The S&A Digest: Ethanol Is Now Cheaper Than Gasoline

Ian on ethanol... Did I hear banjos?... Big J&J buyback... Rob scores with Alnylam... IEA leaning toward "peak oil"... Tax advice?... Seabridge update...

The paved county road ended about a mile before the property line. A dirt track took its place and led into what looked like a junkyard. A rusting front loader was growing out of the weeds. Tires, aluminum cans, and scrap pieces of plywood decorated the yard.

"Cal owns this parcel... but he don't mind ya comin' through here to git to your land... and... well... I hate to say it... but I'mah little worried 'bout ole Cal... He done got a rupture. An he won't go to tha doctor, 'cause he's 'fraid they'll put 'im in tha home... I toll em, 'Cal, ya done gotta git to tha doctor, otherwise it's only gonna git worse.' Anyhow, he won't do nothin' 'cause his sister is already in the home and he's 'fraid he's next... He and his sister done lived in that trailer together for 50 years... They ain't got no kids."

I thought the banjos would start dueling at any moment. I decided not to get out of the truck.

What do financial analysts do when they're on vacation in rural Tennessee? Look at investment real estate, of course. In rural Appalachian counties, you can buy land for around $1,500 an acre. Buy the right pieces, and you can get a fair amount of income from natural gas leases and timber. Build a house near one of the springs, and you'll have a totally self-contained property. With 300 pounds of pressure on some of these gas wells, you've got all the energy you'll ever need to heat and cool your house and run everything inside it. Plus, you'll live near some very interesting people...

We wrote it, did you buy it?

During the last four quarters, J&J has bought back just under $900 million worth of shares. And the buyback will almost certainly increase: On March 6 of this year, J&J's board approved a $5 billion repurchase program.

– Porter Stansberry's Investment Advisory, July 2006

Today, Johnson & Johnson (JNJ) announced a $10 billion share repurchase. The buyback accounts for 5.5% of the company's market cap. The company will fund the repurchases with available cash and debt, and expects to maintain its AAA credit rating. Shares gained more than 1.5% on the news.

S&A Oil Report pick ConocoPhillips (COP) also announced a buyback today. The company plans to repurchase $15 billion of stock – 11% of the shares outstanding – through the end of 2008. Shares of the oil giant are up more than 4% today. Readers have made 30% on the recommendation. Maybe COP sees this purchase, an all-time high, as a bargain.

In early 2006, when Rob Fannon took over as our chief biotech analyst, he maintained coverage on only two stocks in the previous Diligence portfolio – Sirna and Alnylam. Both companies were developing RNA interference technology, a whole new class of drug targets.

In October, Merck announced it would buy Sirna, paying a 100% premium to the share price and netting our subscribers a 203% gain in slightly more than a year. Merck's investment was a confirmation of the technology... as Rob wrote:

In the end, Alnylam is a pure intellectual-property play. The company owns the lion's share of RNAi-related patents... A $1 billion payout equals a $31 share price. We're assuming a 50% premium should an acquisition occur – so our target price is $20.50 per share.

Today, Roche announced it's entering into a major development and licensing deal with Alnylam, valued at... just as Rob said it would be... $1 billion. The stock is now trading for $23, a little more than Rob's target price. Readers who bought the shares on our original recommendation made more than 60%.

Goldman Sachs upgraded Extreme Value pick Home Depot (HD) from neutral to buy. The bank said this is a longer-term upgrade, as the retailer faces ongoing problems from the sluggish housing market. Shares of Home Depot gained nearly 2% in pre-market... and gave it all back before close.

Oil demand will grow 2.2% a year between 2007 and 2012, outpacing production, according to the International Energy Agency's newly released oil market report. This forecast is up from a 2% estimate in February. The group also flirted with the idea of "peak oil," stating that production in non-OPEC areas will fall. All we need now for oil prices to crash is for pension funds to change their charters, allowing them to invest in commodities...

PSIA pick Intel (INTC) will buy $218.5 million worth of VMware, a division of data storage company EMC Corp., at $23 per share. EMC today registered its planned IPO of 33 million VMware shares at an estimated $23 to $25. I'm sure VMware will be a "hot" IPO. But I'd much rather own it through shares of INTC than try to buy it the first few days it trades on the open market.

Credit Suisse released a rosier-than-most report on industrywide subprime mortgage losses. The investment bank says the industry's losses should "only" equal $52 billion. Deutsche Bank has guessed $90 billion. PIMCO has estimated total losses of $75 billion. Assuming the Swiss bankers are right, that's about four years of peak earnings for the largest mortgage company (Countrywide Financial). If things don't get worse than this, then I doubt the subprime debacle will hurt the credit markets anymore than it already has.

Last Thursday, GM announced that June U.S. car sales declined 22% and truck sales declined 25%. Wall Street analysts, who have been bullish on the stock in hopes of a new deal with the union, said they were surprised that Toyota was lowering prices. (What a shock!) They say sales will soon rebound. They'd better. GM owes Wall Street's banks more than $40 billion.

New highs: AngloAmerican (AAUK), BHP Billiton (BHP), ConocoPhillips (COP), Chevron (CVX), Eni (E), Freeport McMoRan (FCX), Intel (INTC), Manpower (MAN), Occidental Petroleum (OXY), Petrobras (PBR), Plum Creek (PCL), Southern Copper (PCU), PetroCanada (PCZ), Posco (PKX), PetroChina (PTR), Royal Dutch Shell (RDS-A), Seabridge Gold (SA), ExxonMobil (XOM).

The mail piled up during our three-day break from the Digest. The holiday seemed to have mellowed our readers, too. Hopefully the summer heat wave will inspire some venom. What's got you steaming mad at us? Let us know: feedback@stansberryresearch.com.

"I read with interest your reply to 'SC' who said your 'stop-loss' method was 'silly' and you could do better by sticking to your original recommendations... even doubling and tripling up as the stock continued to go down. You were right on with your reply. No telling how many investors lost 80% or more during the dot-com bust. I employed SC's plan with K-Mart a few years back. My daughter was working there, and it had been around since I could remember. I owned some stock – stock kept slipping. Some market 'pundits' said don't panic and follow the crowd, buy more stock and it will turn around. That's what I did on several occasions. We all know what happened, and the stock ended up worthless. This one expensive lesson more than wiped my gains from several other transactions. So give me Porter's 25% loss anytime." – Paid-up subscriber John

Porter comment: Investors can deal with risk in several different ways. We know that a mechanical 25% stop loss (or trailing stop loss) system isn't perfect, and we modify it in several of our letters and in certain situations. However, it is a great place to start if you're a new investor. We write about stop losses because they set the stage for the most important lesson of all: If you want to make money as an investor, first you must learn how to avoid losing it.

"I am a long-time paid-up Alliance member and have no intention of ever(!) canceling my subscription. I absolutely love the information and diversification you provide to your Alliance members, as well as each individual service. I have been particularly interested in the various 'retirement' research reports that have been produced, i.e.: Twelve Stocks to Retire With, America's Secret Investment Societies, The 801(k) Retirement Plans, MLPs – A Great Way to Supplement Your Retirement Income, etc. I'm looking to diversify my holdings in both IRA and non-IRA accounts with various stocks recommended in these reports and was wondering if you would be able to comment on which stocks within these reports would best be held in an IRA or non-IRA account and why. Or, in future reports, could you include this type of comment after the mentioned stocks? I know it would be very helpful to me. Thank you for an excellent service. I am sometimes appalled at the brutal and inappropriate comments you receive, but I have to laugh, because obviously they just don't know a good service when they subscribe to one." – Paid-up subscriber Jeri P.

Porter comment: We don't seek to provide subscribers with tax advice or other types of individual retirement planning. That information goes well beyond the scope of our service. There are several reasons for this – it's complex, it depends on your individual circumstances, and, most importantly, it's not what we're trained to do. We're securities analysts. Sit down with a CPA or a good financial planner once a year. It doesn't cost that much, and this kind of personal advice is usually worth a lot more than you pay for it.

"I really enjoyed your spiel on the 'paradox of finance.' I have always thought that someday the overall stock market would too suffer the same end result. It seems to me that 20-30 years ago, the average Joe didn't buy stocks or own mutual funds, but now every Joe has a 401K portfolio, mainly invested in stocks by the way of mutual funds. It has always seemed to me that the market is one giant pyramid scheme that unfortunately, you must engage in and hope to get out before the collapse... Do you see any reasoning to this, or did I engage too heavily in 'paranoia enhancing practices' in my college years? Thanks for the great publications and the brain-stimulating commentary." – Paid-up subscriber Jeff Meyer

Porter comment: I sympathize with your logic, but, no, I don't agree that stocks as an asset class are a pyramid scheme. Strategies that many people follow and wildly popular market sectors, like tech in 2000, certainly take on ponzi-like characteristics. But... stocks are merely a form of ownership. Assuming the price is right and the legal framework robust, I see nothing inherently wrong with a large market for public equities and the public's ownership. Buying great businesses at a fair price is never a bad idea.

"Seabridge Gold continues to boggle my mind. I didn't get in earlier when it was ripe but it seems there's no stop in sight? Is it still a smart play for the mid-term outlook?" – Paid-up subscriber JH

Porter comment: See the last two issues of Sjuggerud Confidential. Steve has extensively updated his research on Seabridge.

"I have worked in the residential construction market in middle Tennessee for many years and do not wish to give a dissertation on the market, but I read with amusement in the new Sjuggerud Confidential, the topic 'Real Estate Is Starting to Crack... Residential housing has been falling apart since shares of homebuilders peaked in the summer of 2005.' Further into the newsletter, it states: "Residential real estate peaked in the summer of 2005 and has been weakening since." I am further amused by many in the investment community looking for any reason to jump back on the homebuilder bandwagon.

"I can give you a very simple way to gauge when to buy homebuilders. It is called The NAHB/Wells Fargo Housing Market Index. Quite simply, when the index is above 50, things are good and when the index is below 50, not so good. Right on cue, June 2005 was the peak, and we have pretty much been in decline ever since. I can assure you that a graph of my sales, delayed three months, would replicate the ups and downs of the index." – Paid-up subscriber JG Dorris

"Porter, Last night I was reading one of your letters and noticed a subscription to a options service for Jeff Clark. At first I didn't know it was from Jan. [2007], six months ago, and as I read it, I knew I wanted in. $2,000 is a lot of money, but that service seemed almost too good to be true. Anyway, as I usually do before going off the high dive, I went back to see how deep the water is and discovered that the letter was put out six months ago. Is there anyway I can find out how well it has performed, and if I were to want in at this time, would it be possible? I hope your summer break was good for you and look forward to an email." – Paid-up subscriber Jack Noble

Porter comment: Jeff's track record is highly variable – as you would expect. Options tend to hit it big... or whiff. On average, though, Jeff does very, very well. Last year, his average recommendation earned 22%. So far this year, his average is 15% – which is pretty darn good for half the year.

"Well, Porter, just a quick note here to wish you and your family a happy 4th. We are having a big Texas cookout, and my kids just keep inviting more people. Hope I have enough food!! Ha!" – Paid-up subscriber Sharen Kirkham

"I wanted to follow some tips from the S&A Penny Letter, but found a problem: For my orders, my bank in Europe needs the ISIN code of the company, the symbol only is not enough in Europe... My question: Is there a simple way to find those ISIN codes, starting from the symbols?" – Paid-up subscriber Jean Bringer

Sjuggerud comment: CUSIPs are easy to come by. Add a few digits and you get the ISIN. Here's how: A bit of work, but it gets the job done.

"PORTER! – The latest Digest has forced me to pen, on the 4th of July no less, yet another awful piece of doggerel from my peaceful lair in Sydney (which is a nice place for a Michigander, even in the southern winter... and they BBQ here like madmen by the way).

"We wonder at the wit, Sardonic,

But please! The Paradox? Ironic!

Subscriptions sell, capital builds well,

Twisted wit? Or j us t th e G i n & T on i c?

"(OK, yes that's an e.e. cummings twist there..)" – Paid-up subscriber DC Williams

Regards,

Porter Stansberry

Ethanol Is Now Cheaper Than Gasoline

By Ian Davis

The price of corn is plummeting... It has fallen 23% in just the last month.

In last week's Digest, I showed that corn prices are increasingly correlated with the price of crude oil. Lately, this relationship has fallen out of whack as corn prices drop, despite the continuing rise in oil.

I believe the relationship will eventually restore itself... However, in the meantime, a bumper year in corn is spelling good times for the ethanol industry.

According to Bloomberg, "Ethanol tumbled 43 percent in the past 12 months, making the corn-based fuel additive cheaper than gasoline for the first time in two years. The difference in price will persist through 2007, spurring ethanol sales as oil refiners use it to stretch fuel supplies."

The following chart shows the steep decline in the price of corn that occurred in June. The cause of this fall is partly due to the volume of corn being planted. American farmers planted more corn this year than any other time since World War II.

Corn Prices Have Fallen Dramatically

The next chart shows the price of ethanol compared to unleaded gasoline. For the first time in years, ethanol has become cheaper than gasoline. This is good news for companies like Archer Daniels Midland (ADM), the largest U.S. producer of ethanol, which has seen its stock price spike by about 5% in the last two days.

Ethanol Is Now Cheaper Than Gasoline

Conclusion

As long as corn is cheap relative to crude oil, ethanol will remain an attractive alternative for motorists interested in trying to save the planet... and profits for companies like Archer Daniels Midland (NYSE: ADM), Verasun (NYSE: VSE), and Aventine (NYSE: AVR) should continue to rise. Currently, these companies' profits are slated to rise by 46% next year.

Good investing,

Ian Davis

July 9, 2007

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