'... Why every solar energy plant has a natural gas generator inside... 'You're a darn good thinker'...

As I write this note, I'm flying from Baltimore, Maryland to Orlando, Florida. Roughly 20 years ago, I graduated from Winter Park High School. I'm attending my 20th high school reunion. As I told my wife, I feel good about going: I've got a full head of hair, a nice bespoke suit, a tasteful Swiss watch, and a very pretty wife.

She gave me that look... the one that says, "Are you really that shallow?" I guess I am. What happened at your reunion? Let us know here: feedback@stansberryresearch.com.

In these Friday Digests, I always do my best to teach you something new about finance... something you're unlikely to learn on your own... something your broker would never mention... something valuable... something that gives you a better "toolbox" as an investor.

It's funny that I continue to write these messages because I don't believe in teaching. Or as I like to say: There is no teaching. There is only learning. Few subscribers actually want to learn anything. It's a wonderful thing to be confident about your ability to invest successfully… to always know how take money out of the market in any environment. What I'm really trying to do is to broaden your horizons and inspire you to learn more about finance. Having access to this knowledge has greatly enriched my life.

Take the short positions in my newsletter, for instance. Since the market peaked on April 29, I've recommended seven short sells against only two long positions. That means, while most people were losing money in stocks this summer, we've been able to make a lot of money – about 22% on average for each position. And all the recommendations have been profitable.

Did I know exactly when the market would peak? No, of course not. Do we make money on every single short recommendation? No, of course not. But... as you watched the market turn over this year... it didn't take a rocket scientist to see why adding short positions made sense. If you're familiar with shorting stocks, employing this strategy was simple and kept you in the market this summer. But if you've never tried it... if you don't understand it... you were probably left absorbing losses with no good way to hedge.

So if you're a new subscriber, I urge you to see what I've written about buying discounted corporate bonds, selling options, and the importance of having access to the downside of the market, via selling stocks short. Looking at the various gauges of market volatility (the VIX is now over 40!), it's probably a good time to look carefully at selling some options. I firmly believe that if more of our subscribers understood these financial options – bonds, shorting stocks, selling options – they would be unlikely to ever simply buy stocks again.

Happily, I think we've made some progress. Paid-up subscriber John Howlett wrote to me this week...

Let me emphasize… John Howlett is not an employee or a relative. We didn't solicit his comment in any way… And we didn't edit his comment for anything other than length and clarity. I say so because I understand there is a tremendous amount of cynicism and skepticism in the newsletter subscriber community – and rightfully so.

The simple truth is… the sophisticated strategies found in our publications True Income and Retirement Trader make these newsletters difficult to sell or even to explain to novice investors. Subscribers must be willing to learn. And most people are not. It's simply up to you. Try these products – along with shorting stocks via my newsletter (Stansberry's Investment Advisory) – and see if it doesn't change everything about your outlook on investing. I know it will. But I also know most people will never, ever take the first step.

In today's Friday Digest, I'm going to return to the unfolding global banking crisis. I know, I know... many of you are tired of reading about it. A longtime reader – probably the first subscriber I ever gained – complained to me this week via e-mail that he doesn't even read the Digest anymore because he is so tired of my doom and gloom…

He's right, of course. If you go back and read my March 2010 issue of Stansberry's Investment Advisory – "The Greatest Danger American Has Ever Faced" – you'll see that I specifically warned about the huge losses facing Europe's banking sector 18 months ago. I didn't believe these losses could be financed, given the perilous state of Europe's sovereign creditors. To give a specific example, I picked Italy's UniCredit, because it is the direct predecessor of Kreditanstalt, the Austrian bank whose failure in 1931 knocked Europe and eventually America, off the gold standard.

Given that outlook... it's not surprising that most of what I've written since then has been a continuation of these warnings. My monthly titles since then include: "Hungary Matters," "The Worst Is Yet to Come," "Risks of a Global Famine," "The BIG Collapse in Bonds," "Time Is Running Out," "For Whom The Bell Tolls," "The Day the Dollar Dies," "Phase III of the Monetary Crisis," and last month's "Europe's Breaking Point." Clearly, I've been hitting people over the head with the message.

And for some people, the message has gotten old... They're tired of reading it. Perhaps they didn't take action sooner to protect themselves... Or perhaps they believe the tide is about to turn, and they want to know what to do next... Or perhaps they're simply tired of reading bad news. Sorry. I don't make the news. I just report it... and I continue to believe these risks are so serious that nothing else is as important. Not even close.

So... here's what will happen next. Soon, Greece will default. This will begin a chain reaction of European bank failures, because most banks in Europe have only written off a small portion (21%) of the value of the Greek bonds they hold. French banks are particularly vulnerable right now. This, in turn, will cause banks to stop lending to each other out of fear.

It will also lead to big losses in the commercial paper market. That's how the crisis will spread to the U.S. – our money-market funds still hold roughly 42% of the assets in loans to Europe's banks. Companies with exposure to European financial assets (like GE) and those that depend heavily on the commercial paper market for funding (like Capital One) will see their share prices plummet. As the global economy stalls and then moves into recession, unemployment will worsen... and political tensions will greatly increase. I expect large-scale civil unrest in both Europe and the U.S.

In the short term, commodities are also likely to fall sharply. The crisis is nearing a breaking point. Europe represents the world's largest economic area. I expect oil will fall at least in half from its peak. You could see silver fall, temporarily, by maybe another 30%. Gold could fall by maybe 25% from its peak. Base metal and energy commodities – stuff like copper and coal – will get crushed, like they did in 2008. In short, this is Europe's turn to have a Lehman Brothers-like banking collapse. Only this time, it will involve dozens of huge banks and several different countries, all of which have different ideas about how the crisis should be solved.

And that means it will probably be a longer and deeper crisis than Lehman Brothers. But... sooner or later... we're going to see a massive reversal. The Fed will step in to support the ECB, and a tremendous amount of new euro will be issued. I expect the euro to fall to parity – 1:1 – with the dollar before this crisis is over.

The hard part will be knowing when the time comes to jump back into blue-chip stocks, strategic commodities (like oil shale assets), discounted corporate debt (which I believe will get much, much cheaper from here), and strategic metals (like gold, silver, copper, and iron). During the Lehman crisis, the peak interest rate spread between junk bonds and U.S. Treasurys was around 22%. The spread on European bank debt could get at least that high, as will most of the sovereign debt of the peripheral nations. And we're just not there yet.

Is there a chance I'm wrong? Is there any realistic way to solve this crisis without a Greek default and a European banking crisis? I don't see how. Germany is the only truly solvent, large European country left. And the German voters continue to hand the ruling party loss after loss in local elections, specifically because the public is almost unanimously against Germany bailing out the rest of Europe. Likewise, the German representative of the ECB resigned last week out of protest against any future quantitative easing, aka money-printing.

What should you do while this crisis continues to deepen? The same advice I've been giving since March 2010. If you're sophisticated, you want to build a large book of short sells to hedge your stock market exposure. You should own at a minimum 15% of your assets in gold and silver. If you're unable or unwilling to hedge your portfolio, I recommend putting half your portfolio in Treasury notes (via the iShares short-term Treasury Bond fund, SHY) and half your portfolio into gold (via the iShares gold fund, GLD). Doing this 50-50 split between gold and the U.S. dollar is the only true way to go to "cash," given the tremendous uncertainty in the future of the global paper money system.

I wish I had better news... or a more promising strategy I could endorse. But as always, I've got to write what I believe. I hope you'll remain patient with me and continue to subscribe. When the market turns, I'll get you back in… just as I did in November 2008 through May 2009.

New 52-week highs (as of 9/22/11): short position in Gannett (GCI) and short position in Deutsche Bank (DB).

In the mailbag... a probably too-long explanation of my skepticism about the future of solar power as a source of on-grid electricity. If you're not interested in physics... the summary is pretty simple: It'll never work.

Please note: After my long explanation, we publish two notes from well-qualified engineers who agree with me completely. Send your comments to feedback@stansberryresearch.com.

"Gee, did it ever occur to you that the amount of feedback is maybe a sign? You know, it's hard to tell if you are more pigheaded or ignorant. I have explained this to you in grown up language and in an analogy that a child could understand. How many people have to point out that you don't know anything about thermodynamics? Did it ever occur to you that to admit a mistake is actually a sign of confidence and strength?

"Might I suggest that whoever is telling you about the 2nd law – I mean you couldn't have thought of this yourself being a biz major from a state school – is making you look bad? Why don't you call the local university and ask to speak to a prof of chemistry and have him explain it to you.

"Until you do that, you might want to stop displaying your pathetic ignorance for all to see. I must admit I do find it pretty funny that you say such idiotic statements so brazenly and arrogantly. You remind me of my son when he was 6. But wait, now that I think about it, those are happy memories. I take it all back, please don't ever grow up or learn anything. The comic relief is too good to do without." – Paid-up subscriber Cathy Cuthbert

"I think the reason you and a few 'others' don't like Solar is because once it's set up it can't be taxed, can't speculated on in the 'Market,' can't be sold on Wall Street and is self sufficient there by leaving you, Wall Street, AND the 'Oil Company's' out in the cold. Can't make money on it can't be good, Right?" – Paid-up subscriber "JH"

Porter comment: I've made plenty of money from solar energy. I've been shorting First Solar, for example, since it was trading for more than $200 per share. If I were unethical and cynical, I'd be a huge backer of solar power since it's totally inefficient. Nothing is easier than taking money from fools who believe it works.

"It is hard for me to rationalize your comments on Solar. After all you have some minimal education to be able to write your investment column. There is no violation of scientifically proven and accepted laws. Solar energy comes to us at no incremental cost. The only additional cost is it's conversion to another suitable form. We do this every day with coal, gas etc. Do they violate (your) laws as well?

"I guess people with limited education and knowledge should stick to their knitting although your comments on this subject make me doubt the veracity of your other statements... You are about as ignorant as it is possible to imagine and not worthy of further discussion." – Paid-up subscriber Barr Rodgers, retired aerospace engineer

Porter comment: I have received all kinds of funny notes – like these – sent to me regarding my solar comments. Folks with Ph.D.s and engineering backgrounds, who should really know better, have sent some of the best. But most of the notes were simply ignorant comments from folks who desperately want to believe in the political "promise" of solar energy – that in the future, energy will be nearly free... if only trolls like me would get out of the way. Other folks were merely curious. They just wanted to know more about why I'm so skeptical. Or they wanted me to clarify what I meant – on the differences between local, passive solar energy and grid power.

This is as clear as I can be: Solar power, as a source of energy for the power grid, will simply never work. And by "work," I mean it will never even be even remotely economic. The reason why it will never work has nothing to do with technical hurdles or innovations that have yet to be made. The reason it will never work is because of the laws of nature, in particular, the Second Law of Thermodynamics.

Several readers have sent me quotes from various sources saying the laws of thermodynamics only relate to objects cooling, electron equilibrium, etc. Likewise, politicians, who know nothing of physics, have come to believe solar energy is akin to Santa Claus – a sort of electrical "freebie" that solves all our problems. Just wait until the voters realize they've been had again...

Alas... the laws of thermodynamics apply to solar power, just as they do to everything else in the universe. The Second Law of Thermodynamics, in particular, has many useful applications, including information technology (Shannon's Law), which is where I learned it. The critical point to understand about the Second Law is that the usefulness of energy (its ability to do work) decreases over time and space. Thus, by the time sunlight reaches the surface of the Earth, it has lost much of its useful energy.

The total amount of energy in sunlight doesn't change – that's the First Law of Thermodynamics – but the amount of useful energy dissipates over time and space. That's why some passive solar power applications, such as heating your pool or perhaps powering minor appliances during the peak heat of the day, can be relatively efficient. I say "relatively" because, in many places, the energy required to aggregate the sunlight and convert it into electricity will render the total costs of such systems uneconomic compared to grid power, which is generated with other fuel sources (coal, uranium, natural gas) that are far denser in useful energy.

Currently, tremendous efforts are being made with various types of technologies to harness the energy in sunlight. Major investments are being made – on the back of demands and with financing from governments – to use photovoltaic semiconductor (PV) technology to convert sunlight into electricity for the power grid. I believe this is a tremendous waste of capital. It certainly would NOT occur without the intervention of governments – which are notoriously bad at capital allocation – because it is horrendously inefficient.

PV processes use photonic energy in sunlight (not heat) to "lift" electrons and create electricity. The thermodynamic limitations of this approach mean that many of the electrons fall back into the hole from whence they were lifted. This makes the panels very inefficient. Theoretically, something called the Landsberg Efficiency stipulates that under perfect conditions and with perfect materials, semiconductors could convert 95% of the sun's power into electricity. This is the academic justification for the investments into PV solar power.

The catch is, in the real world, the materials needed to reach such efficiencies are rare and expensive. The other more important catch is that the main impediment to PV efficiency is... heat. Yes, that's right. As PV solar cells are exposed to ambient temperatures above room temperature, their efficiency plummets. And seeing as how most of the places best suited for solar power panels (like the roofs of buildings in warm climates) also have high ambient temperatures, I believe it's unlikely that this approach will ever prove worthwhile. I'm convinced PV solar panels will never be economic. (I'll explain more about the theoretical aspects of my cynicism in a moment.)

Currently, the best PV solar cells only convert about 15% of the energy they're exposed to into electricity. This makes solar power the most expensive of all energy sources – so using solar energy to power the grid is a functional impossibility.

The other approach to solar energy harvesting is based on using mirrors to focus the sun's rays from a broad area on some type of heated medium. This approach is called concentrated solar power (CSP). The medium can be water or gas ... or even molten salt, which is more efficient thermodynamically.

CSP works like any other kind of power plant – and thus the standard thermodynamic limitations are in effect. The amount of useful work created is dictated by the amount of heat generated. Think of nuclear power plants. They sometimes meltdown because their cores are so hot. There's a lot of useful potential energy being created there. While that makes them dangerous... it also makes them extremely efficient. Nuclear power is, by far, the most economic way to produce electricity. That's because uranium is the most abundant dense form of energy on Earth.

Here's a simple, common sense way to think about nuclear power versus solar power. Who, historically, has been the best judge of power sources? The world's big navies. Governments might screw around with wind power or solar power... But you can bet the U.S. Navy won't – not for its most important ships. Navies switched from wind to coal… from coal to oil… and finally from oil to nuclear. You can bet they will never switch to solar. Not ever. Why not?

Very simply: Sunlight is a diffuse energy source. Attempts to aggregate into more useful forms of energy (capable of doing more work) require additional energy – lots of it. If you don't believe me, just take a close look at the world's biggest operating solar power plants. They are CSP plants. Inside every CSP plant in the world you'll find... a lot of natural gas. In fact, these plants require natural gas pipelines to operate. No, I'm not kidding.

I believe without the natural gas burners inside CSP plants, these plants wouldn't work at all. California state regulations allow natural gas to produce 25% of all the energy at "solar" plants. What's not measured is the percentage of useful work the natural gas is providing. And my bet is, almost all of it.

The diagram below shows a schematic of the operations at Nevada One, a huge, 64-megawatt CSP power plant built in the late 2000s in the Nevada desert. Note the crucial "additional heat" box immediately in front of the turbine generator. Guess what "additional heat" means? You guessed it. Natural gas.

Now... you'll recall from my earlier writings and from above in this note, that I'm particularly concerned about the government's massive investment in PV solar technology. My concern is that it will never work. PV isn't a heat engine. I don't believe it will ever generate much useful energy in the real world. The Second Law of Thermodynamics renders it practically irrelevant as a source of on-grid electricity. Quite simply... technology can't do much to improve a weak fuel. That's a fact of nature.

What solar plants actually do is hide huge energy inputs in the form of materials. Take a CSP project like Solar Two, which claims to produce a peak of 10 megawatts of electricity from 130 acres of mirrors. (Actual output is much lower, only about 1.6 megawatts.) Scientist Petr Beckmann calculated that solar plants like these were not capable of producing enough energy to build another solar plant of comparable size. To put the limitations of thermodynamics in stark relief… to produce as much power as a 1,000MW nuclear plant, Solar Two would require 127 square miles of mirrors.

The physics (and thus the economics) of PV plants are even worse. Florida Power and Light recently opened its Desoto PV plant – billed as the largest solar photovoltaic plant in the country. It is rated at 25MW peak production. But the company actually estimates the plant will create 42,000 megawatt-hours over the course of a year... or 4.79 MW per hour on average. That's roughly a 19% operating capacity factor.

Worse, there's no way to store this power, which means it's only available for a few hours each afternoon. Assuming perfect operating conditions, that's enough power (for the part of the day) to serve about 3,000 homes. And for this small amount of electricity, Florida Power invested $150 million – or $50,000 per customer. Do the amortization and merely paying for the capital cost of the plant (not the costs of its operation, which are substantial) will cost each rate-payer $322 per month... For electricity they can only use part of the day.

On the wholesale electrical markets, nuclear power costs about $1.65 per kWh. Solar power is selling for around $14-$20 per kWh, depending on the location. That's roughly 10-12 times as much. Why?

Because when you study the physics closely you will find that the sun isn't providing any of the useful power. All of that must still be delivered by other, more dense sources of energy. What you're buying is solar panels that are being metaphorically stuck on top of natural gas generators, nuclear power plants, and coal-fired power plants. This is merely to appease the idiocy of our political leaders, who are in turn, responding to the absurd dreams of the public, which knows nothing about the hard realities of energy.

Chris Lee, writing in Physical Review, about the limiting impact of electron behavior in PV solar cells said…

The truth is, some scientists (and their backers in government) aren't fighting something like the laws of thermodynamics… they're fighting THE laws of thermodynamics. Doing that my friends is simply stupid – the laws of thermodynamics are undefeated. And they always will be.

"You are a really good thinker. You are correct. In the global view, it is possible to include the costs of all components in any system to effect optimal design...

"System design is also possible to incorporate 2nd Law in for system design using minimization of entropy over the life cycle of the system. This is not normally done, but it certainly is valid and would assist a designer to create minimum life-cycle costs. I have actually incorporated such an approach in examples presented in my advanced thermodynamics classes... I don't know how you understood this except that you are a darn good thinker. This design approach in not normally used; we adhere to economic principles and rules of thumb for subsystem design. However, darn ya', we should be using thermodynamic underpinnings for design so that photovoltaic panels for electric power would not even be in the running... I hope I taught you a bit of second law detail, but you seem to have very keen intuition about all that." – Paid-up subscriber Bob Colwell, Ph.D.

"I'm a retired engineer from The Boeing Company. I have been studying the feasibility of solar/photovoltaic and wind turbine generated electricity. It's ludicrous to think that solar power sources could provide any meaningful electricity to the national electricity grids...

"In the real world of market economics solar/photovoltaic is only economical for niche applications. High feed-in tariffs for photovoltaic-produced electricity is the only reason arrays are being built. If the playing field were leveled, without high feed-in tariffs for photovoltaic electricity, they couldn't compete with other power plants. By the way, wind turbines are plagued by analogous problems in the effort to scale them up to be major sources of electricity.

"Oh, by the way, I love reading your Friday S&A Digests. I'm learning a lot from them. Keep on writing them." – Paid-up subscriber Gregg Armstrong

Regards,

Porter Stansberry

Baltimore, Maryland

September 23, 2011