Editor's note: Don't miss a short essay from S&A Resource Report Matt Badiali on how to hedge your portfolio against the BP oil spill. It's at the end of today's Digest.
Our home-buying odyssey gets more interesting by the day. A couple weeks ago, the appraisal on our house came in about 11% below the contracted price. We soldiered on and dropped the deal price to meet the appraisal. Yesterday, the same thing happened to the home we're buying. It's a bitter pill for sellers to swallow. Imagine offering your house for $500,000 and being told by the bank that your buyers will be approved to pay $450,000 for the house. And once the underwriters get that appraisal number in their heads, forget it. It's over. The only thing to do is drop your price, sell your house, and move on.
Our real estate agent told us she has clients who are refusing to sell. They're going to miss the prime selling season, spring and early summer. How sellers will cling to their asking price. They get a number in their heads and refuse to admit they drastically overpaid for their house in 2004-2005. They can't accept their house is only worth what someone will pay for it.
The house we're buying is the largest one in the development. There's one around the corner, whose owner is asking $100,000 more than we're paying. The poor sod will not sell his house. That he's a homebuilder by trade makes it all the more poignant. He's a homebuilder who built at the top of the bubble and now can't face the reality that he's still priced $100,000 too rich.
Billionaire Louis Bacon founded Moore Capital in the late '80s as a global macro hedge fund. He's made investors around 20% a year since then, and now manages $15 billion. In his latest letter to investors, Bacon sees three types of risks in today's market. First, there's investor risk, the risk of being your own worst enemy:
There are times when an almost unlimited amount of assets can be put to work – as in the second half of 2009 – but these are normally the times that the flow of clients' funds are redeeming, as happened last year. And there are times – like this year 2010 ahead – where the landscape is more divided, asset prices are richer, and investors are more extended.
In other words, cash is king during a market panic. But that's when most investors wind up selling. As Bacon notes, today's markets are overextended. Profit-taking would help prepare you for the next buying opportunity. You can make a fortune if you have plenty of cash on hand when the market corrects.
Bacon also mentions regulatory risk. World governments are currently clamping down on banks and hedge funds. Government regulation can seriously hamper these firms' future performance. Still, I think government is more likely to do what it always does, especially in financial services: Select a few winners and a whole lot of losers.
The third risk Bacon acknowledges is market risk:
I will note that one of the polling services that canvasses investment managers found there is the widest divergence of forecasts ever for inflation, bond rates, stock prices, GDP, and house prices. There are potentially what we call very fat tails on each side of the forecasting distribution curve that make players very nervous. Although I am easily entertained by both sides of the extreme forecasts, I do not feel convinced, leaving me wary of long-term investment commitments.
We mentioned the same problem in Monday's Digest:
These bailouts come with another ancillary problem: They make it much harder for entrepreneurs around the world to invest across borders. You can't price assets into the future when every government in the world is printing money. When entrepreneurs can't estimate the future value of different currencies, they stop investing.
Entrepreneurs are scared. They don't want to invest any money in the face of this uncertain future. And when the government turns off the printing press, it's the entrepreneurs who will lead us out of this mess.
Bacon's point of regulatory risk is well taken, but the opposite point applies to the huge oligopoly financial institutions. Sure, there's plenty of theater to suggest otherwise. Most recently, the government has widened its mortgage investigations to include Citigroup, JPMorgan, and Bank of America. Now, every big bank except Wells Fargo is under investigation for fraudulent mortgage trading. It has the appearances of an all-out witch-hunt.
But this is where Bacon and I disagree, at least when it comes to the megabanks. None of these big banks are going to fail or even suffer much at the hands of the government's investigators. Sure, asinine politicians like Barney Frank will slobber, spit, and lisp at the bankers, pretending to grill them. But in the end, the big banks' competitive positions will be sealed up even tighter, as they work with government to create the new regulatory regime...
I've told you repeatedly in the Digest more regulation creates a government-fed profit stream into the coffers of the biggest regulated financial institutions. The new financial reform bill is no different.
Cliff Asness and Aaron Brown of hedge-fund group AQR Capital Management wrote in today's Wall Street Journal an opinion piece basically agreeing with me. The two hedge-fund managers show how the new financial reform bill sponsored by Senator Christopher Dodd will "create the largest and most powerful crony system in history," a "Treasury-financial complex" that'll be "as expensive and hard to kill as the military-industrial complex President Eisenhower advised us to fear."
Anyone who doubts the big banks will succeed in the new regulatory environment by quickly jumping into bed with government is already wrong. To secure its place in the Treasury-financial complex, Bank of America has come out in full support of Komrade Obama's sweeping overhaul of financial services regulation. As Bloomberg put it, "The Obama administration has found a banker it can do business with: Bank of America Corp.'s Brian Moynihan."
Moynihan, Bank of America's CEO, has wined and dined the likes of Treasury Secretary Tim Geithner and economic advisor Lawrence Summers. He's in. He's one of them now. And Bank of America will remain competitive because of it.
Jamie Dimon, CEO of JPMorgan Chase, is coming around, too. Back in June 2009, Dimon warned in a Wall Street Journal op-ed piece about "the danger of the pendulum swinging too far," meaning too much government intervention in the economy. A month ago in a Chicago speech, according to Bloomberg, Dimon expressed support for 80% of the overhaul plan. Goldman Sachs has already settled with the SEC in the mortgage trading scandal. Big bankers make big money not in spite of the government, but with its substantial assistance. Whether they admit it or not, government support is one of the most important reasons investors like John Paulson and Bruce Berkowitz own stocks like Bank of America, Goldman Sachs, and Citigroup.
Last month in Extreme Value, I told my readers about a way to benefit from the government's "regulation" of the banking system. An elite group of banks is getting much more help from the government than other banks. These elite banks are being given free money by the FDIC.
One bank recorded a $15 million quarterly gain after entering a single FDIC-assisted transaction. It's got plenty more capital for other FDIC-assisted, "free money" transactions. And it's located next to one of the top eight states where the FDIC has been operating over the past year. Another bank just like it is located dead smack in the middle of one of the top two states where the FDIC has been operating the past year. It's getting "free money" deals, too.
To get access to Extreme Value, click here. Once you sign up for Extreme Value, go to our password-protected website and read the March 2010 issue, titled "Welcome to the Money-Manufacturing Business." That's where you can read all about my plan to double my readers' money over the next year or two by getting their fair share of government guaranteed bank profits.
New highs: PowerShares UltraShort Euro (EUO), iShares Silver ETF (SLV), St. Mary Land (SM), Altria (MO), Portfolio Recovery Associates (PRAA), DirecTV (DTV), HMS Holdings (HMSY), Seabridge Gold (SA), Silvercorp Metals (SVM), Silver Wheaton (SLW), Eldorado Gold (EGO), Inter-Citic Minerals (ICI.TO).
In the mailbag... Several subscribers describe how our advice has helped them. Please send your e-mail to feedback@stansberryresearch.com.
"I think it was Clark that caused me to go puts on the dow transports. I got a 5 banger on that one. Better yet, for the first time I picked out my own puts when I saw what was happening in the gulf. I don't know why none of my 30 newsletters (yes I'm a newsletter junky) touted puts on Transocean but that gave me a 4 banger in just days. I guess I'm a bit of an expert on your industry, and I have known for over a year that Stansberry is the ABSOLUTE best I will probably be canceling the others. However I wish you would zip your lip. This wonderful govt of ours is dangerous to mess with and folks like me out here need you. I THINK YOUR OUTFIT IS MY ONLY HOPE FOR RETIREMENT Many thanks for all your research." – Paid-up subscriber Kurt Meyer
Ferris comment: I'm really glad you're getting such great results with your S&A subscriptions. Good point about the government. But it hasn't squelched us so far, try as it might.
"When some slick S&A salesman talked me into paying $5,000 for an Alliance membership, I wondered afterword if that was a smart thing to do... My investment in ADP, MCD, NLY, PZG, REXX, ENC/DNR and SA together have returned ten times my Alliance membership fee in unrealized gains. If all goes well, my grandchildren will end up owning them... ROY returned nearly five times my Alliance membership fee in realized gains... You could say that I am a happy camper." – Paid-up subscriber Richard Shaw
Ferris comment: Thanks for the note, Richard. Happy camping!
"Just wanted to drop a line to say thanks for all of the interesting reading I am catching up on since joining the S&A Alliance. I am particularly happy with my Gold Eagle and the Silver Eagles which have already turned a 25% profit for my investment of $10,000 and from the looks of the market today could actually end up being a double or better." – Paid-up subscriber Kerry L.
Regards,
Dan Ferris and Sean Goldsmith
Medford, Oregon and Baltimore, Maryland
May 13, 2010
Hedge Your Portfolio Against the Political Oil Disaster
By Matt Badiali
The costs are staggering... The April 20 oilrig blowout that has spewed 110,000 barrels of oil (and counting) into the Gulf of Mexico will cause more than $10 billion in damage to the region... As the slick floats toward land, it could obliterate Louisiana's oyster, shrimp, and fishery industries.
And if that's the worst of the damage, we should count ourselves lucky.
I'm worried consequences of the blowout could compound our economic problems for years...
The problems started when a huge bubble of natural gas, probably millions of cubic feet worth, shot up through the drill pipe, surrounded the drill rig, and exploded. The resulting fire claimed 11 of the crew of the drillship Deepwater Horizon.
The principal safeguard – giant hydraulic valves called "blowout preventors" – failed to engage. The broken well only partially closed. It continues to gush 5,000 barrels of oil per day.
But we still don't know exactly what happened. There are three potential culprits: Halliburton, the service contractor; Transocean, the driller; and British Petroleum, the well operator. According to the recent British Petroleum executives' testimony before the House Energy and Commerce Committee, all three were partly to blame.
First, Halliburton screwed up the cementing of the well – designed to create a solid bond between the pipe and the rock around it. That would have prevented any gas from escaping in the first place.
Second, Transocean's blowout preventor had a hydraulic leak as well as some other mechanical problems. Low hydraulic pressure couldn't overcome the well's huge flow. When asked to perform its job, the faulty valve wasn't up to the task.
Finally, British Petroleum altered one of the big hydraulic valves on the blowout preventor so it could be used for well tests – which made it unusable for preventing blowouts. When the other valves failed, the one altered for the test wasn't available. You know what happened next.
Who's to blame is a secondary issue. What matters now is the damage to the Gulf of Mexico and the offshore drilling industry of the United States.
The second-largest oil spill in history occurred at PEMEX's IXTOC 1 well (the largest spill was an intentional act – When Saddam Hussein set a Kuwaiti oil terminal on fire during the first Gulf War to counter a potential invasion). IXTOC 1 was the last time a massive blowout occurred in the Gulf of Mexico (yes, it's happened before). Mexico's state-run oil company let 3.3 million barrels of oil leak out before they got the well plugged.
It will take 20 months for that much oil to leak out of the current well. At 22 days right now, the current spill is roughly half the size of the Exxon Valdez spill.
People's emotions are running high right now. After all, it's easy to be upset over this catastrophe. I expect lawmakers to use that emotion to further their own political agendas. There will be calls to halt all drilling off our coasts. I've already seen language in the energy bill that will effectively halt drilling within 75 miles of any state's coast that doesn't want it there.
If that kind of language passes, the price of oil will soar. Currently, about 29% of U.S. oil supplies come from offshore drilling. If that stream is curtailed by 10% or 20% by reactionary limits on drilling, it could play havoc in the markets. Nervous traders could easily send spot prices for crude past the $174-a-barrel highs of July 2008.
And as we all saw then, expensive oil does more than just make the morning commute more expensive. It hurts virtually all facets of the economy, increasing costs and sapping earnings for businesses in most every sector.
As an investor, one thing you should do to hedge your portfolio against this is buy land-based oil drilling companies. If the government limits offshore drilling, oil companies will redouble their efforts to get more oil from older inland fields. This would be a boon to companies engaged in so-called enhanced oil recovery (EOR) or oil producers mining the Canadian tar-sands. Check out Denbury Resources (DNR) or Suncor (SU) as possible investments to hedge against the political backlash of this oil spill.