The S&A Digest: The Secret of the S&A Top 10

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

As of 06/27/2013

Dan's secret of the Top 10 list... Leverage works in reverse, too... Gold to fall?... Venom in the mailbag... Munger's inversion test...

 "Put these sunglasses on..." The dental hygienist handed me perhaps the ugliest pair of plastic, Chinese-made sunglasses I'd ever seen. They were dirty and were evidently being passed from customer to customer... like a filthy blanket on U.S. Airways.

I protested, gently, "What fresh hell is this? Are my teeth so dirty you've got to use a laser on them?"

"No. New OSHA (Occupational Safety and Health Administration) regulations."

Here in the land of the "free," the government now sets conditions under which I may consent to have my teeth cleaned. Thank goodness. I don't know what we'd do without our friends in Washington, D.C.

 In 2001, money manager Nassim Nicholas Taleb described how "rare events" play out when leveraged investment funds get hit with an unusual credit crunch:

The rare event is not limited to one security. It can readily affect the performance of a portfolio. For example, many traders engage in the purchase of mortgage securities and hedge them in some manner to offset the risks and eliminate the volatility, hoping to derive some profits in excess of the Treasury bond returns... Such a portfolio shows stable returns for long periods. Then, suddenly, as if by accident, the portfolio drops by 40% of its value when you expect, at the worst, a 4% drop. You call the manager to express your anger and he tells you that it was not his fault, but somehow the relationship dramatically changed. He will also point out to you that similar funds also experienced the same problems.

- Nassim Taleb, Fooled by Randomness

 We obtained a copy of Jeff Larson's recent letter to his investors in the Sowood Capital hedge fund. Sowood was heavily leveraged into mortgage bonds and other, supposedly offsetting, types of fixed income. As Taleb predicted, Mr. Larson wrote:

 Winning on Wall Street? A group of individuals, including Eli Broad and Hank Greenberg, will sink $3 billion into Goldman Sachs' failing hedge fund. The investment bank said its Global Equity Opportunities fund "suffered significantly," losing as much as 14% over the past 12 months. The bank's two other funds, Global Alpha and North American Equity Opportunities, also suffered losses, but the bank has "reduced risk and leverage."

 The European Central Bank injected an additional $65.3 billion into the market today, insisting that market conditions are "normalizing."

 Gold's failure to rise amid the current market turmoil and decline in the dollar is leading many analysts to cut their price forecasts for the precious metal. Citigroup cut its 2007 forecast to $679 from $700. UBS, which predicted gold would return to its 1980 highs of $850, now predicts $670. Analysts are scared by the fact that central banks, holders of one-fifth of the world's gold, increased their sales of reserves this year by 7.3 percent.

Central banks have been selling for a long, long time, and gold's price has continued to rise. Imagine what will happen to the price when they stop selling... or when they try to buy it back.

 Citigroup analyst Doug Leggate upgraded the refining sector to "hold" from "sell." The analyst sees refiner stock prices as more attractive after the recent selloff. Leggate expects refiners to switch production to diesel and heating oil to improve margins amidst falling gas prices. In particular, Leggate upgraded S&A Oil Report pick Marathon Oil (MRO) to "buy" from "hold." Lehman Brothers also upgraded Marathon to "overweight" on August 9.

 New high: Seabridge Gold (SA).

 In the mailbag... we've gotten a whiff of the acrimony we've been expecting. When stocks drop sharply, the "brilliant" newsletter editor is quickly reassigned to the circular file, but not before a nasty parting shot. If our mailbag is any indication, our readers only buy the recommendations that go down. The market can't bottom until we've gotten several hundred such notes. Send yours: feedback@stansberryresearch.com.

 "I'm a 4-year subscriber to several of your publications and have won some and lost some but am still with you. With that said, I want to add my endorsement to several other letter writers' observations, and ask you to consider one more thing: As copywriters, you and your staff are without equal. However, your relentless hyperbole hurts your credibility as a serious newsletter publisher... Whether you win or lose the appeal (as you admit, a longshot), I hope you come away with a lesson and some needed humility. You can't just blow off good people who are betting their life savings on what you publish, with a comeback of caveat emptor..." – Paid-up subscriber Fred Daily

Porter comment: Fred... if you've been with us for four years, you must have seen how much we care about our readers and how seriously we take our responsibilities. Take Steve Sjuggerud's pioneering use of trailing stop losses. Steve, almost single-handedly, has made trailing stop losses popular with individual investors, thereby improving the investing results of hundreds of thousands of people. (By the way, if that's been true for you, if Steve Sjuggerud has helped make you a better investor because of his disciplined approach, please let us know about it. There's always a debate about whether or not trailing stops work... we'd like to know about your experience.)

We launched Extreme Value, arguably the safest and most consistently high-performing newsletter over the last five years, even though the letter didn't make a reasonable profit for a long, long time. I've been an outspoken critic of other publishers in our business, who publish letters with terrible track records (or worse, no track records at all). On the other hand, we publish complete track records on all of our products, annually. Finally, take one look at the people we've hired over the last few years – folks such as Tom Dyson, Matt Badiali, Rob Fannon, Dr. George Huang, and Jeff Clark. These folks have decades of experience in their respective fields.

The work we do is powered by our advertising. Without great advertising, we'd never be able to afford the analysts we've hired or do the kind of research we know works. But every offer we make comes with a money-back guarantee. If you ever think we've oversold a product, we're happy to give you your money back, no questions asked. Not many businesses can make that kind of offer. We make it as a condition of every product we sell. Humility has nothing to do with it: We're trying to build the best independent publishing business in the world. In fact, we plan to open a major new office in Japan this year and are working on the final details with our partner there.

And the issue of caveat emptor isn't at all as you pose it. No matter how qualified our analysts, no matter how in-depth our research, making predictions, estimates, and recommendations based on constantly changing and uncertain market conditions is inherently risky. As Yogi Berri said: Predictions are tough, especially about the future. We urge our readers to diversify their holdings, use small position sizes (no larger than 4%-5%) and, where appropriate, use stop losses or trailing stop losses. But we cannot guarantee that any recommendation we make will be profitable. I'd wager that nearly all of our readers understand this, as a matter of common sense.

 "I think some of your readers need a wake-up call and should quit whining. I guess they can't deal with adversity. Markets can go down sometimes and when they go down, individual stocks do also. I must have missed the part in your newsletters where you guarantee only winning recommendations... I love your newsletters and the investment wisdom imparted to your humble reader." – Paid-up subscriber Steve T.

 "For those who complain about your publication, what do they think it's going to be? That you guys will put out a newsletter entitled, 'Mediocre Investments' or 'Investments Bound to Bomb'??!!! They are humorous! I myself have done far better on your recommendations than on my own. Compared to what my portfolio has increased in value, the subscription to your advice has more than paid for itself exponentially. They can do their own research; the Internet is an incredible place to dig up their own information, chart their own course, make their own decisions!!! Guess they would only have themselves to blame when things go south..." – Paid-up subscriber Tim B.

 "In The Digest of [August 10], I read your following comment: 'Every experiment with paper money has failed. We don't know what will happen with the banks or when the dollar will collapse. We only know it will happen. Make sure you write down how many steps from the corner of the house the gold is buried.'

By far this is the scariest thing I've ever read from you or any of your team members since your message basically means:

 Two questions: 1. Assuming you are right, then what sense does it make to invest in anything apart from physical gold and the gold ETF? 2. By using the word 'collapse' you probably mean 'continuous loss of purchasing power,' or inflation. Why do you think 'inflation-proof' investments – like real estate, dividend-paying stocks, and commodities – are not suitable anymore?" – Paid-up subscriber Hank van der Wijk

Porter comment: Charlie Munger says when you're working on a problem, invert the question, and you'll find your answer. So... let's invert our question. Instead of asking if the paper dollar will collapse, let's ask ourselves what would have to happen for it to remain stable for the next 50 years. Well, first of all, we'd have to begin producing a surplus in the federal budget and start repaying our national debt. To do that, we'd have to seriously cut federal spending on Medicaid and Medicare. We'd have to privatize Social Security, which would mean applying honest accounting to this government Ponzi scheme. That would probably require cutting benefits to everyone who is now less than 50 years old. Next, we'd have to increase interest rates and decrease taxes to the point where we wouldn't have to borrow constantly from our neighbors. Third, we'd need to come up with a much more efficient way of defending ourselves. Whether you believe a huge standing army stationed in more than 120 countries is good for America or not, we surely can't afford the expense indefinitely. What would you estimate the chances of even one of these things happening? Close to zero, right?

The only presidential candidate that's even discussing these issues is Ron Paul. He is the only honest man in Washington, which explains why he is probably unelectable.

Finally, to your point about the other ways to protect yourself from inflation... while real estate, commodities, and dividend-paying stocks have offered good protection from relatively benign rates of inflation, I would rather own gold and silver in a real currency crisis. Just look to history to understand why.

 "I just want to thank you all for your wonderful research. I have worked since I was 16... World War 2 in England left mother with no money for college. The 9-5 office was [where] I landed in the U.S in the 1960s. I worked as an assistant with fund managers for the investment funds division of a large U.S. corporation for 17 years in the Seagram Building, New York City (pension funds and profit-sharing plan for all employees). In those years, I never, and nor did anyone else, get any 'good' advice on buying stocks and bonds to make any profit (My monthly pension in my retirement years is barely enough for bus rides!). When I retired in late 1970s, I foolishly(?) selected large brokerage houses with money I made in real estate transactions! There again, I wound up with losses and excuses for bankruptcies that brokerage management should never have 'unnoticed,' while I was busy from 2000 on, trying to make a business from my art and learning how to handle the computer and my website building... all needing my full focus. I really appreciate the work you all are doing to help us manage our own investments." – Paid-up subscriber Joy Gush

 "Do you guys agree with each other in your investment ideas? What if I subscribed to the Alliance, for example, and get all of the recommendations... Is it right that they contradict themselves???? What I mean is: Steve is talking about a play to bet on a rising dollar... and you, Porter, in The Digest keep on stating that the dollar WILL collapse and that you should buy and bury some kilos of gold etc. etc. Who should a subscriber listen to? Or better yet, shouldn't you guys aim for the same target?" – Paid-up subscriber Mr. Barnatan

Porter comment: Why in the world would I go to the trouble and expense of hiring a top-notch analyst, if I only expected him to parrot my conclusions and pander to the boss? No, we do not always agree. But in almost every case, the real issue is simply one of timeframe or circumstance. Steve may be bullish on the dollar relative to other currencies for the next few months. That doesn't mean he thinks the dollar is immune from its long-term sickness. Likewise, Dan Ferris doesn't use trailing stop losses on his recommendations, but he doesn't object to using them in some situations. Before you cry "contradiction," you have to understand the circumstances and the timeframe.

 "Porter, while I certainly do not profess to be worthy of your subscriber advisory board, when next you feel like advising to go long on a mortgage lender, or even a builder, at least ask me my view first. I'm here in the trenches. You may not have to eat so much crow, or, if you chose not to listen, as I have done on some of your recommendations, I could just hit you up side of the head with a brick, as I wish you'd done with several of your recos that I didn't get in. Success is getting up one more time than you've been knocked down." – Paid-up subscriber John Allen

 "What is this talk of Smuckers putting a little bit more jam in their jars than what they claim on the label? How on earth would you know this? No one in their right mind would weigh the empty jar and compare it to a full jar to determine this! If you did you should have your head examined! Besides, why would Smuckers give away their jelly for free without even advertising that you're getting more jelly for your money? [It is] in the business of selling jelly, not secretly giving it away. It just doesn't make any sense. Do you really think that your readers will take you seriously if you continue to write such wackiness? This had to be the oddest line I have read in the Digest yet. I had a good laugh though." – Paid-up subscriber David Shurkin

 "I know the difference between brash (hasty, reckless, rash, impetuous, offensively bold, pushing, presumptuous, impudent) and outspoken – you are indeed brash – your wish to be thought merely outspoken is your dream. Will your empire survive? Time will tell." – Paid-up subscriber Elaine Lawry

Porter comment: The only definition of brash I'll accept is the third notation in the Oxford Dictionary: Energetic or highly spirited, esp. in an irreverent way. In regards to my "empire," it is merely a financial research publishing company. As long as we work hard to serve our customers and put their interests ahead of our own, we will surely prosper. Very few financial firms can say that they genuinely put their customers first. It's a terrific competitive advantage.

 "I find it moderately interesting (depressing?) that there is no stock listed with substantial gains that was recommended after 2005. I'm just curious whether your... stock picking is that great or whether this was just a case of picking some reasonably good stocks at the right time when the market was set to go up? Seabridge (SA) is an interesting case since most of the run up is very recent. I got in just on the cusp of the run up with a small position – ah what might have been!" – Paid-up subscriber Collins Richey

Porter comment: You're looking in the midst of the sharpest downturn in stocks in four years. It's natural that in such a period, stocks recommended recently (in the last 18 months) wouldn't look as good as stocks recommended between 2002 and 2004. Dan Ferris gives another reason, below.

The Secret of the S&A Top 10

By Dan Ferris

Here's a housing story with a very profitable ending...

Suppose you were building a house.

Wouldn't it be great if you could build the foundation... and have the foundation automatically build the floors? And have the floors spontaneously generate the walls? And have the walls automatically grow the roof?

Once you laid the foundation, your only remaining job would be to do nothing... to sit and wait for the house to finish building itself.

The dream of a foundation that builds a house is a perfect description of what happens when you harness the greatest wealth-building power there is... a power that Albert Einstein called, "the greatest mathematical discovery of all time."

Einstein was talking about the power of compounding.

If you want an example of the power of compounding returns that's close to home, just look at the Stansberry Top 10 list. These are the 10 best-performing open positions from the model portfolios of Stansberry's many research services. You'll notice something about them right away: All 10 of them were first recommended at least two years ago. Some of them go back to 2002.

Everybody wants a black box, a perfect machine that'll always pick stocks that go up a lot in a short period of time. But that'll just create a bigger tax bill for you, eating into your compounding returns.

In fact, the folks at Tweedy, Browne Company did a study about this. It showed that, if you make 20% a year for 20 years without selling, you'll make 38 times your money. If you make 20% a year for 20 years, but sell and reinvest 30% of your holdings every year, you'll make 20 times your money. The difference – 18 times your money – is taxes generated by selling. If you sell and reinvest 100% of your holdings every year, you'll make about 15 times your money at 20% for 20 years.

And that's not even including the spreads and commissions, which eat away at your money, too. The more you trade, the more likely you are to make less money over time, not more.

It's something to think about.

In my monthly Extreme Value letter, we've recommended 50 stocks since September 2002. We're still holding 34 of them. I can readily identify at least a dozen that I'm confident will not need to be sold for decades to come.

Right now, many people are scrambling to find new ideas based on the current crisis in the housing and mortgage industries. This is certainly rational behavior. But it's much more difficult than finding a great company which you can hold for decades, allowing your money to compound to 10 or 20 times your original investment or more.

If you want the ultimate example of a man who got rich by the power of compounding, just look at the growth in book value of Berkshire Hathaway. It's grown at about 21% a year for 40 years. That's more than 2,000 times your money, an amazing performance.

That's what the power of compounding can do for you.

Good investing,

Dan Ferris

Stansberry & Associates Top 10 Open Recommendations

Stansberry & Associates Hall of Fame