The S&A Digest: Still Waiting for an Uptrend in Refiners

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Waiting for the market... Wanna buy an apple?... Peak Oil doesn't exist... No more LIBOR... Porn finds Jesus... Still waiting for the trend...

 "My house just got destroyed by the biggest earthquake in 32 years. Wanna buy an apple?"

That's my impression of this peculiar quote from today's Financial Times: "Many buildings are destroyed and many people are dead," said Fan Xiuying, a survivor selling fruit next to the remains of her house.

If there were a 7.9 Richter scale earthquake in the United States, I bet it'd be hard to find somebody "selling fruit next to the remains" of his or her house. They'd be complaining about how long it took someone to come and help them.

The United States used to be the land of self-reliant frontiersmen. We used to be the place where people kept selling apples after their houses got crushed in a massive earthquake. Now it's the place where crybabies and busybodies whine about the government not helping us.

Now it's the land of 10,000 laws, where everyone with an opinion complains about oil companies gouging us, but no one will allow a new oil refinery to be built.

Now it's the land of Al Gore winning a Nobel Prize for promoting an apocalyptically paranoid view of a natural phenomenon, which, the last time it happened, was a great boon to humanity.

 The market likes to wait to prove me right (when it deigns to do so). It waited almost three years on Janus Capital. Now Extreme Value readers are up 94%. And it's waited about that long with Extreme Value pick H&R Block.

I always thought the tax business was good and the problems with H&R's other businesses would be ironed out. Today, new management is cleaning up the mistakes of the past, and the tax business just reported its fees were 9% higher this tax season. The stock hit a new 52-week high yesterday.

 I'm in Las Vegas at the Money Show. Last night, at the pre-show cocktail party, I spoke with a 20-year Chevron veteran who told me he's been scared of running out of oil his whole life. I was polite, even though I thought this was an insane viewpoint.

Later, I asked S&A Oil Report editor Matt Badiali about it. He said, "There are 200 billion barrels of oil locked in a tight shale in North Dakota and Wyoming. With the current technology, we might get 2.5 billion out... that's 1.25% of the total oil. You can't tell me someone won't figure out how to improve recovery. As the price of oil rises, our ability to get creative rises. That doesn't mean gas will get cheap, but I'm not worried about the pumps going dry."

 The British Bankers' Association (BBA) is considering changing the way it sets the London interbank offered rate (Libor) for the first time since 1998. BBA's CEO, Angela Knight, said, "We've put Libor under review," but she would not give any specifics. The BBA will announce any changes on May 30.

One of the risks in the financial world you'll read about here and there is the possibility of a long-term disconnect between the Libor and the fed-funds rate. Some businesses borrow in Libor and lend off of the prime rate, which is based on the fed-funds rate. So if Libor goes up and fed-funds rate comes down, you're paying more interest and collecting less interest. Since we don't know what changes the BBA is considering, we'll just have to wait and see...

 Be sure to check your inbox today for details on a huge project our colleague Dan Denning is working on in Australia. We've known Dan for years... and you won't find a smarter guy writing an investment newsletter anywhere in the world.

Dan's thesis is this: One of history's great mining booms is taking place in Australia right now... but few investment analysts are doing the necessary research to find the right investments. Australia is incredibly rich in iron ore, uranium, gold, copper, and coal... commodities China is willing to pay any price to secure.

You don't get many chances to participate in a mining boom... and even fewer chances to participate in one most people know almost nothing about. You can read more about Dan's project here, or check your inbox for details.

 The abundance of free pornography on the Internet is crushing the for-profit players... so much, in fact, that they're changing business models.

Penthouse, longtime publisher of Penthouse magazine, is getting religion. Last December, Penthouse purchased Various Inc, a social networking web-community for $500 million. Now it's focusing on dating sites like AdultFriendFinder.com, an online swingers community, and BigChurch.com, a Christian dating website. Penthouse is also changing its name to FriendFinder Networks. When a porn company gets into Christian dating, you know things are bad. It might be time to short New Frontier Media (NOOF), the biggest pure play in porn.

 New highs: EnCana (ECA), Petrobras (PBR), Sabine Royalty Trust (SBR), H&R Block (HRB), Aracruz Celulose (ARA).

 Porter leaves for two days, and the mailbag slows to a trickle. Hopefully we'll have something for his return tomorrow... feedback@stansberryresearch.com.

 "I read a lot of financial news stuff, mostly from you firm which i love and adore. But in May 7's Digest, you helped me, the little guy, learn how to read financial statements. Granted, I have already started to comprehend what those statements contain, but your giving of this knowledge on how you have learned to master sifting through the company's jargon is absolutely philanthropic. Thank you from the bottom of my heart. You have and will continue to have a definite impact on my financial future." – Paid-up subscriber Sean Doll

Ferris comment: We're glad to be of help. You can re-read Porter's essay here.

 "I'm holding some GM's 2010 $20 put, what will happen to my put if GM goes bankrupt before expiration date?" – Paid-up subscriber VC

Goldsmith comment: You will make a lot of money... If GM goes to $0, each of your puts will be worth $20.

 "I must say that it is quite frightening to read letter to the Digest and find comments from people who are putting money into individual stocks without even understanding the concept of a stock split! Is it any wonder to discover that most of the people who put money into the stock market lose, rather than make, money? This is one of those times when I am not sure whether to laugh or cry.

I am positive this comment will enrage some but I can only advise that none of us should place our money into a vehicle which we do not understand and have anything other than a dismal expectation for the eventual result." – Paid-up subscriber Ken McGaha

Ferris comment: I agree. People think because it's easy to open a brokerage account and buy and sell, it's easy to make a lot of money doing it. But they're wrong. It's easy to place a bet here in Las Vegas, and but nobody wins but the house. A stock is a piece of a business. If you don't know the business very well, you have no business buying a piece of it.

Good investing,

Dan Ferris

Medford, Oregon

May 13, 2008

Still Waiting for an Uptrend in Refiners

By Ian Davis

On March 18, I wrote about refiners in The Digest. Here's what I said...

"If you are looking to buy refiners, I believe we are approaching a bottom. However, you must wait for the trend before jumping into this sector."

In the last two months, little has changed...

Refiners had a fairly strong two-week rally that didn't hold... And now they're back in purgatory.

 Refiners still have terrible margins... And those margins still depend on the crack spread – the difference between the cost of oil and the price of gas or diesel. (Click here to read my essay on the crack spread.) The crack spread is still likely to improve sometime in the near future. In the meantime, the refiner stocks are getting killed.

The following chart shows an index of the four largest U.S. refiners along with my crack-spread indicator. The orange portions show what's happened since March 18.

Conditions Should Start Improving for Refiners...

 Wait for the Trend to Buy

As you can see, when the crack spread is small, conditions are poor for refiners and refining stocks suffer. Conversely, when the crack spread is large, conditions are great for refiners and refining stocks do well.

Since 1987, the crack-spread indicator has been below the blue line roughly 13% of the time and above the red line roughly 13% of the time.

However, the indicator rarely remains at these extremes for long... Since 1987, it's only stayed above the red line for an average of 28 days at a time. Similarly, it's only stayed below the blue line for an average of 36 days at a time. It's currently been below the blue line for a very unusual 173 days, barring two short volatility spikes out of the blue territory.

So the best time to buy is when the crack-spread indicator bottoms below the blue line and begins to rise. This is what we're waiting for. Once the trend in refining stocks starts to turn around, it'll be time to jump into the sector. I'll have my eye on the crack spread, and I'll keep you posted.

Good investing,

Ian Davis

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