Still investing the wrong way?... The right way to buy a stock... Why GDX looks like a buy... Double your gains, eliminate your losses... How to legally buy stocks for much less than the current market price... Cesspools of human waste...
Before we get to our "normal" Digest fare... I have a serious question to ask you. Are you still investing the wrong way? Are you still making the same basic mistakes over and over and over? My question is, if you've been reading our newsletters for more than a few weeks and you haven't yet altered the way you conduct yourself as an investor, why haven't you? And if you haven't changed yet, when will you decide to change? After a few years? After a decade? Or maybe never?...
I'm asking you this question for two important reasons. First, the No. 1 piece of feedback we get in our mailbag is: I wish I'd known this stuff sooner. Once people learn the basics of sound investing, some of them immediately change. They start making better investing decisions right away. But on the other hand, the second most common piece of feedback I get is: I didn't follow your advice [on buying and selling, on trailing stop losses, on positions sizes, about bonds, etc.]... now what should I do?
So... I want to know, which type of subscriber are you? Are you investing the right way yet – all of the time? Do you still put way too much money at risk when you buy an individual stock because you won't use proper position sizing and you won't cut your losses? Do you still sell your winners way too soon because you're afraid of giving back a small gain? Do you refuse to sell stocks short, even though it's often easier to make money selling stocks than it is to make money buying them? Have you never sold an option to capture a low-risk, high-yield premium? Do you still buy expensive mutual funds that are no better than a cheap index fund? Or even worse... do you still buy cheap index funds constructed stupidly, mimicking indexes that overweight the most expensive stocks, rather than the cheapest? Are you still waiting to buy gold, thinking you'll be able to catch it on a "dip"?
My bet is, close to 90% of our audience still makes all or some of these mistakes, year after year. I've been thinking about asking our readers to voluntarily sign an agreement wherein they promise to stop making at least the most fundamental, basic mistakes. We'll have to put together a definitive list... and a treatment program. "Hi... My name is Porter. I just can't seem to cut my losses..."
For today, though, I'd like to show you one simple thing you can do to greatly improve your investment results. Using this technique, you can routinely double your returns on capital when you make an investment. Using this strategy, you can buy stocks for less than current market prices – you can legally cheat other investors. And you can vastly increase your margin of safety when you invest in stocks.
If you want to increase your winning percentage to 90% or more when you buy stocks, if you want to eliminate your losses, and if you want to make more money investing, there's only one thing you have to do. Yes, really.
Write this down: There's a way to buy stocks where you can: 1. vastly increase your returns, 2. get substantially better prices – lower than the current market – when you buy, and 3. nearly eliminate even the possibility of a loss. This is the right way to buy stocks.
Before I tell you how to do it, let me tell you why you probably won't do it. To follow this strategy, you will have to call your broker to set your account up to buy stocks this way. This will be uncomfortable because you'll be doing something new. And your broker will probably be a jerk and tell you this kind of investing is too "sophisticated." If that happens to you, get a new broker. Trust me, it will be worth the time and trouble.
Now... let me show you exactly what to do. Over the next 10 days or so, whenever you're ready, I want you to do one trade using this technique. I just want you to try it – one time. You can use a tiny fraction of your account. Don't put much at risk when you're learning something new. But I want you to at least try it. Once you've tried it, I promise you'll never buy stocks the old way again. Never.
You might remember, a few weeks ago, I told you why most individual investors shouldn't buy stocks at all – they should only buy bonds. That's certainly true: Corporate bonds are vastly safer and can be just as profitable as owning stocks – or even more so. On the other hand, from time to time, there are good opportunities in certain stocks (both long and short). You shouldn't ignore these opportunities simply because you don't know the right way to buy stocks. What's the right way? Whenever you decide to buy a stock, stop... Don't do it. Do this instead: Sell a put option.
I know that sounds complicated. But it's not. It's really simple, actually. And it's much safer than buying stocks directly. Let me show you how easy it is with a real, live, current example...
Today, right now, I'm pretty bullish on gold. I've been buying gold for myself, year after year, since it was trading around $400. You should know by now all of my reasons for wanting to own gold. In a nutshell, the world's governments are broke and their paper currencies are going to collapse. It has already started to happen and it's going to get a lot worse.
You should also know by now that I prefer to own gold bullion – plain old regular gold. But there's a special situation in the gold markets today. Right now, I'd recommend buying gold stocks instead of gold bullion.
Why gold stocks? The value gap between gold stocks (GDX) and the price of gold itself (GLD) has recently widened. In other words, right now, you can buy gold cheaper via gold-producing stocks than by buying bullion. This kind of "spread trade" opportunity happens in gold from time to time. (The chart below shows this value gap opening up over the last three months.)
The last big value gap between gold and gold-producing stocks was in December 2008. I recommended GDX then to my subscribers, and we've made about 50% in a little over a year. I think GDX is a good buy again right now, if for no other reason than the value gap to gold. So if you're bullish on gold, this is probably another opportunity to make a little bit extra on the next leg up in the price of gold.
Here's another way to see the value gap between gold-producing stocks and gold bullion prices. This is a five-year chart. You can see how gold and gold-producing stock prices are linked... and how they separated in late 2008 and have begun to do so again now.
So... let's review what we want to do. We want to own gold. But instead of buying gold directly, we checked to see whether or not gold stocks were significantly cheaper than gold itself. They were. So we're going to buy gold stocks instead of gold.
Alright... we could buy the GDX fund today for $44. Let's assume we're going to buy 100 shares. That would cost us $4,400 – plus a small amount of money for the transaction. If we're right about gold going up, we might expect to see a 20% move in gold this year (conservatively). And if we're right about the value gap, we might make another 20% as GDX "catches up" to gold prices. Thus, we might reasonably expect to make 40% on this trade this year, or $1,760.
Assuming this is a $100,000 portfolio, these position sizes would all be about right. Putting $4,400 into a stock is just over our recommended 4% position size. Using a 25% stop loss on the position, you're putting a little over $1,000 at risk – roughly 1% of your portfolio. So you're risking 1% of your portfolio and you expect (conservatively) to make a profit equal to 1.7% of your portfolio this year.
All of this sounds pretty reasonable. But there's a vastly better way to make this trade.
Instead of buying GDX outright, what if we sold a put on GDX instead? When you sell a put, you're selling a promise to buy GDX at any time during the life of the put contract. Since we want to own GDX anyway, there's no real downside to us promising to buy it. And we can promise to buy it at any price we want. So instead of buying GDX today, we might do better by simply promising to buy it anytime this year.
Let's look at how the deal would work...
If you look at the chart, GDX seems to have "support" around $40. That's about 10% less than where it is trading right now. Wouldn't you like to pay $40 to own GDX rather than $44? You can. Right now, there's a trader out there who wants to hedge his exposure to GDX below $40. He is willing to pay you a considerable amount of money to get rid of his risk that GDX will fall below $40 at some point this year.
Why would he be willing to sell you GDX at $40 when the stock is trading today at $44? Honestly, it doesn't make much sense to me, because I'm bullish on gold. But there are folks out there who think gold will fall this year. The other trader – your counterparty – wants to eliminate any risk below $40 for himself, and he's willing to pay you money today to get your commitment to buy GDX from him if it goes below $40.
Right now, you can get around $5 per share if you're willing to promise to buy GDX anytime between now and January 2011 at $40 per share. You're getting $5 for a promise to pay $40 at some point in the future. That's a premium of 12.5%. That's a nice yield, isn't it?
Now... you might be thinking, 12.5% sounds good... but I was expecting to make more by simply owning GDX outright. That's true, but there's a catch – a big one. And it works in your favor.
You see, you've only promised to pay $40 per share for GDX. You haven't actually put up any money yet. There's still a good chance GDX won't trade below $40 for the rest of this year, in which case the $5 you've been paid is yours to keep, free and clear. As a result, your broker should only require that you set aside 20% of the potential purchase price ($40). So you only have to put up $8 per share.
You'll receive $5 per share in exchange for selling the put. Thus, you're positioned to earn $5 for every $8 you've put up for this trade. That's a return of 62.5% – quite a bit more than the return you were expecting to make on this investment by simply buying the stock. Also, don't forget, if nothing happens with the stock, you won't make a penny owning it. The "tie" goes to the dealer when you buy a stock outright. But when you sell a put, if nothing happens, you get to keep your 62.5%. This ends up making a huge difference because you end up collecting money even when nothing happens in the market.
There are two ways to approach selling puts. The first way is the safest – you sell puts the same way you'd ordinarily buy stocks. So in this example, instead of spending $4,400 on 100 shares, you'd simply sell one put option. (Each put option represents a contract to buy 100 shares.)
This is the apples-to-apples approach. You don't have any more risk selling one option than you do buying 100 shares. But by selling the option instead of buying the stock, you've got a lot more downside protection. You're not paying $44. If you end up buying the stock, you'll only pay $40. That's a 10% margin of safety advantage right off the bat.
More importantly, you were paid $5 in exchange for your promise to buy GDX. You keep that money, no matter what. So your effective entry price isn't $40 – it's $35. Using a 25% stop loss on a $35 entry price gets you down to $26.25. For you to be forced to close this position at a loss, GDX would have to trade all the way down to nearly $26. This gives you the widest possible opportunity for a successful investment.
Without the additional margin of safety, you'd be stopped out of GDX if it traded 25% below $44. That's $33. Because of the extra safety of selling the put, your normal stop loss point is now much less, which increases your odds of success.
If you follow the apples-to-apples approach, you won't increase your position sizes, you'll merely be selling puts instead of buying stocks outright. This will increase your margin of safety substantially as you saw – making it nearly impossible for you to lose money buying stocks. This is the right approach for retired or very risk-averse investors.
The other approach is to use the greater margin of safety you have selling puts to increase your position size. Instead of basing your position size on the total amount of the contract, you could base your position size on the amount of margin you must put up to make the trade. So instead of spending $4,400 on buying a stock, you could spend $4,000 on margin. Rather than selling one put option, you could sell five. (You must put up 20% of the total value of the contract to make the trade. Five contracts have a total fulfillment cost of $20,000. And 20% of this amount is $4,000.)
When you use this more aggressive approach, there are two possible outcomes. First, if the put option isn't exercised, you'll end up keeping the $5-per-share premium on five contracts, or $2,500 in pure profit. That's about 40% more than you could expect to make by buying the stock – if everything goes right.
What's the downside? Your risk is that you end up owning a big position of GDX. If you are put the stock, you'll end up owning 500 shares of GDX at $40. That would be a $20,000 position in the stock – which is too big of a position size for a $100,000 account.
Normally, you wouldn't want to allocate so much capital into any single position. But this isn't a normal position because you have such a large margin of safety. For you to lose a penny on this trade, GDX has to trade below $35 and stay there. Your maximum possible loss would occur if GDX traded all the way down to $26 and you were stopped out. If that happened, you'd end up losing $4,375 – which would be a big loss, but wouldn't cripple you.
In my experience, if you're selling puts at 10% below the market price or more, you will almost never end up being forced to buy the stock. In my options-trading newsletter, Porter Stansberry's Put Strategy Report, selling puts is our main investment strategy.
I've recommended selling more than 25 separate puts over the last year and a half. Our average gain on margin was over 50%. And we had one losing trade – one.
If there's one lesson I could teach all individual investors, it is that corporate bonds are better investments than stocks most of the time. My second lesson would be what I've just explained to you...
If you're going to buy stocks, you should almost always sell puts instead. Doing so allows you to pick your entry price and gives you an enormous margin of safety. You can use that cushion to safely use a margin account and increase the profitability of your investments.
Do yourself a huge favor this year. Let this year be the year you finally step up your game as a stock investor. Start selling puts instead of buying stocks directly. At the very least, try it once. A great way to get started with selling puts is to simply read my weekly newsletter – Porter Stansberry's Put Strategy Report.
Yes, subscriptions are expensive. But so are most valuable things in life. And nothing will be more valuable in your career as an investor than the knowledge of how to safely sell puts on stocks. This expertise can easily double the amount of money you make investing every single year and will reduce the number of losses you take by up to 90%.
Sales of existing homes unexpectedly fell for a second month in January. Purchases fell 7.2%, the second-largest decline in history, to an annual pace of 5.05 million. Purchases fell 16.2% in December.
At the current sales pace, it would take 7.8 months to clear the 3.27 million previously owned unsold homes on the market. And with the $8,000 first-time homebuyer tax incentive expiring on April 30, first-time buyers are already waning. They only accounted for 40% of home purchases in January, down from 43% in December. Distressed sales accounted for 38% of total homes sold, up from 32% the prior month.
The situation is worse in the new-home market...
Purchases of new single-family homes fell 11.2% in January from December (down 6.1% from a year ago) to an annual rate of 309,000 – the lowest level in nearly 50 years. Sales fell in every region except the Midwest.
These housing numbers are bad. Sales are down, the tax-incentive extension isn't spurring interest, and there's a huge overcapacity of unsold homes. You would think homebuilders would be hunkering down for lean times, trying to sell accrued inventory before investing in new projects. Despite the discouraging stats, homebuilders are loading up on distressed land – especially in the most troubled Western states. And hedge-fund billionaire John Paulson is there to profit from it.
Paulson's real estate recovery fund is bidding on a portfolio of land in various stages of development throughout Arizona, Nevada, and California. Homebuilders, whose shares are up 72% from the March bottom, are bidding up distressed development land in an effort to rebound. This buying looks counterintuitive, and I don't know exactly what it means. But it's interesting to note one of the world's best investors is getting involved in the sector while everyone else thinks the end of the world is coming.
The Wall Street Journal reported on its front page today that a massive oil reserve in North Dakota and Montana called the Bakken Shale could contain up to 4.3 billion barrels of oil. That would make it the biggest oil discovery in the U.S. in more than 40 years.
Until recently, most of this oil could not be touched because of the thick, nonporous rock. But that's all changed. Today, companies can drill horizontally or use carbon-dioxide flooding to extract oil. Carbon-dioxide flooding is the process of pushing a liquid form of CO2 into a well. The CO2 mixes with the remaining oil and then pushes it to producing wells.
According to the Wall Street Journal, Marathon Oil is a major player in the Bakken Shale. If Bakken meets just half of its potential production, the major oil producer should be a big beneficiary.
In the latest Phase 1 issue (published last night), new Phase 1 analyst Frank Curzio recommended a stock that just made a major purchase in the Bakken Shale area. But unlike the giant Marathon Oil, this company trades under $2 a share... The CEO is a long-time oil insider. He left an oil giant to run this microcap company. And he's been loading up on shares over the past few months.
Frank believes this tiny oil and gas stock could easily double in the short term and rise more than 300% longer term. To find out more about Phase 1, and another huge opportunity in the Phase 1 portfolio, click here.
New highs: Icahn Enterprises (IEP), IMS Health (RX).
In the mailbag... Did we convince you to start buying corporate bonds or selling puts on stocks, rather than just buying and holding stocks? If so, how have these strategies changed your investment outlook and your results? Please let us know: feedback@stansberryresearch.com.
"I've read and responded to the 'End' and have seen some answers to most of my concerns through your response to better asked questions... which is fine with me... But I'd like to ask a question about the general recommendations from the entire suite of newsletters. If the worst case eventual bankruptcy of American plays out like Argentina... and banks close, credit cards don't work, other taken for granted infrastructure is not available, and when banks open huge sums have been stolen from everyones accounts... the question is what is likely to happen with our brokerage accounts, our holdings? If we follow to the letter the PSIA portfolio and other hedged ideas, we still would be holders of stock or gold ETFs and some physical gold. Do stocks with moats that are seen as 'inflation proof' somehow whether the situation? Is the idea to have gold and groceries for the shut down window until the services are back up and trading begins again? What good are the best stocks in this situation? Must I liquidate in preparation while they still have some value, then replace with gold? I know there isn't a known certainty here, but you lay out some pretty dire scenarios. Can you talk to the market in general? It seems foolhardy to toy with the market anymore... unless for a very quick in and out for the last few grabs." – Paid-up subscriber Pete
Porter comment: If there is a real currency crisis, like the kind I think we will eventually have, the stock market will shut down for a long time – probably six weeks to six months. That's why it's important you have access to your bullion coins.
The timing of this crisis is uncertain. I don't think it's time to go completely to gold yet. But in my most recent newsletter, I showed my subscribers how to have a hedged cash position. And I'm currently recommending buying six stocks and selling six stocks short. We have what traders would call a "hedged book." Thus, we have no exposure to the stock market in general.
"I just read the most recent Digest, and there's one thing that I having a rough time reconciling. Robert Prechter takes the stance that cash and cash equivalents will go up in value... but my instinct tells me that you're both right, that somewhere in the middle lies truth and I hope you'll consider addressing the differences and why you are more accurate than Prechter in your thoughts on the dollar." – Paid-up subscriber Brian
Porter comment: In my experience, the truth rarely lies in the middle. To believe Prechter is right, you must believe the value of the U.S. dollar can rise materially over the next decade and hold its value – despite the fact that our government can't afford its debt load and is printing money to pay our creditors.
To expect the dollar to strengthen under these conditions is completely delusional. There is no paper money in history that had any residual value at all after the bankruptcy of the sponsoring government. If Prechter were right, Zimbabwe would be the wealthiest country in the world. Try going over there and let me know what you think...
"I don't know if this is the correct forum to give feedback on the Digest. The issue delivered today (2/24/10) is one of the best ever. It is rewarding to hear of your success in creating such a successful enterprise. You have correctly identified the most important ingredient for success in any business. Treat the subscriber fairly and do a great job for him. I have been a subscriber for several years and a recent PW Alliance convert. I have been following markets for over 30 years and yours is the best by a wide margin..." – Paid-up subscriber Bob R.
Porter comment: Thanks, Bob... I really appreciate your support and recognition. Most people probably don't know (and don't care) how hard I work at my job... and it feels great to know my efforts haven't totally been in vain.
"I gotta ask, what makes you so sure Nicaragua, a poor, communist, country will be safe in the event the US implodes? Hey, you can run but you can't hide from such fallout that would have global consequences. Wouldn't it be wiser to work to make changes to avoid the scenario you describe? Violence is not foreign to Nicaraguans even in their recent history. It has a fiat currency like practically all the rest of the world and debt, and a government aligned with Castro and Chavez who have no compunction of confiscating private property. I am really baffled why you want to flee Amerika for Nikaragua." – Paid-up subscriber Erich
Porter comment: Well... first off, the Nicaraguan government treats me much better. When I step off the plane, they say hello, we're glad you're here. And then they leave me alone.
Also, I have more in common with the Nicaraguan people than I do with most of my fellow Americans. Nicaraguans are incredibly hardworking, charitable, honest, and family-oriented. They still know what matters in life, and they don't expect something for nothing. Too many Americans have forgotten these critical lessons. Believe me... come spend a day walking around Baltimore. Large parts of America have become cesspools of human waste. It's a shame. But that's the way it is.
"While I believe you are right about the shenanigans with Goldman Sachs, I think your prediction that Goldman Sachs people will go to jail is off the mark. Remember you predicted that Steve Jobs would do jail time? You didn't consider that Al Gore was on the board of Apple. Steve Jobs got away with back dated options! A similar situation is present in this case except that it is not Al Gore. The Treasury Dept, the Fed and many other government institutions have been infiltrated by Goldman Sachs people. If an investigation were carried out and it dug deep enough there would be treasury people, congressmen, and senators that would do jail time as well, but it won't happen." – Paid-up subscriber Luis
Porter comment: You might be right... but I still wouldn't want to own shares of Goldman Sachs.
Regards,
Porter Stansberry and Sean Goldsmith
Baltimore, Maryland
February 26, 2010