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

An outhouse on a boat?... Stealing kegs, not for the beer... The "paradox of finance"... Big loss for Conoco... Why don't you have "balls"?

I had to look twice... Our summer home is situated on the top of a small rise in the Cumberland Mountains, in Scott County, Tennessee. The house overlooks a river gorge – a river that in the summer is barely navigable by a small canoe. Yet... sitting in our front yard was a 30-foot, blue and white, aluminum pontoon boat... that looked to be about 30 years old. What's this? Even more strangely, a carpenter was at work on the starboard side of the stern of the boat. He was erecting what looked like a vertical wooden coffin.

"Porter... did you see my fishing boat?" my uncle asked me later, clearing up how the boat ended up in the front yard.

"How could I miss it? What's the carpenter doing to it?"

"Oh, that's an outhouse. We're going to cut a half moon in the door, too."

"Mmmn... How do you think the boat is going to float with all that extra weight positioned outside of and on the rear of the starboard pontoon?"

"Well, we thought about that. We figured we'd have to build a live well on the port side of the bow to balance it out."

"How long is all of this going to take?"

Note: We're going to take a few days to enjoy our family, cook a lot of barbecue, and light some deadly incendiaries. We hope you're doing the same. Barring any major event in the market, we'll return to the Digest on Monday. Not that anyone will notice our absence. We can tell by the volume of mail... nobody is reading us this week.

PSIA pick Nokia, through its Nokia Siemens joint venture, landed an $889 million deal with India's largest mobile phone operator, Bharti Airtel. Nokia Siemens will install 1.8 million ports and also set up an international prepaid calling-card service that will help add 4.5 million new customers. To the chagrin (and perhaps even disgust) of my subscribers, I've predicted that Nokia will prove to be a much better investment in wireless communications than Apple – despite the launch of the new iPhone. And, even though Apple's stock has predictably rallied on the overwhelming media hype... Nokia's shares have done even better:

Signs of a top in metals prices... The beer industry expects to lose hundreds of thousands of kegs and tens of millions of dollars this year as customers steal kegs and sell them for scrap metal. The Beer Institute, the industry's main trade group, expects many customers to forego the $10-$30 deposit in order to sell the kegs as scrap for $15-$55. The institute also expects many people to steal kegs from bars and restaurants. Last year, brewers lost $50 million in kegs industrywide.

S&A Oil Report pick ConocoPhillips said it could take many more months to come to terms with the Venezuelan government over compensation for its operations in the Orinoco Valley. The company will likely write off the investment as a $4.5 billion "impairment" in the second quarter. The stock seems unfazed by the news... it's still trading for close to its 52-week high.

Investors in hedge funds, beware. Over the years, we've seen that they can become "roach motels" for capital: Your money can check in, but it can't check out. John Devaney, who invests in subprime mortgage bonds, restricted redemptions for his Horizon Strategy hedge funds to protect them from a firesale. Devaney manages a total of $619 million.

What's happening with the Horizon fund is typical of what I call the "paradox of finance." What often works for a small amount of capital proves to be disastrous when a large amount of capital tries the same thing. In the subprime case, as long as most of the mortgage market was well-disciplined, then you could make a lot of money lending to marginal borrowers on the fringe, because you could hedge with plenty of good borrowers.

But... in 2005 and 2006... subprime lending became the mainstay of the mortgage market. Instead of lending to a few marginal borrowers on the fringe, subprime became the largest single component. The credit quality of the entire industry collapsed – just as a huge wall of money found its way into mortgages. What started out as a good idea turned into a farce... and ended up as a fraud.

Ah... you might say... that's why I only invest in index funds. Doesn't matter. You can't escape the paradox of finance. Any investment idea, no matter how sound, at some point will be ruined if too much capital tries to follow the same strategy.

Index funds were, at one time, a great idea. They allowed you to "piggyback" for free on the handicapping that was done by the majority of other investors, who actively managed their portfolios or who paid for active management. But... as soon as most of the money in the market was "indexed" – which happened in U.S. stocks sometime around 1998 – then you were investing in a farce. If most of the money in the market goes into indexing, then everyone is buying stocks on the basis of market cap (since indexes are normally weighted by market cap). That means most of the money is going into the most expensive stocks... simply because they're the most expensive. Hopefully you can see that the future returns of a strategy that seek to buy the most expensive stocks, purely based on price, aren't likely to be good (and they haven't been).

The fraud stage of indexing is now occurring. Funds that are really actively managed and have high fees and costs have begun to call themselves "index funds." Now folks who think they're indexing, aren't.

How do you avoid the paradox of finance? Well... it's difficult for most people. You have to think for yourself. You have to employ your capacity to reason. And... as I'm sure you know... most people would rather do anything but think for themselves.

New highs: BHP Billiton (BHP), BG Group (BRG), Chevron (CVX), Eni (E), FLIR Systems (FLIR), Petrobras (PBR), Plum Creek (PCL), Southern Copper (PCU), Petro-Canada (PCZ), Royal Dutch Shell (RDS-A), Seabridge Gold (SA), Total (TOT), Taiwan Fund (TWN), CGG Veritas (CGV).

Not much by way of the mailbag last night. Already starting with the celebrations? When you're stuffed with barbecue and beer, send us a line at feedback@stansberryresearch.com.

"I met Cactus many years ago. In fact, he sold a deal to a client of mine (Enserch). I was on the rig floor while we were pulling a DST (Drill Stem Test). Ask him if he remembers getting soaked by the salt water." – Paid-up subscriber Mike (owner of West Texas wellsite)

"You printed a letter from Mike Doyle defending that nice Mr. Jobs and how he works for $1. I know you did it just to annoy us. Jobs was the highest earning CEO in the U.S. last year, with a $630 million bonus. And that's on top of the backdated options." – Paid-up subscriber Barry Hatfield

"Dear Porter, I've written to you about several of the basket cases your recommendations have gotten me into, and now I have one to thank you for... Radio Shack. However, also thanks to your recommendation, I also got in early and lost money initially when I bought and then suffered the large further decline when the CEO was exposed as a liar. The thing that has made this turn out well instead of another loss is that I did not listen to your subsequent recommendation to 'stop out' of RSH. Instead, I bought more stock and long-dated calls. I have done very, very well on both since... more than a triple on many of the calls. Now, since you are grousing about your missing out on the beautiful rebound of RSH... a business you actually thought was a very sound and good one... and the reason the stock went down further was mostly related to executive nonsense instead of a further deterioration in the company's actual business, why didn't you have the balls to stay with your recommendation and keep your readers in so that they could have made large profits instead of taking losses and also missing more gains on the way back up? I know you have your 'stop out' rules... but really they are silly when they cause you to recommend your readers to do stupid things. Sometimes I thank god for these types of nonsense 'rules' because when I do not employ them mechanically... as you do... I almost always make much, much more than when I adhere blindly to them!" – Paid-up subscriber SC

Porter comment: Yes... well... thanks for pointing that out... I wouldn't have noticed it on my own... As for our stop loss and our trailing stop loss rules, they aren't in place to optimize the return of any given investment. We use these "silly" guidelines to prevent the possibility of a catastrophic loss. Maybe there were things we didn't (and couldn't) have known about RadioShack. Maybe the CEO hadn't only lied about his resume… maybe he'd also cooked the books. In retrospect it's easy to see our rules prevented us from making gains - in this case. But… what if RadioShack had gone the other way? We know from experience this can happen. Opportunity is infinite. Capital is finite. It only takes one catastrophic loss to destroy an entire portfolio's gains for the year. Our rules are designed to optimize portfolio results by avoiding catastrophic losses.

Also, you might ask the millions of investors who were wiped out in 2001 if they wished they'd kept protective stops on their retirement portfolio positions.

Regards,

Porter Stansberry

Scott County, Tennessee

July 3, 2007

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