The S&A Digest

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 06/27/2013

A man with a gun... How I met the Rockefellers... Record short interest... How to buy Canadian stocks... Update from Ireland... Honest and fair?...

"Mike... how in the world did you play two of these courses in one day?" I was pulling my golf bag up a giant sand dune... looking for yet another lost golf ball. The world had turned green around me, except for the ocean to my right. Despite the fact that it was after 9 p.m., the sun was shining, albeit weakly, through the permanently overcast Irish skies. We were playing our first links course – the first I'd ever seen up close. Mike Palmer – who literally wrote the book on Irish golf courses – told us this course, Strandhill, would be the easiest to play. So despite being severely jet lagged and sleep deprived, we all lined up on the first tee.

That was five hours ago. Eight golf balls poorer and nearly 100 shots later, I wondered aloud how Mike had played 44 of these obscenely difficult golf courses in only four weeks, during his book research trip. Nothing in the United States is like the rough on an Irish links course. It's not only deep, but steep. Each fairway is bracketed by sand dunes, some 40 feet tall. Any ball hit off of the fairway has a 50% chance of being lost. Combine that kind of rough, with hilly fairways and elevated greens that are as hard and fast as Teflon... and even fairly good golfers will shoot above 100. I am not even a fairly good golfer... and after walking my first course, which featured something like 5,000 feet of elevation changes... I wonder if am going to be a golfer at all by the end of this trip.

True Wealth pick BHP Billiton (BHP) is believed to be evaluating a $40 billion bid for Alcoa, though BHP Billiton has not formally contacted the aluminum maker. This would be the second transaction involving Alcoa in the past two months, as the company made an unsuccessful $27 billion bid for Alcan. Neither company commented on the matter, but shares of both gained on the news.

A new bidder may have emerged for Dow Jones (DJ)... General Electric (GE) and Pearson (PSO) may launch a bid to rival that of News Corp. The companies, which own CNBC and the Financial Times, respectively, would be a better journalistic fit for The Wall Street Journal publisher. Under the structure of their bid, the Bancroft family, which now controls Dow Jones, would keep up to a 20% stake in the company.

Nobody likes a bearish mentality... At least that's what Wall Street bigwigs have been telling their analysts throughout the years. "Sell" ratings scare off potential customers, and the big banks want as much business as possible. However, it seems the Street is changing its opinion. "Hold" recommendations outnumbered the buys as a percentage of total U.S. stock picks for the first time ever in February. Also, short-selling has reached its highest level since at least 1931 – 3.1% of listed NYSE stocks. The tendency for Wall Street to convey bearish sentiment seems to be paying off. At the last market peak in 2000, only two of the big 10 banks produced S&P-beating returns. Now there are nine.

New highs: Nokia (NOK), Intel (INTC), Plum Creek (PCL), Petro-Canada (PCZ), Posco (PKX), BG Group (BRG), KHD Humboldt Wedag (KHD), Grey Wolf (GW).

I can't promise to offend and enrage you like Porter does... but I'll try. Give us your antiphons at feedback@stansberryresearch.com. We read them all.

"Loved your story on David Rockefeller... and I'm not surprised. I didn't know David very well, but I was part of Nelson's political entourage in the 1960s and 70s. My wife and I had many wonderful evenings of delight in his home, at special functions at the Waldorf Astoria, and at his office on 55th Street in Manhattan. On our first visit to Nelson's home in Pocantico Hills, we mistakenly stopped at David's home, which was on the road leading to Nelson's, believing it to be Nelson's. We were greeted by David at the door, who very graciously accepted our apology and proceeded to provide directions to his brother's home. David and especially Nelson were VERY friendly, down-to-earth gentlemen who regarded everyone as equals and thrust themselves into life with gusto. I accompanied him on many of the political junkets and speeches throughout the state and the country when he was a national figure. Nelson had quite a large collection of fine art in the private gallery under his home and many sculptures in the surrounding gardens. He had a Polynesian room built overlooking the hills of the estate containing the many artifacts sent from his son who disappeared somewhere in the Pacific Rim. We have many fond memories of our association with him and his associates." – Paid-up subscriber DJ

"Porter, Re Larry Herbst complaint on Canadian stocks, I was able to purchase them all on U.S. exchanges. My broker at Ameritrade could purchase them on the Toronto exchange, but he told me they had U.S. symbols. I have forgotten how he told me to find them but tell Larry to Google "Stock Symbols." On the moneycentral link, type the company name with United States as the country. They all have five-letter codes with the first three letters the same as Toronto. I did have to go to the Toronto exchange website to get the prices. I multiply their price by .94 and round up to get an approximate US dollar equivalent. With limit orders, they were all executed over a three-day period." – Paid-up subscriber David Bisson

"I was wondering why some of the stocks that you recommend with the dots and dashes ... come back as an unknown symbol [when I try to look up the price]. Can you explain this to some of your subscribers?" – Paid-up subscriber Steve Hunter

Goldsmith comment: Dashes in a stock symbol usually signify a classification of stock. For example, Berkshire Hathaway sells A shares (BRK-A) and B shares (BRK-B). Periods are usually followed by a stock exchange. For example, you may see a ticker followed by ".TSX," which means it is traded on the Toronto Stock Exchange. You may also see ".OB" or ".PK," which signify stocks traded over-the-counter or on the pink sheets.

"I've enjoyed your newsletters, just wish I had access to this kind of information much earlier in my 'career.' My favorite is anything Dan Ferris writes. I never would have received it had I not signed up for Alliance. I've purchased Automatic Wealth for Grads for my H.S. graduate, but wish there was some ... type of investment advice newsletter you would provide via e-mail for the 18-25 age group. Something that would teach them about options, stocks, bonds, and basic financial advice." – Paid-up subscriber SJH

Goldsmith comment: I think you're on the right track. My brother just graduated high school and I got him a signed copy of Mohnish Pabrai's

The Dhandho Investor. It's a great book. In fact, Porter ranked it No. 4 on his top-10 list of investing books. Also, we've got an investor education program in the works...

"'[R]esearching the economics of the golf industry.' Gosh, I'll bet you'll be making 18 or more likely 19 stops every day! And how come poor Goldsmith gets shafted? Doesn't he play? Your verbiage also would indicate you are making this trip a tax write-off as well. Let's see, idyllic trip to Ireland, round after round of golf, large tax write-off, someone else doing the work, hmm, can I come with you next year?" – Paid-up subscriber Frank Cannella

Goldsmith comment: Actually, Frank, I'm the only guy from Augusta, Georgia, who doesn't play golf. It's almost sacrilegious.

"Rain every day for your golf week; the Global Warming Gods have gotten the last laugh. Couldn't happen to a nicer guy!" – Paid-up subscriber Tim Nealon

"In response to your question about Fidelity... I've been with Fidelity since 1978. They are indeed a good firm, and I'm very happy with them. At my usage level, commissions are only $8, which I basically ignore. They almost always answer the phone immediately and are all-around helpful almost all the time. However I do everything online, and [the] site is fast, logical, and useful. My only beef is that the low commissions do not apply on stocks less than $1, which applies to many junior mining stocks. My Toronto purchases are always via the pink sheet (five-character) equivalent, and I've been satisfied with the executions for these. Direct purchases on a foreign exchange would indeed be $50, which is not really too bad unless the holding is small or you trade a lot." – Paid-up subscriber J McDonald

"I started subscribing in the old Pirate days with just True Wealth, mostly because of the 1-2-3 analysis, but also because I firmly believe in a stop loss and an exit strategy. Steve provided that with the 25% stop loss on most things. Then I expanded to Extreme Value because I wanted to learn how to find stocks like Graham/Dodd/Buffett. Now I take the attitude that I run my own investment business. It is my job to decide which stocks to buy, how much to buy, and when to buy. I don't have the time, expertise, contacts, etc. to do the research that you guys can do. So I hired my own R&D team to do it for me. YOU. The most economical way to do that was [through] the full Alliance membership... I get all you publish forever, so don't ever disband the 'team.' All the negative, nonsense, feedback [in the Digest] about, 'I'm dropping my subscription because of this that or the other thing' ... is from folks that just don't get it. But I suspect you already know that. I also appreciate your candid comments about how the newsletter business works... That info helps me keep my R&D team's recommendations in perspective. Ultimately, I am responsible for what I buy, when I buy it, at what price, when I sell, etc. I use your valuable input and don't expect you to be right all the time, no one has a crystal ball. But you guys can certainly shove the odds in my favor." – Paid-up subscriber Greg D.

Porter comment: Thanks for your business, your trust... and your appreciation. We'll do our best to keep earning it.

"Dammit, I've been a card-carrying gay man since I came out 24 years ago. Why haven't I ever received my copy of the agenda? What does the socialist, tyrannical, meddling scumbag George Soros know that I don't know about this supposed agenda? Oh well, I probably don't need the agenda because I'm sure I won't be invited to the meeting. This particular gay man is a hardcore, gun toting, unapologetic libertarian, objectivist, and capitalist. And who says Soros is gay? I checked the double-super-secret registry, and I didn't see his name." – Paid-up subscriber Ken

"OK, this is ridiculous. I can't stand it that you keep getting lambasted for quoting George Soros, "the homosexual agenda promoter." As probably your only Pro-Life Catholic Democrat Lesbian Trial Lawyer Paid-Up Subscriber, I would like to ask: Do all of your subscribers forget your opinions of Barney Frank? I seem to remember several e-mails that basically called you a homophobe just a few months ago, which forced me to go back and examine your original words on the subject to see if I could continue supporting you... obviously, I concluded that your opinions were based on something other than hatred or fear or stupidity, so I will stick with you, you Libertarian Chip on Your Shoulder Man." – Paid-up subscriber Julia

"Sorry to disappoint you, this isn't going to be a rant about you or your company. When I first read your 'politically incorrect' missives in the S&A Digest, I considered calling and canceling my subscription to True Wealth.... but as I read more, I have to admit that I have gotten hooked. Your position against backdating options won me over. I want someone on my side that has a sense of honesty and fairness. I now look forward to every issue of the S&A Digest and will renew in a large part because I don't want to be without your entertaining and informative e-mail (Steve's investment ideas are also first rate). Please keep up the good work." – Paid-up subscriber Chuck Vaniman

Where Crude Leads, Natural Gas Follows

By Ian Davis

On January 1, 1999, an investor could have bought crude oil for just $12 a barrel. Two years later, he could have sold that barrel at almost $27, a rise of 122.7%.

However, another energy investment would have made even more money.

If you had invested in natural gas instead of crude oil, your investment would have grown by an impressive 439.4%.

The price of natural gas almost always tracks the price of crude oil.

Research from the federal Energy Information Administration shows that, statistically, a change in the price of crude oil leads to a comparable change in the price of natural gas, all else being equal.

According to the paper:

A significant stable relationship between the two price series is identified. Oil prices are found to influence the long-run development of natural gas prices, but are not influenced by them.

Competition between the two energy sources causes the correlation.

On the demand side, EIA notes that roughly 18% of natural gas usage can be switched to petroleum products. So when the cost of crude oil is very low, natural gas usage decreases as users switch to the cheaper petroleum alternative.

On the supply side, EIA found:

Natural gas and crude oil operators compete for similar economic resources such as labor and drilling rigs. An increase in the price of oil would lead to higher levels of drilling or production activities as operators explored for and developed oil prospects at a higher rate.

In other words, when the price of crude oil rises, the demand for labor and drilling rigs also rises (as oil companies seek to increase their production, and new oil projects become economically feasible). This bids up the cost of labor and equipment, affecting both natural gas and oil companies.

The reason the crude oil price affects the price of natural gas, but not vice-versa, is the difference in size between the two markets.

The global crude oil market is vastly larger than the global natural gas market, which simply is not big enough to influence the global price of oil, though this may change at some point in the future.

The following chart shows the relationship between natural gas and crude oil since 1994.

Natural Gas is Correlated to Crude Oil

Buy Gas When It's Cheap Relative to Oil

So how does the relationship between natural gas and oil help us make money?

Well, since natural gas and crude oil should have a stable relationship, one profitable trading strategy would be to invest in natural gas when it is cheap compared to crude oil and hold it until things get back to normal.

When natural gas is cheap compared to oil, the energy generators that can convert to natural gas from crude oil do so – increasing the demand for natural gas. Also, the high cost of crude oil will drive up the cost of labor and drill rigs, tightening the supply of natural gas.

Inevitably, rising demand and shrinking supply lead to an increase in the price of natural gas.

The following chart shows the price of natural gas compared to the ratio of gas to crude oil. The lower the ratio, the cheaper natural gas is in relation to crude oil. Conversely, the ratio increases when natural gas gets more expensive relative to crude oil.

Buy Natural Gas When It's Cheap Compared To Oil

If you bought the natural gas index when it was cheap (below five on the previous chart) and held until it became expensive relative to oil (above eight on the previous chart), then you placed the following trades:

This trading strategy would have put you in the market for 3.7 years and returned an annualized 73.88% (neglecting tax and fees). You would have experienced a drawdown of 43.4% as opposed to a buy-and-hold drawdown of 79.7%.

Conclusion

Currently, the ratio of natural gas prices to crude oil is 5.55, so it is too early to place a new trade based on this strategy. However, if we had been following this strategy for the previous couple of years, we would have entered a trade in March 2006. Since then, the natural gas index has risen by 19.2%.

When it comes time to place a new trade based on this strategy I will alert readers of my weekly trading service, the Quant Trader. Although we can't invest directly in the natural gas index, a simple alternative would be to invest in a natural gas ETF, such as The United States Natural Gas Fund (UNG).

You could also juice your returns with call options on a company with heavy natural gas exposure, like EnCana (ECA).

Like I said, this is not the time to enter an oil patch trade. But when the gas-to-oil ratio swings in our favor, I'll alert Quant Trader readers to the best way to play it.

Good investing,

Ian Davis

June 18, 2007

Stansberry & Associates Top 10 Open Recommendations

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