The S&A Digest: Is the Management Worth Its Salt?

Baltimore in spring... The subprime mess gets bigger still... Value buyers move into real estate... Weber on a possible pullback in precious metals... How much cash should you hold?... Dansker, again... Experienced management...

Ah, springtime in the big city. The cherry trees are beginning to bloom... and the police academy is getting ready for graduation.

The trainees jog past my office window, which looks out over St. Paul Street to the beautiful, stately townhomes of Baltimore's Mt. Vernon neighborhood. I saw the recruits today for the first time this year. They wear blue champion shorts and white T-shirts. The guys are in good shape – they haven't yet spent years sitting in squad cars eating fast food. They seem to run effortlessly. They are all young and all black, which isn't unusual. What was strange was that about half of them were jogging backward and most of them were shouting... loudly. What were they shouting about?

Trailing about 100 yards behind the main group of young men were about half a dozen obese, young black women. Oh, those poor ladies. While some women may be able to physically compete with men in jobs like a city cop... these ladies were not the ones. And although the matter seemed clear enough, the guys made sure they knew it. Nothing like watching our tax dollars at work.

As Yogi Berra put it, it's tough to make predictions, especially about the future. We have noticed every prediction of losses from the subprime fiasco is getting larger. Goldman Sachs analysts now predict $460 billion in total losses – almost four times the already disclosed amount. They estimate residential mortgage losses will account for half the total, and commercial mortgages around 20%.

Though losses may continue rolling in, one of the premiere value hedge funds dove into real estate this quarter. The $9 billion Lone Pine Capital disclosed a 6.6% stake in commercial real estate company CB Richard Ellis Group. The fund bought 13.24 million shares and is now CB Richard Ellis' fourth-largest shareholder. Lone Pine is an interesting group to watch because the manager runs an extremely selective and concentrated portfolio. The fund's top-five holdings constitute 40% of its assets.

Our friend Chris Weber on why gold and silver are due for a pullback:

When you hear of metals detectors by Florida beach communities being sold out to people wanting to find Spanish gold in the sand; when you hear of people bringing their gold jewelry into pawn shops to cash in on the high gold price... that's the sign that things are about to cool down. It's been almost exhausting to watch the gold and silver prices rise without interruption over these past six months or so. It would not surprise me to see now beginning a correction that may be long and even violent. That in fact would be in the normal course of things. People who'd waited to buy until just recently will panic and sell. That's normal too. The precious metals market needs a rest, and I think it'll get it. Let's see how far down it goes. There may be some good opportunities to come.

To read more about Chris, click here...

New highs: none.

In the mailbag, Dansker is back. This time, rather than insulting or threatening us, he's complaining about our bad manners. Remember, we promise to read whatever you send us: feedback@stansberryresearch.com.

"I want to thank you for teaching me so much about investing. However, I think I've figured out a couple things that you have not explicitly stated. 1. To be a great investor, you should hold at least 25% of your capital in cash waiting for the best opportunities. You guys don't seem to stress that in your asset allocation or position sizing. 2. The portfolios of the best value investors of our time averaged 12%-25% and they all held a lot of cash. Therefore, there actual positions/holdings averaged much better than that. So our goal for each position should really be much better than 12%-25% and practice extreme patience holding cash, waiting for the best opportunities. 3. You should not be fully invested all the time if you want to make big money. Do I have it right?" – Paid-up subscriber Matt Oswald

Porter comment: You've got to remember one thing about mutual funds and mutual-fund managers: Mutual-fund shareholders always redeem (sell) at the worst possible time. Thus, fund managers who want to hold securities through down markets (like the value guys) must have enough ready cash to meet demands for redemptions without resorting to liquidating their positions. That's the real reason value managers hold so much cash. That's not the most efficient way to manage your own account, and it's not the way they'd choose to manage their funds... It's a penalty they pay for being public mutual-fund managers. (And it's yet another reason you should almost never invest in a mutual fund.)

Now... to answer your question about how much cash you should hold... I can't give personalized investment advice, and there's no single right answer to this question. It simply depends on your situation and your goals. Consider my situation, for example. I have one tremendous advantage over most of my peers: I'm still relatively young (35). Because I have a 30-year time horizon, I'm unlikely to outperform long-term compounding investments with trading or market timing. Additionally, because I am still working and earning income, I am able to contribute substantially more capital each year to my investment account. It makes sense for me to be fully invested, all the time.

On the other hand, most of our subscribers are retired, most of them have relatively short time horizons, and most of them must generate income from their accounts. For these subscribers, it makes more sense to remain mostly in cash and safe fixed-income securities, except when the stock market provides truly exceptional and very safe opportunities.

"They haven't replaced the light bulbs on the outdoor signage at my local Corus Bank branch in a couple months. Hmmm..." – Paid-up subscriber R.B.

Porter comment: Interestingly, the Wall Street Journal just picked up on the Corus story. See today's WSJ, C1. The Journal's reporting is more detailed than what I wrote, but it missed one critical detail. In the past, Corus has always insisted on paying its loan officers their bonuses after the condo construction loan was repaid – which typically takes about four years. But... late last year... the company changed this policy and paid out the bonuses for all of the loans it made in Miami over the last few years – most of which are likely to end up in default. Pay the executives before the ship sinks...

"Porter, you disappoint me. Not only that you agree with the nosy 'elegant' jerk who 'withheld' the names of 'these fools' who cancel trial subscriptions (B.T.W. how did he get those names in the first place?), you are threatening your subscribers... On one hand you welcome trial subscriptions as a part of your ad – otherwise it is hard to sell - on the other hand you 'keep tabs on those customers'. Sounds like 'Freedom! But the Big Brother is watching you and eventually may punish'. Would you like to tap into those customers' phone lines and emails to check if they are sharing 'stolen' ticker symbols with their friends? Once I wrote to you about your hypocrisy. So far you have not dissuaded me from this thought..." – Paid-up subscriber Alex K.

Porter comment: Uh... what Digest are you reading? You've turned my actual reply upside down. I strongly disagreed with the subscriber who recommended we end our no-questions-asked refund policy. I explained that while we do encounter some folks who will routinely take advantage of our offers (by subscribing and then canceling, repeatedly, to the same newsletters), this small subset of what we call "professional refunders" is easy to manage. On the whole, we know most people are honest and it's impossible to please everyone, all the time. Thus, we have no problem refunding our subscribers, whenever they ask, and parting as friends.

"Steve is off to a great start with his new Partners Letter. The first issue managed to match (in timing) and beat (in implication) the Wall Street Journal, which featured a story on the 10-year stock stalemate this morning. I suspect Steve didn't need a gaggle of editorial assistants and a New York skyscraper to put his article together. He deserves an oceanfront house..." – Editorial Review Board Member Larry Honig

Porter comment: Over the last decade, Sjuggerud has become one of the most widely respected investment advisors in the world. Having him on our staff is a tremendous honor. And I think you're right. His latest effort (available only to lifetime subscribers) is his best yet.

"'We think it's a smart policy to part as friends, no matter what the dispute, for a simple reason: That's how we'd like to be treated, if our roles were reversed.' Touche, monsieur pussycat. I sent you a serious invitation to join our group at a poker party held monthly amongst us consultants, and I was completely ignored. I also sent you a picture of a part of my family to show you that this 66 year old was 'real'. I would have expected at least a polite reply. I didn't do so well earlier this month, losing a little over $20. Bad cards & over-enthusiasm. The invitation still holds. I'll send you another invitation & see if you'll respond. We really don't bite. All of us have advanced degrees, are deeply committed to the defense of the good ol' USA, have impeccable resumes, and are nice guys. We'd enjoy your company and you'd get an impression that we conservatives are really not all that bad." – Paid-up subscriber Steve Dansker

Porter comment: Dansker, in the words of a country song and Warren Buffett, "When the phone don't ring, you'll know it's me calling." My offer is only to part as friends.

Regards,

Porter Stansberry

Baltimore, Maryland

March 26, 2008

Is the Management Worth Its Salt?

By Dr. George Huang, editor, The S&A FDA Report

Today we touch upon the fourth and final criterion in our FDA Report trading strategy. In the preceding essays, we've highlighted the first three requirements:

Now, I'll highlight the last question we ask ourselves before diving into a trade:

Past trades that fit all four FDA Report criteria have generated about 75% return in one year, handily beating the market. But this final part of our trading strategy is perhaps the most difficult to measure...

It's fairly easy to evaluate whether current management has previous hands-on experience with bringing a drug to market. What's harder to scrutinize is whether management can articulate a clear contingency plan in the case of an approvable letter or an outright rejection. So we try to measure management's ability to execute company plans moving forward... during good times or bad. An inexperienced management team can torpedo a perfectly fine drug and wreck any successful trading strategy.

Our evaluation of management hinges on our existing relationships with executive teams at dozens of the biotech industry's top companies. We make it a point to personally visit almost every company we recommend for investment. In addition, our tireless travel to industry trade shows, scientific conferences, and one-on-one meetings enables us to make the right judgment call on a management's experience and credibility.

On a related note, we also have an extensive list of industry and academic research contacts to help us validate both the science and strategy put forth by upper-level management.

These contact lists and relationships add a crucial element sorely lacking in traditional "trading strategies." They separate the S&A FDA Report from your run-of-the-mill trading services, which are often based solely on numbers, charts, and price trends.

On Friday, I'll share with you the first exit strategy we'll be taking once an eligible biotech trade triggers our "buy" signal. As you'll see, these huge gains can come very quickly...

Good investing,

George Huang

Stansberry & Associates Top 10 Open Recommendations

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As of 06/21/2013