Don't read this...

Don't read this... A Friday Digest that's bad for you... Investment crack... Why everyone is drawn to junior miners... GM's woes continue...

In today's Friday Digest... something that's a bit unusual. I'm going to give you some very dangerous advice, which is completely wrong for most of you. (After the fun stuff, I'm also going to update you on the GM situation I wrote about last week in my newsletter. There's some new data out that will make you gag...)

As you know, we normally reserve this space to try and teach you something useful. We know... the effort is mostly wasted because so many of our subscribers aren't going to bother reading that closely. You're merely looking for a stock tip. You don't actually want to know anything about investment strategies. Nevertheless, I've always felt an obligation to show you the things I'd want to know, were our roles reversed. And I know, for certain, that how you go about investing is vastly more important than which stocks you buy.

But that's not what I'm going to do today. Instead, I'm going to show you something that I'd rather you not see. I'm going to give you something you really shouldn't have. And I'm going to admit – upfront – that what I'm about to do has a good chance of hurting you... Maybe even severely.

You shouldn't ever buy junior mining stocks. Not ever. Not once. That's actually the best piece of advice I can give you about them. Just don't do it. Think about it this way... our friend and Gold Stock Analyst editor John Doody has spent most of his adult life studying gold-mining companies. It's fair to say no one in the world knows more about gold production firms. And even John won't recommend junior mining exploration companies. Why not? Because they're just too risky. John will only cover gold stocks that have existing production or are on the verge of producing. You can do very well as an investor and never buy a junior mining company.

But... having said that... and having given you plenty of fair warning... I know that most of you, sooner or later, will take a 'flyer.' You'll put a few thousand dollars... or maybe even a few tens of thousands of dollars into some tiny gold-mining stock. If you're lucky, you'll lose all your money the first time. Because... once you start making five and 10 times your investment (which happens regularly in these stocks), you'll be hooked like we are...

What can I say? I know better. But I can't help myself. It's like standing on the tee box on the 10th hole at Baltimore Country Club. I know I shouldn't hit my driver. I know I shouldn't try to get to the green in two shots. I know there's water in front and a green with a false front. Anything below the hole will roll into the pond. I know I should lay up. I know. I know. I know. And then I hit the driver every time. Every stinkin' time. And guess what? I end up in the pond about 50% of the time. I do it because making a birdie on the signature hole makes you feel like a champion. I do it because the pain of those bogeys and double bogeys doesn't compare to the greatness of reaching the green on my first shot and sinking the putt.

The same thing is true of junior miners. If you look at our Hall of Fame (located at the bottom of every S&A Digest), you'll see a few, including our best-ever recommendation – Seabridge Gold. Now look... I know the odds aren't good that I'll make my fortune investing in junior mining stocks. But it could happen. I know several people who have done it. And that's why I always keep my ear open for the best new names, the 'hot' plays. In fact, at our annual Atlas 400 meeting in New York, I always give the audience my best junior gold-mining idea for the year. (Last year, it was Gold Standard. I said to buy it around $1. Today, it's trading around $2.85.) Getting it right with these stocks is the greatest thrill in investing. And it's one of the few ways you can actually get rich in stocks – not just richer.

We have one advisory – Phase 1 Investor – that covers the most speculative sectors of the stock market. I'm talking about the junior miners and development stage biotechs. These stocks are "Frisbees." You know how when you throw a Frisbee, it never flies on a level plane? It jumps up and down constantly. That's how these stocks move. Getting into them requires discipline and patience. You have to know what price to pay. You have to wait for the market to come to you. You have to have nerves of steel. And that's why having the very best, most detailed research is absolutely the key. With these stocks, you have to really, truly know what you're doing and why. And of course, you have to be prepared for plenty of volatility.

We've made lots of our subscribers a lot of money with Phase 1 over the years. I know for a fact we made one guy $4 million with a single biotech recommendation. These stocks can be the best thing that ever happens to you... but you have to know what you're doing and you have to have risk capital available. Like you wouldn't take your life savings to Vegas, you don't want to bet your house on these stocks, either. Phase 1 is about very risky investments. On the other hand, when these deals pay off, there's simply nothing better. You've used your brains and your guts to make millions. It's a lot more fun than having to work.

I'm bringing up Phase 1 today because we have a great lead on a new junior gold-mining recommendation. Three of our best sources in the sector have recently piled into the stock. They put in $20 million. That's a serious position. I can't tell you the whole story, but I can tell you this is one of the deals I'm 90% sure is going to work out. I believe that mostly because it's so well-financed. That means you're not looking at making five or 10 times your money here... But a double or a triple is actually likely... And this is a lower-risk situation because of the cash the company has in hand.

Now look... all these deals are "no tears" recommendations. Yes, we've done tons of research. And yes, we've checked with our best sources, a few of whom have already put up huge amounts of capital. We believe this is a very good deal – the best we've seen all year. In fact, I'd bet this small stock is bought out by the end of the year at a large premium to today's price. But there are no guarantees. This is for big boys only. If you can't take the risk, don't buy the stock. Got it? If you're interested, be sure to read about the situation here.

By the way... even though I think most people shouldn't put their savings into high-risk/high-reward speculations, I do recommend subscribing to Phase 1 if, and only if, you're managing at least $100,000 in equities. Yes, it's expensive. But it's also clearly worth it, as you'll see the moment you subscribe. It's our highest-quality, most in-depth work. It only covers stocks that have the opportunity to make you very large gains. And as we've proven, we can help you find big winners.

Now... in the June issue of my Investment Advisory, I argued that the "bailout" of GM has been catastrophic for Detroit. I showed that commercial real estate has fallen by an additional 60% over just the last five years. And I predicted the real estate market is foreshadowing what will eventually be another catastrophe at GM. The issue is simple: the bankruptcy process resolved none of the company's core problems. The process was subverted by the political establishment, which sought to protect one class of citizen, at the expense of the regional economy, GM's bondholders, and its customers.

The GM situation is very important to understand because it's a microcosm of what's gone wrong in our country. If we can't apply the rule of law and sound economics to fixing one of the world's most important manufacturing concerns... it doesn't bode well for anyone else being afforded these privileges, either. Most people simply don't realize that the bailout of GM wasn't a bailout of the company. It wasn't a bailout of its shareholders, who lost everything... or its bondholders, who lost almost everything. Where did the money go? To the union. The United Auto Workers (UAW) ended up with all the money. Let me show you how it happened...

GM slid into bankruptcy primarily because it couldn't profitably manufacture cars. (Yes, there were plenty of other issues, like too much debt, investments in subprime mortgages, etc... But the primary reason it couldn't solve these other problems was that it hadn't been making routine profits from manufacturing cars in about 20 years.) And the biggest single reason it couldn't profitably make cars was because its labor costs had soared. Well, guess what? At $56 per hour, GM still has the highest labor costs in the industry.

The bankruptcy process didn't deal with the biggest financial hurdle GM faces, which is an enormous (and growing) unfunded pension liability. When the company entered bankruptcy, it owed $20 billion to the trust that was established to pay for the health care of its retired workers. Its pension program, with $100 billion in obligations, was also underfunded by roughly $10 billion. That's $30 billion in legitimate claims, the union had to present to the bankruptcy court on behalf of GM's employees. It could have received a mixture of cash and equity in the new GM – just like any other unsecured creditor.

But there wasn't really a bankruptcy court. Instead, there was Steve Rattner – "the Rat," as we call him – the crooked Democratic political operative under investigation for bribing New York State pension officials. Obama made him the "car czar." And his job wasn't to fix GM. It was to deliver billions to the union and thus, deliver Michigan for Obama in the next election.

Bondholders at GM were owed $30 billion, too. A legitimate bankruptcy would have sold or liquidated the company's assets and split the proceeds between the two major claimants, the bondholders and the unions. GM had roughly $20 billion in tangible assets, plus probably another $10 billion in intellectual property. These sums could have either been liquidated or put into a new company, with the equity split between bondholders and unions.

Not surprisingly, the current market cap of the new GM is $33 billion, right around the same number that could have been raised in a liquidation. The bankruptcy court should have given the unions roughly $15 billion worth of cash or new equity and the same thing to bondholders. Everyone would be square. And the company (or at least the company's assets) would have been freed from the stranglehold of huge debts and pension obligations.

Taxpayers shouldn't have paid a dime in this process, because frankly, it's none of our business. Remember... the purpose of bankruptcy isn't to repay creditors. They're screwed. They're not getting all of their money back because they bet on the wrong horse. That's how capitalism works. That's the price of liberty – you're free to make bad choices.

The purpose of bankruptcy is to free productive assets from the burden of debts that can't be repaid or refinanced. We do this because it's good for society, not because it's good for creditors. Had the bankruptcy been handled legitimately, GM's assets would have ended up in the hands of better entrepreneurs. Its workers could have found new, productive jobs at a rate the market would bear. (Other carmakers are paying $47 per hour – these aren't bad jobs.)

Yes, GM's retirees, its pension program, and its bondholders would have taken a hit. But they wouldn't have walked away empty-handed. They would have been the owners of a profitable company, operating debt-free and without the burden of seemingly endless obligations to a pension fund.

But that's not what happened. Instead, the government injected an amazing $50 billion into the company and, at last count, has lost roughly half of it. How did taxpayers lose $25 billion on a company whose total tangible assets were only worth $20 billion? How did bondholders lose almost all of their $30 billion, too? And most importantly, how did our country end up with a GM that can't earn a genuine profit because of never-ending obligations to its pension fund? I think you probably know, dear subscriber. The Rat did what he was being paid to do... he delivered billions and billions of dollars to the union. Amounts that will never be recovered... billions that will never be found.

Here's what we do know about where the money went... Bondholders got 10% of the new GM – about $4 billion worth of stock at the time of the IPO. However, they weren't allowed to sell until much later, so that value dropped about one-third by the time they could have actually liquidated. Thus, bondholders ended up getting about 10 cents on the dollar. The unions, on the other hand, got paid 100% of the pension liability – about $10 billion, which was simply passed onto the new GM and has now grown to $13 billion.

In addition, the Union's health care trust got 17.5% of the new equity (worth about $6 billion), plus $9 billion in preferred stock and notes. These securities are not only worth more, but they will also likely end up with essentially all the company's cash flows for the next decade. In total, the unions walked away with about $28 billion in cash and stock (out of $30 billion owed). Not surprisingly, that's almost exactly the amount of money that's gone missing from the government's accounts.

They also retained a position of absolute control over the company's earnings. In short, the unions got paid 93% of what they were owed and will very likely continue to have a legal claim to virtually all of GM's cash flow. The bondholders got a few pennies. The taxpayers lost $25 billion. And GM still can't make a real profit. Bravo!

I'm sure that folks as virtuous, thrifty, and honest as the good people of the UAW will prove to be excellent stewards of GM's assets and reputation. Surely GM's future has never been brighter. And Obama's legacy as the savior of Detroit is assured...

By the way... the numbers above are all real. Most of the stuff you see reported about GM is not. There's a good reason for this, of course... the government continues to own a large portion of GM's stock, and GM is one of the largest advertisers in the U.S. Nobody wants to take on those two powerful interests.

Take, for example, what Morgan Stanley's GM analyst, Adam Jonas, told the Wall Street Journal last week. He claimed that GM had gotten rid of 20% of its roughly $100 billion total pension obligation by spending only "$3 billion." Imagine if that was true! If the company was able to resolve $20 billion in obligations by spending $3 billion now, well... that would dramatically improve the financial standing of the business and probably double or triple its stock price. Strangely, that's not what happened. Instead, the credit ratings agencies warned they "might" have to downgrade GM's debt. And the share price continued to fall...

I don't know Adam Jonas. And I don't know that the paper is quoting him fairly. But whatever the case, nothing could be further from the truth. GM unloaded $26 billion in future pension liabilities by contributing $25 billion in pension fund assets, $1 billion in cash, and paying $3 billion in an insurance premium. So what actually happened is that the company put virtually all of its earnings – $4 billion – toward its pension (again) and saw the total unfunded liability drop by a mere $1 billion, from $14 billion to $13 billion.

Assuming the rest of these liabilities could be extinguished at the same rate, it would cost GM roughly $50 billion to wipe out all its remaining pension liabilities. Strangely, neither Jonas nor the Wall Street Journal saw fit to mention that part...

I'll leave you with these two simple questions... If we can't count on the media to keep us informed about the major problems of our country's most important companies... and if we can't count on the government (which still owns 26% of GM's equity) to deal with its pension obligations honestly and fairly... what does this say about the likely future prospects of GM? What does it say about our country?

Think we're being too harsh on GM? Send your feedback – good or bad – to feedback@stansberryresearch.com.

Regards,

Porter Stansberry

Baltimore, Maryland

June 15, 2012