The S&A Digest: Natural gas update

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

As of 06/27/2013

Natural gas update… Big Fitch downgrade… Why gold will keep falling… GM's in big trouble… A good stock idea, from a subscriber… Advice for retired readers…

A recent Associated Press poll shows that one in four adults read zero books last year. Of those who did read, women and seniors were the most avid, and religious books and popular fiction were the most popular. My view is that if you're not reading at least one book a month, you're letting your brain stagnate… and I'd argue that religious books and popular fiction don't count (though they are certainly better than nothing). I usually read one book a week. My favorite financial books? We published a top 10 list a few months back.

If the Fed cuts the fed-funds rate, conditions would be ripe for Steve Sjuggerud's "virtual banks" to make a killing. Sjug is recommending two of them right now in his True Wealth portfolio. Make sure you're familiar with his strategy… It might be the best way to play stocks for the rest of the year.

Fitch Ratings placed $92.1 billion of securities backed by subprime mortgages "under analysis," which is the first step toward a possible downgrade. That's a huge amount of bonds… Fitch said the $4.2 billion of bonds ranked below BBB are the most likely to face a downgrade. The mortgage mess may take a long time to unravel. Lots of folks – both homeowners and lenders – will have to take a "haircut." If the losses are written off, through failure, bankruptcy, and foreclosure, the damage to our economy will be contained and should pass quickly. My fear is that the government will come to the "rescue."

Wherever there's a crisis… there's sure to be a bottom-feeder. U.S. financier Wilbur Ross is warming up to subprime mortgages. Ross, through his $3.5 billion WL Ross private-equity firm, is looking to buy mortgages. He said his exposure to the subprime market could come through acquisitions of lenders, mortgage portfolios, or companies that service loans.

We've gotten several questions about gold. While the price hasn't moved much since last month (down from $680 to around $650), lots of folks thought gold would perform much better, given its role as a "safe haven" investment. Well, it turns out that most of the world still prefers three-month T-bills to gold. As the crisis reached a peak last week, three-month T-bills experienced their biggest rally in 19 years. As long as the dollar remains the world's reserve currency (and no one knows when the eventual run on the dollar will begin), gold will primarily function only as a hedge against inflation. With banks in trouble, loans going bad, and mortgage lending coming to a halt, we expect the economy to slow rapidly. The collapse of the mortgage industry will be deflationary.

Looking back to the last big credit crunch (1990), which was centered around S&L lending to commercial real estate developers, we see that gold fell from around $400 in 1989 to a low of $327 in early 1993 (about 20%). We would be surprised if gold didn't fall at least that much during the next 12 to 18 months, which would put gold at around $550.

We have long believed that American car manufactures were making a terrible mistake by relying on 0% interest lending as a sales incentive. Selling more by loading your customers with debt only helps in the short term. It will depress future sales by the same amount as it boosts current results. And… it seems the future has arrived, at least for General Motors. The company announced that despite offering 0% financing again (launched in July), customers aren't buying as many full-sized trucks or SUVs as GM expected. GM is cutting production of these vehicles (which are its main source of North American operating profits) and ending the financing incentives.

Reading the current issue of Tom Dyson's 12% Letter, we were reminded of our own (very unpopular) bearish view of oil and (particularly) natural gas.

Early last October, we attempted to explain in detail the rationale behind our view (The Oil Bust, How Bad Will it Be?). What we saw was a classic investment mania. You had all the elements: highly leveraged hedge funds taking long positions; huge merger deals put together with shaky debt financing; a guru – T. Boone Pickens – who made it seem like making money in oil and natural gas was as easy as buying it at the station; and, most importantly, a crazy theory (Hubbert's peak oil) that justified any higher price. It's impossible to know when a market will regain its senses… so we kept watching, kept waiting.

We updated our bearish view in February, with another (shorter) article, The Coming Carnage in Natural Gas. By that point, the natural gas rig count had set a new, all-time record – despite slowly falling prices. The table was all set. We didn't think it took a genius to figure out that, sooner or later, a record number of rigs operating and a record amount of gas in storage would bring prices down. And, at last, our predictions have begun to bear fruit. Natural gas has fallen from around $8.50 to around $5.50. We think it's going to get a lot worse. While we're not "technical" analysts, we are watching two natural gas drilling stocks (Nabors and Patterson-UTI) closely. They're both bouncing around new lows… and seem poised to fall further.

New high: Oakley (OO).

We've received several interesting suggestions for inclusion in our Correction Opportunity Report, which will appear again on Friday in place of The Digest. Many subscribers, it seems, think if they send us the names of all the Canadian junior mining stocks they own, we'll endorse them… We did get one very good idea – it's in today's mailbag, below. If you send it to us, we'll at least read it: feedback@stansberryresearch.com.

"My suggestion is Moody's (MCO). Besides being one of Warren Buffett's largest holdings, it has an incredible moat in my opinion, great margins, strong cash flow, and is trading at 52-week lows… It seems to me like one of Dan Ferris' picks." – Paid-up subscriber Adriano Romano

Porter comment: That's the best suggestion we've gotten, so far. Thanks, Adriano.

"You wrote, 'It always amazes me to see that folks who have decided to pay for our letters routinely assume that we're cheating them…' How does that saying go? Something like: 'Wake up and smell the napalm!' You work in an industry that specializes in lying con men who have amazingly diverse ways to separate people from their money when money is one of the most precious things to most people. Then you're amazed when those in your field cast a shadow on you. I tell people that God said what He meant and meant what He said in the Bible. I always have to spend the first several minutes convincing people that there is a difference between what God literally wrote (including the grammar) and what some religious liar says that He wrote. This isn't amazing, it's part of the environment that I choose to operate in. The shadow of your industry is part of the reality that you chose to operate in."

– Paid-up subscriber Gerard Cotter

"It seems to me that the recent recos for financial companies like AACC et al are eerily similar to the recommendations for PXRE and other reinsurers that appeared after Katrina. Both sets of recommendations seem to be based on companies that come in after the mess, buy the mess, clean it up, and sell the good that is undamaged and still useful for further business. The opportunity seems obvious, the numbers seem to work, and after all 'its what they do.' We all know what happened to PXRE because the scope of the mess was underestimated. What is the difference now?"

– Paid-up subscriber Reginald Baker

Porter comment: AACC isn't an insurer, for starters.

"Porter, I've been an Alliance subscriber for a couple of years now and I'm very happy with the education I'm receiving and the past and current state of my portfolio. My question is: As I approach retirement (at my age, I could do it now, but I'm having too much fun) what should my portfolio look like? I know you can't offer specific advice, but I'm sure there are others like me who wonder how to structure a portfolio for a safe, comfortable retirement. I am slowly moving into dividend paying positions to fund monthly expenses in retirement, but I don't want to forget growth in the total value of the portfolio to keep abreast of inflation." – Paid-up subscriber Jeff Sawdon

Porter comment: Well, as you say, I can't give you specific advice. But here's what I tell my parents… You can buy anything that's recommended in my "No Risk" portfolio, in Dan's Extreme Value, or in Steve's True Wealth. These recommendations are made primarily to avoid any downside. Never put more than 5% of your portfolio into any single stock. You should have at least half of your savings in very safe fixed-income investments. Trade as little as possible. And, if you trade, only trade up in quality and safety. Most importantly, don't think about your investments more than two or three times a year. Worrying won't improve your performance and will often make it worse. Finally, find something you enjoy doing to create day-to-day income that will keep you engaged in society and get you out of the house.

"Wow, I'm really not as stupid as your comments imply. I was not advocating this method, only relaying it to you for possible analysis by your 'quant guy' to see if it had any validity. On the other rude remark, Warren Buffett was on CNBC with Becky Quick for a couple of days. Is there something wrong with him as a money manager? If I accepted all on that show as fact, I certainly wouldn't be a paid-up Alliance member following your numerous writers' recommendations. Or maybe you think I am stupid because I went to college, got a professional degree (class valedictorian), and had an outstanding practice before becoming physically disabled. Or maybe you just get off on being rude and condescending to elevate your statue in your mind. Whatever!" – Paid-up subscriber Ron Ceurvels

Porter comment: Your question didn't have any validity because its premise is obviously false. You cannot get wealthy by investing in what 80% of the market has already bought. And that's why I thought it was a stupid question.

"…let me tell you one more thing: Your comparison with Buffett's comments about CFC was just amazing. I know that some people confuse a sharp brain with an egocentric attitude, but I'm starting to see that's not your case. I'm learning so much from the Digest. It is a source of fresh air in the financial world for the smart people! Keep it up!"

– Paid-up subscriber Mr. Barnatan

"That is a question I have been asking myself and I have been searching hard for a good answer. Why has the price of gold declined during this crisis? I believe the answer to your question, Porter, is as follows: Central Banks have been manipulating the price of gold by dumping tons of gold into the markets. This is no surprise as they've been doing this for some time. So what's the new twist? The recent market crisis has caused people to sell their good assets to cover losses they had in other areas. Gold has dropped, but not by much. Silver took more of a beating than gold but it's still doing fairly well and this is the time of year when gold and silver traditionally fall in price, and if it keeps with tradition, it should rise again very soon. I hope people do keep selling their gold so my brother and I can get more of it at a better price than we are now." – Paid-up subscriber Daniel Duke

"You are full of it. Steve's recommendations are frequently showcased in S&A Digest shortly after True Wealth is released. I often have wondered why I pay for TW when I can get all the recommendations for free. Perhaps you should wait a couple weeks to allow subscribers to take positions? Or just give TW away for free." – Paid-up subscriber Brett Fromme

Porter comment: You can have your money back anytime you want. Steve's True Wealth is probably the greatest bargain available in financial publishing. And, as I keep telling you, The Digest is only sent to subscribers, nearly all of whom already have received True Wealth. We discuss Steve's ideas here because they're brilliant and interesting. Sorry that upsets you…

"Its too bad you disagree so strongly with Bill O'Neil. I would love to see you offer an IBD-style momentum trading service. I don't agree with everything he says, for example: An 8% stop is not appropriate all the time, but then neither is 25%. A stop should be placed according to the style and time frame of the trade. A momentum stop, which could be a fixed percentage, if you have measured your range and determined the percentage necessary to maintain the trend, or a position stop, under strong support, which is much more applicable to newsletter recommendations. At no time should a fixed percentage be used arbitrarily. However, I do agree with him about diversification. This is similar to how I work. I also agree with you, that it is not for the average part-time investor, and that beginners should have smaller positions, and looser stops." – Paid-up subscriber Ken

"Everything you say about General Motors is true in spades – they are truly bankrupt. However, is it possible that they are 'too big to fail'? Remember the Chrysler Motors bailout quite a number of years ago?"

– Paid-up subscriber George Holloway

Porter comment: I don't know. And I don't know that it's possible to accurately answer the question… But maybe that's because I don't know much about politics (except that I don't like it).

Regards,

Porter Stansberry

August 22, 2007

Baltimore, Maryland

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