The S&A Digest: A Rare Bull Market in the Carnage

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

As of 06/21/2013

Last chance on the True Wealth Alliance... Porter called it: Fed rescue... Gross buys Thornburg... Shorting Lehman... The yen vs. the dollar...

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Plus, this year, we're introducing the Partners Letter. In addition to True Wealth and Sjuggerud Confidential, you will receive Steve's market outlook, travel stories, and top three stocks every quarter. The first Partners Letter goes out March 25. And you will receive any new research product Steve develops in the future. We're offering the True Wealth Alliance for $1,200, but only until midnight tonight. To learn more, click here...

 We wrote it. Did you listen?

Sooner or later, the Federal Reserve and the federal government will intervene to stop the cycle of margin calls and falling collateral prices... We might argue about whether or not the government ought to play this role in the market, but we can't argue about whether or not it will intervene. We know it will. And we know how the story will end – the government will end up either buying mortgages via a bailout of Freddie and Fannie or accepting mortgages as collateral for long-term credit via the Federal Reserve.

– March 2008 PSIA

The Federal Reserve announced today it would lend up to $200 billion in Treasuries in exchange for debt, including mortgage-backed securities. The Fed set up the new tool, the Term Securities Lending Facility, to lend Treasuries to banks for 28 days, as opposed to the normal one-day lending period.

 The Fed isn't the only one purchasing discounted paper... Pimco, the world's largest bond fund, bought "hundreds of millions" of dollars of Thornburg Mortgage debt in the past few days. CEO Bill Gross would not say how much Pimco paid, but said it was buying to achieve a 9% to 11% yield "on an average life type of basis," factoring in defaults and losses.

Those losses could be more than anyone imagined. We were shocked by the downward movement in Thornburg, considering the company only holds prime loans. But Gross claimed Thornburg holds subprime assets, "They do have AAA paper, but remember, it's AAA paper that's basically been rated AAA by the services, and we know that it consists of a lot of subprimes and other structures that are trading at 70 to 80 cents on the dollar."

Subprime holdings or not, Gross is already up on his Thornburg bond investment. Shares of Thornburg exploded more than 140% today (from the insolvency-portending price of 71 cents a share) following the Fed's announcement, and on news the company is working with banks to meet its margin calls without dumping assets.

 In the end, the Fed's actions will only prolong and deepen the inevitable pain caused by an enormous financial burden that never should have come into existence. The Fed certainly can't save the economy. It won't even be able to hold back another wave of downgrades. Ratings agencies Standard & Poor's and Moody's have already downgraded almost 10,000 subprime mortgage bonds, but they haven't touched the ABX index, a bundle of AAA securities popular with banks and insurance companies.

A bond sold by Deutsche Bank in May 2006 is rated AAA by Moody's and S&P, even though 43% of the underlying mortgages are delinquent. AAA debt is already selling for as low as 61 cents on the dollar, and a decline to AA could drop the prices to $0.26, according to Credit Suisse. J. Kyle Bass, CEO of Hayman Capital Partners, a Dallas-based hedge fund that is short subprime, estimates most AAA subprime bonds in the ABX indexes will be cut six or seven levels within six weeks.

 Lehman Brothers is the latest Wall Street bank to fall victim to the credit crunch. The largely unscathed Lehman announced it will cut 5% of its global workforce, around 1,400 employees. The bank announces first-quarter earnings next week, and analysts expect $1.5 billion to $3 billion in writedowns.

Last November at the Value Investing Congress in Manhattan, hedge-fund manager David Einhorn gave a detailed presentation on why Lehman would be the next to fall. Much like Goldman Sachs, Lehman held billions in bad paper, and it was a matter of time before it took a hit. Shares are down 30% since Einhorn's presentation.

 Einhorn got Lehman right, but he's still reeling from his position in subprime lender New Century Financial – shares are trading at $0.01. Einhorn's actions are a good lesson: He tried to work on the long side of a subprime operator and got burned badly. Now he's short a big mortgage holder, and he's doing great.

 New highs: Sabine Royalty Trust (SBR), CurrencyShares Japanese Yen (FXY).

 The Fed's actions are the financial equivalent of putting a penny behind a fuse. I've never done that, but I hear it can lead to some interesting results. E-mail your penny-behind-the-fuse stories to feedback@stansberryresearch.com.

 "You know that old saying 'If it sounds too good to be true, it probably is.' Well, all your offers/newsletters sound too good to be true and if I were to invest in each one I'd not need to invest for too long since it all sounds so good. And do you only use one writer? You're newsletters all sound the same and read the same with the same writing style. Just food for thought. Otherwise, keep up the good work!' – Paid-up subscriber Brian Williams

Ferris comment: A couple of weeks ago, someone wrote in to say that Sean and I were lousy writers and Porter was great. Now you're saying we all sound the same. Makes me wonder what you're reading.

 "To show the Freddie Mac chart with a logarithmic value scale is quite misleading. The vertical distance between 20 and 25 is very nearly the same distance as between 55 and 65. This makes the last weeks (end of Feb to date) slump look precipitous. Looking back at mid October, the same amount of movement occurred, it just doesn't look bad because the scale is narrower. And if a 'point' is being made about how rapidly it is falling now, mid November was far worse than what is currently showing for end of Feb/beginning of Mar. I think that to display this kind of information using an irregular scale to emphasize ones contention is rather beneath you, as your stated goal is informing your subscribers, yet this is a form of mis-information." – Paid-up subscriber J. Douglas Holmes

Ferris comment: I certainly won't say you're wrong to point out this sort of thing (if, in fact, your observation is the correct one), but was the implication of the chart approximately right or precisely wrong? I don't know.

 "I prefer bourbons to scotch, and since top-shelf bourbons are usually a fraction of the price of high-end scotches you can enjoy much more of them. If you haven't tried it already, give Booker's a try. It's from the guys over at the Jim Beam Distillery and is excellent. Be careful though, it's bottled straight from the barrel at it's natural proof (120-130 proof). On the other hand if all your customers drank it, there would be far more praise in your mailbox. For a bargain bottle, Evan Williams 12-year single barrel only costs about $25 and very good as well." – Paid-up subscriber Connor

 "All this talk about buying gold coins and bullion, why not just buy the gold ETF and be done with it?" – Paid-up subscriber Roland

Sjuggerud comment: Buying rare coins and buying the gold ETF are two different things entirely... If you want gold, buy the ETF. If you want leverage to gold, buy gold stocks or rare coins. It's a big difference...

Past bull markets in gold tell us that once investors finally believe in gold, you can make many times your money in rare coins and gold stocks. The nice thing about rare coins is, they won't go to zero, like a gold stock could.

Rare coins and gold stocks haven't "done their thing" yet. People don't believe in them yet like they believed in dot-coms in the 2000s or real estate a few years later. If and when that day comes (and it should), the lack of supply of rare coins and gold stocks won't equal the crazy demand that could hit them... which could easily drive them hundreds of percent higher, as we've seen in past gold bull markets.

 "So the S&P 500 is down 6.18% since Brian Heyliger took over the Inside Strategist? What did he do wrong????" – Paid-up subscriber John DeJongh

Heyliger comment: Now my readers will have a better entry price for next week's recommendation.

Regards,

Dan Ferris

Medford, Oregon

March 11, 2008

A Rare Bull Market in the Carnage

By Ian Davis

On September 22, 1985, France, West Germany, Japan, the U.S., and the U.K. all agreed to a radical revaluation of world currencies. On that day, these countries signed the Plaza Accord, stating that they intended to devalue the U.S. dollar in relation to the Japanese yen and the German deutsche mark through intervention in the world currency markets.

Between 1985 and 1987, the yen appreciated by 100% relative to the U.S. dollar. A similar revaluation could happen again soon.

This excerpt comes from a Digest essay I wrote a little more than a year ago. But I didn't pull the trigger on a trade. Despite the Japanese yen being cheap, it was still getting cheaper... and it's never wise to fight the trend.

Today, the financial markets are a very different place.

Since October 9, the S&P 500 has fallen by 18.6%... but the yen is now strengthening.

The yen has risen by 4.9% since June. And it still looks extremely cheap versus the currencies of Japan's major trading partners... except the U.S.

But first let's look at the trade-weighted Japanese yen. The trade-weighted yen is simply a weighted average of the exchange rates between Japan and its major trading partners. The more significant the trading partner, the larger the weighting applied to that exchange rate.

The Japanese Yen May Rise 42%

As you can see, the yen will have to strengthen by an additional 42% before it's considered strong by historical standards. So on a trade-weighted basis, the currency still looks extremely attractive.

Now let's take a look at the exchange rate between the United States and Japan.

The Japanese Yen Doesn't Look as Cheap

Compared to the U.S. Dollar

As you can see, the yen doesn't look as cheap versus the dollar.

In order for the yen and dollar to return to a normal long-term exchange rate, either the yen has to strengthen significantly, or the dollar has to fall significantly.

In actuality, both things have been occurring over the last six months. The yen is up 4.9% versus its major trading partners, and the dollar is down 15.3% versus the yen.

So how much more can the yen appreciate versus the dollar?

I believe it still has a ways to go.

The trade-weighted U.S. dollar is now approaching its weakest level in more than 30 years. And I don't see the dollar strengthening significantly – at least not in the short term. With the liquidity crisis in the U.S. and the Fed slashing interest rates, the dollar is not an attractive investment for foreign money.

As for the yen, I think its bull rally is just getting under way. In this week's Quant Trader, I'm going to show my readers the best way to invest in what is nowadays a rare bull market.

Until next time...

Good investing,

Ian Davis

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