Look out: The Fed moves up the curve...

Every weekend that goes by, we think, "OK. This Sunday will be the day they announce the Greek default... or Germany leaves the euro." But it hasn't happened yet. The longer it takes, the worse the crisis will get. Keep that in mind when you're trying to judge what to do next. And that's what I'd like us to focus on in today's Digest...

(By the way... although it's not Friday, I'm writing the Digest today because Goldsmith is with The Atlas 400 on an African safari. What a job that guy has... When I die, I'd like to come back as Goldsmith.)

What the world's governments must do is convince their creditors (and bank depositors) that there's no risk of inflation. They need to herd their financial liabilities into long-dated, fixed-coupon paper – the kind that gets wiped out during a period of raging inflation. That's what the Fed is doing right now with operation "twist." It's exchanging short-term debts for long-term ones. Once it's done this... once it has locked its creditors into long-term bonds with fixed coupons... it can inflate away and wipe out these debts (and its hapless creditors).

There's a perfect historical analogy. In 1946, Britain exchanged its 2 billion-pound World War I gold-backed 5% war bond (worth $739 billion in today's dollars) into a 3.5% sterling perpetual obligation... that was completely inflated away over the subsequent years. Our government will do the exact same thing...

To retain and grow your wealth, you need to do the exact opposite. You need to find long-term assets that do not have a fixed coupon. You need assets whose value will compound over time to far outpace the inevitable inflation. The best of these kinds of assets are operating companies with low capital requirements (companies with so-called "economic goodwill"). Longtime subscribers to my Stansberry's Investment Advisory may remember my December 2007 recommendation of Hershey as an example.

Next... during periods of panic, like the kind I believe we're building toward right now, you also need plenty of cash on hand to purchase the world's greatest "trophy" assets. I'm talking about the core material resources the world's economy will always need – stuff like oil, strategic metals, and critical infrastructure (rail systems, ports, communications networks, etc.) The trick to buying these assets via the stock market is that you've got to make sure you buy at a cheap price. And you have to be ready to sell because, over the long term, being an investor in asset-rich businesses will only produce marginal returns.

For my next issue, I'm putting together a list of the world's 20 greatest trophy assets. You want to buy these when they are down 75% from their recent peaks. And yes, you get the opportunity to make purchases like that every now and then... But you have to be ready, you have to be confident in your approach, and you have to act fast. The window to buy them opens and shuts quickly.

Let me show you one simple way to judge how much stress the world's economy and financial markets are enduring. The chart below compares ExxonMobil – the world's biggest oil company – with shares of Apache, one of the world's leading "alternative" technology oil companies…

Apache uses a smart business model. It takes proven resources from the majors and applies new technologies to increase the productivity of these aging assets. This chart highlights the gap between "new" oil and "old" oil.

When you compare these stocks over short periods of time (less than a year), they tend to track each other closely… But over longer stretches (say, five years), you'll notice Apache has generally done better. It's a smaller company capable of more rapid growth.

However... during periods like we're in right now, when investors shun risk... Apache's shares tend to collapse, because investors crave the relative safety of larger, more established stocks. Our goal over the next several months is to find and highlight lots of situations like these. We're going to build a great "buy" list stocked with dozens of the world's leading growth companies (like Apache) trading for 50%-75% less than their intrinsic value. Our opportunity is coming... But we must be patient. This euro crisis is going to get a lot worse before it gets better.

The corollary of a declining euro is a rising dollar. The U.S. dollar index has gained approximately 6% in the past month. Although the dollar has severe long-term problems, it is still the refuge of choice for large money managers when they decide to flee stocks and commodities. Our monetary mandarins will use this rush back into dollars to extend the average Treasury maturity from about 36 months to eight or 10 years.

But in the short term... the strength in the dollar is going to kill the stock market and the commodity markets. You can imagine this as a replay of 2007-2009... But it will be worse this time. You can see clearly that since the early 2009 market bottom, stocks and commodities have become joined at the hip... rising and falling at the same rate, in the same pattern. Statisticians would say they exhibit "high correlation."

The chart below shows this correlation. It plots the performance of the benchmark commodities index (black line) versus the performance of the benchmark S&P 500 index (blue line). They are moving in lockstep…

Nowadays, there's little difference between owning bank stocks, retail stocks, energy stocks, copper, corn, or semiconductor stocks. It's all become one huge "risk-on/risk-off" trade. In a "risk-on/risk-off" world, most people look at their retirement portfolios and think, "I'm diversified." Your financial analyst might agree. But many folks are simply holding huge, dangerous, leveraged bets that everything will be "just fine." They're going to get crushed.

That's why we've constantly told our subscribers not to go and borrow a bunch of money to leverage your portfolio – not even into gold and silver. What we're experiencing is a major collapse in the world's monetary system... This instability will likely continue for a long time... and it will get worse and worse and worse. The volatility will hurt the value of everything – even gold and silver. Gold has dropped from $1,900 per ounce to less than $1,650 in the past month. Silver has slid from $40 to $31 per ounce in a week.

Why aren't gold and silver performing better? When folks panic and sell stocks and commodities (like they're doing now), liquidity trumps all concerns. They sell everything in a mad dash for cash. Investors call up hedge funds and ask for their money back. Exchanges raise margin rates, which dictate the amount of leverage traders are allowed to use. In this environment, everything that can be sold to raise cash – including gold and silver – is dumped. You can cry and moan about the volatility... Or you can take advantage of it. We suggest the latter.

New 52-week highs (as of 9/23/11): None.

In the mailbag... a letter that's almost too ironic to be true (but I promise, it's real). Plus, our first note from Bahrain... and the exquisite wisdom of the legendary Butthead (of Beavis and Butthead fame). Send your notes here: feedback@stansberryresearch.com.

"Re: your use of 'the second law of thermodynamics' for solar power. I suspect that you are using this phrase to cloak yourself in the infallible starched long white jacket of science, to elevate yourself as disseminating absolute indisputable truth. You certainly aren't using it to better communicate with readers, because the majority of them wouldn't be able to make the connection. They just have to say 'oh, if its scientifically that way, it has to be 100% true.' No, I think you are puffing yourself up to seem more an authority than your credentials allow. I suspect that if pressed, you couldn't give a thorough explanation of what that means. It sort of makes me wonder if you are doing that in spots with your financial advice." – Paid-up subscriber Tom Lawford M.D. BSEE MIT

Porter comment: I spent a lot of time studying the Second Law when I was researching new communications technologies during the late 1990s. An application of the Second Law (Shannon's Law) relates to entropy in communications channels. Without that background, I probably would not have thought about solar energy through the lens of entropy/heat loss.

But knowing the basics of the Second Law, I always knew that photovoltaic (PV) solar power was absurd and concentrated solar power (CSP) would never justify the costs... for the simple reason that sunlight is highly entropic. That's the way I've always thought about it... And it seems so obvious to me, I didn't think it required much in the way of "credentials" to realize.

If that's "puffing myself up" in your view... well... OK. But I must say, I got a real chuckle out of a seeing a medical doctor accuse someone else of "cloaking" himself in the "long white jacket of science" and claiming more authority than his credentials would allow. I mean, it makes me laugh out loud. So thanks for your note.

Dear Porter... I am a professor in IT and education from Bahrain with around 15 years of investment experience in U.S. markets. I have served as a university president for past 10 years and assumed many academic responsibilities since 1980. I have graduated with M.S. (1976) and Ph.D. (1979) out of University of Michigan, Ann Arbor. I am simply writing to confirm that I have never in my life read anything more sincere, educational, and factual in finance than that written by three people: Chris Weber, Jim Rogers, and Porter Stansberry.

"I have continued to enjoy your newsletter and other related S&A ones since early 2008 and have listened, understood (or tried to), but certainly acted upon your advises since then. Yes, I made some money but more importantly developed over time a more balanced view on life, money and business in general. I have delivered many keynote speeches in my region, India, and Europe and have always echoed your concerns and forwarded your financial outlooks and warnings. My audience applauded but never cared even to adopt such ideas as they probably thought such talk was too contrarian to mainstream media talk and even better it came from Mr. nonspecialist dreamer.

"By the way, being also a subscriber to Chris Weber's newsletter, I would like to refer your readers to his recent letter in August where he was told quite sometime ago by a highly trustworthy friend that Porter Stansberry is highly regarded as the next Chris Weber. I am only quoting this and providing my independent opinion because I believe that you should continue your noble mission to educate your readers and well wishers who are increasing in number because: 1) truth eventually prevails. 2) lies cannot continue to impact large number of people for extended periods. Thanks for your patience, and with my best wishes for your success and happiness extended to your family and yourself. Truly yours…" – Paid-up subscriber Samir Qasim Fakhro Manama, Bahrain

Porter comment: One of the kindest letters I've ever received. And by the way, Weber mentioning my work in a positive way in his letter is one of the highest compliments I've ever received. For folks outside of our industry, it might be hard to believe... But that was a true highlight of my career. Weber is universally respected – he's a guru's guru.

"Was just reading some pretty harsh criticism from some of the 2nd law 'experts' (of course no facts, just personal jabs) and was starting to feel bad for you as it seemed they really had you on the ropes. I was wondering how you were going to answer the onslaught, I was even seriously considering their last shot 'Can't make money on it can't be good, Right?'

"Then I saw a thing of beauty: '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.' LOL. Great stuff. I think Beavis and Butthead summed it up best: "How come all the smart kids are always such dumba**es?" – Paid-up subscriber C. W.

Porter comment: I'd like to add a corollary to Butthead's famous rhetorical question... Were it not for rich and powerful people doing incredibly dumb things with money, we'd have nothing much to publish and zero edge in the financial markets. So if you know a really foolish rich person, be sure and thank him. (And don't tell him to read our newsletters... We need him out there, doing what comes naturally...)

"Trying to use sunshine directly to power our grid is akin to using rainfall directly to drive hydro turbines. No one would be so foolish as to collect raindrops while they fall, to power a turbine. Instead, we clear thousands of acres of land upstream from a dam, so water can be concentrated and stored to power our hydro turbines below the dam. The solar equivalents are coal, oil, and natural gas, the products of millions of years of concentrating and storing energy from the sun." – Paid-up subscriber "MacEntyre" chemical engineer

Porter comment: That's a great analogy... I wish I'd thought of it.

Regards,

Porter Stansberry

Baltimore, Maryland

September 26, 2011

Look out: The Fed moves up the curve... Building a list of trophy assets to buy... Why diversification doesn't work during a financial crisis... A great analogy in the mailbag... 'You are puffing yourself up to seem more an authority than your credentials allow'...