A lesson on short-selling...

My thoughts from the ground of this dangerous and racially charged country...

S&A Global Contrarian editor Kim Iskyan recently returned from a trip to Africa.

In today's Digest Premium, he recalls Zimbabwe's unusual stock exchange... and how he learned more about a valuable opportunity in precious metals...

To subscribe to Digest Premium and receive a free hardback copy of Jim Rogers' latest book, click here.

A lesson on short-selling... Coke is buying Green Mountain... The VW short squeeze... The next best thing to shorting the government... Big numbers from KKR... Why gold stocks could double from here...

 Selling stocks short is a tough business...

Short-selling is a trade that profits when a stock's share price falls. To sell short, you borrow shares of a stock you expect to decline and sell them into the market. You close the trade by buying back those shares. If you pay less to buy them back than you received for selling them, you keep the difference.

Don't let the explanation discourage you… Your broker handles all the logistics of borrowing and trading. For your purposes, you'll click the "sell short" button with your online brokerage.

 As a result, when you sell a stock short, your upside is 100%. (That only happens, of course, if the share price goes to zero.) However, your downside is unlimited... There's no maximum share price a stock can reach.

That's why you have to be selective on your short targets. As longtime Digest readers know, we focus on three types of companies to sell short: "frauds," obsolete firms, or companies with unsustainable debt loads. We never short a stock based on valuation... Because obscene valuations can always get more obscene. (You can read Porter's analysis of short-sale target and electric automaker Tesla here.)

Even sticking to our three criteria, plenty of things can go wrong...

 We'll tell the story of Green Mountain Coffee Roasters (GMCR) – the maker of the ultrapopular Keurig coffee machines.

GMCR had a spectacular rise to glory. It was a sexy growth story... Green Mountain started in 1981 as a single café in Vermont. It, along with the rest of the premium coffee sector, enjoyed huge growth in the 1990s, increasing revenues by 25% a year.

In 1998, it partnered with Keurig, which makes the single-cup coffeemakers. It bought the whole company in 2006. Then it exploded...

Green Mountain was revolutionizing the market with its hassle-free brewers. The stock traded for $1.50 a share in 2004. It peaked at $111 a share in September 2011 – a 7,300% gain.

 Then, in October 2011, hedge-fund manager David Einhorn announced he was short the stock. Einhorn has built a reputation for recognizing and profiting from short sales (like Lehman Brothers and Allied Capital).

Einhorn believed Green Mountain used fishy accounting practices (including "channel stuffing," or pulling demand for products forward). Plus, the company was losing its patent on K-cup coffee packs (the now-ubiquitous single-serving coffee pods) in September 2012, which would increase competition and force GMCR to lower its prices.

Within a month of Einhorn's presentation, shares of Green Mountain were down 52%. The company was plagued with earnings misses and lowered sales guidance.

 Things eventually picked back up. But investors were still wary of the stock... Green Mountain was among the 20 most-shorted stocks in the market, with more than 31% of its tradable shares (called "float") sold short.

 When lots of investors are betting a stock will go down, they're vulnerable to a "short squeeze." (We shared S&A Short Report editor Jeff Clark's explanation of short squeezes here.) If something happens to move that stock up, the short-sellers flee en masse. They'll close the position at any price...

In October 2008, automaker Volkswagen experienced a short squeeze.

Like Green Mountain, Volkswagen was a popular short target. But unbeknownst to short-sellers, luxury carmaker Porsche was acquiring a massive position in the German company (in addition to the 31% it already owned).

Porsche made a surprise announcement that it had acquired 74% of Volkswagen's voting shares. Less than 6% of VW's voting shares remained floating in the market.

 Short-sellers paid any price to cover their positions... and eventually ran the share price up to 1,005 euros, almost double the opening price. For a moment, Volkswagen was the most valuable company in the world, with a market capitalization of $370 billion.

(On a side note, several hedge funds are suing Porsche for $2.4 billion, claiming the company quietly accumulated its position on VW while publicly saying it had no plans to do so... thereby engineering the short squeeze.)

 Another problem with selling short is that you have no idea if someone will come along and pay more for a company.

Today, soft-drink giant Coca-Cola announced it would purchase a 10% stake in Green Mountain for $1.3 billion. Coke will work with Green Mountain to produce single-serving drinks at home.

Coke is looking for other avenues to sell products... Its traditional soft drinks are losing market share to iced coffee, teas, etc. Keurig Cold will launch later this year.

Shares of Green Mountain were up as much as 37% on the news. Once again, the shorts got squeezed.

 Despite the cautionary tale, short-selling can be very profitable. And it's a great way to hedge your portfolio – especially in times like these, when we're caught in a government-orchestrated bubble.

 One rule of thumb that produces consistent profits is to "short the government." Sadly, you can't actually short the bureaucrats in Washington, D.C. (We'd be "all in" on that trade.) But you can short shares of government-controlled companies, like Brazilian oil giant Petrobras, for example.

 Some investment gurus used to tout state-owned companies like Petrobras simply because they were backed by the government... And the government wouldn't let them fail.

But S&A Editor in Chief Brian Hunt disproved that fallacy in the February 11, 2013 Growth Stock Wire...

 Petrobras has massive oil reserves... But most of that oil is offshore. That's why the company announced it would spend $237 billion to get it out of the ground. But remember, bureaucrats are spending that capital.

And in Petrobras' case, it gets worse... Since 2006, the Brazilian government has capped fuel prices to combat inflation. So while the country's demand has been booming, Petrobras has been forced to supplement its production with imports... which it sells at a loss.

Shares of Petrobras hit a nine-year low yesterday.

 Small Stock Specialist recommendation Kohlberg Kravis Roberts (KKR) announced blockbuster earnings today...

The private-equity firm reported that fourth-quarter net income rose from $96.7 million in the fourth quarter of 2012 to $277.9 million last quarter. Its full-year profit was $691.2 million, up 23% from 2012.

Like fellow private-equity firm Blackstone Group, whose earnings we discussed last week, KKR profited from cashing out of some positions. The company also earned record management fees of $175.2 million – a 21% increase from a year ago. Total assets under management rose from $75.5 billion at the end of 2012 to $94.3 billion at the end of 2013.

 Shares rose 2.5% on the news. Small Stock Specialist subscribers are up 80% since Frank Curzio recommended the stock in July 2012.

 In today's Growth Stock Wire, Jeff Clark explained why it's a great time to buy gold stocks...

The best time to own gold stocks is when they are outperforming gold.   From the beginning of the gold bull market in 2001 until the end of 2003, the price of gold rallied from $250 an ounce to $375 an ounce – a 50% gain. Gold stocks, however, far outperformed the metal. The major gold-stock index – the AMEX Gold Bugs Index (the "HUI") – rallied 400% during that same time frame.   But the pendulum swings both ways. Gold stocks have solidly underperformed the action in gold over the past two years. Gold topped near $1,900 an ounce in 2011. It ended 2013 at about $1,200. That's a 37% loss. The HUI lost 70% of its value during that same time frame...     When this chart is rising, gold stocks are outperforming the metal. When the chart is falling, gold stocks are underperforming.   As you can see, following the last two years of severe underperformance, gold stocks are nearly as cheap – relative to gold – as they were at the start of the gold bull market in 2001.   Over the past 17 years, the average ratio on this chart has been about 0.35. The ratio is currently 0.17. Even if the price of gold goes nowhere this year, the HUI could double just to get this ratio back up to its average level. That's how oversold gold stocks are. And if the price of gold rallies this year, the HUI could soar even more.

 A number of S&A analysts are bullish on gold stocks today, as we explained in the January 15 Digest. Porter, S&A Resource Report editor Matt Badiali, Small Stock Specialist and Phase 1 Investor editor Frank Curzio, and True Wealth and True Wealth Systems editor Steve Sjuggerud are also bullish on the sector.

The reason is simple... Gold stocks fell 50%-plus last year. There's nobody left to sell. And today, lots of gold companies are trading at a discount to their reserves.

Plus, the technicals are pointing toward a breakout in the sector. As Jeff explained, these stocks could double from today's levels just to get back to average.

 After 26 years, Jeff released a special report detailing how you could make thousands of dollars per month in gold stocks... It's the secret he used to retire two decades early. To gain access to this report – titled "Spotting the Perfect Gold Play" – click here to learn more about a subscription to the S&A Short Report.

 New 52-week highs (as of 2/5/14): Fluidigm (FLDM) and Virginia Mines (VGQ.TO).

 What exactly is the S&A Digest? We explain in today's mailbag. Send your e-mails to feedback@stansberryresearch.com.

 "I'm a new subscriber and was looking forward to some specific recommendations on portfolio actions to take today in the light of what appears to be a bear market? The recent Digest reports and discusses the various markets but nothing specific on what stocks, or commodities, or actions to take in light of these events. Can you please advise if this is covered in this sector and or where to get that kind of information? Is it covered on the web site perhaps?" – Paid-up subscriber Barrie Day

Goldsmith comment: The S&A Digest is a free daily e-letter you receive with any paid S&A subscription. Please refer to your paid advisories for specific investment recommendations (though we do provide them in the Digest from time to time).

Regards,

Sean Goldsmith 
Miami Beach, Florida 
February 6, 2014

My thoughts from the ground of this dangerous and racially charged country...

Editor's note: In today's Digest Premium, Kim Iskyan, editor of the S&A Global Contrarian, shares some thoughts and observations from a recent trip to Africa. While he was there, he learned how stocks are traded in Zimbabwe... and learned more about a valuable opportunity in precious metals...

 Johannesburg is in some ways a paradise... great weather, amazing nature, pleasant people, good food, cheap... "Southern California without the earthquakes" is how one American described it during the trip I (Kim Iskyan) recently took. Of course, it also has some of the highest murder and carjacking rates this side of Detroit.

South Africa also has enough race-related cultural and economic tension to preoccupy generations to come. For example, this year, the country's mining companies are being required to increase the number of shares that are held by black South African employees, communities, etc. from 18% to 26%. Yes, they're being required to simply hand over a chunk of their shares.

The country's hotly debated race discussions are hurting economic growth, destroying its work ethic, undermining meritocracy, and so forth based solely on skin color. That's a big reason to be bearish on the country.

 I also visited Zimbabwe, which probably has some of the worst public relations of any country in Africa. But it has massive natural resources, and boasts the highest literacy rate on the continent. That's not what I was expecting from a country with a gross domestic product per capita of around $800.

Zimbabwe has no foreign-exchange risk. The economy has been completely dollarized since 2009, following years of hyperinflation. (There was a three-year period when its currency had 26 zeroes lopped off... Now that's inflation.)

I visited the Zimbabwe Stock Exchange, where trading is conducted via open outcry. Twice a week, for an hour and a half, brokers assemble at a long wooden table on the fourth floor of an office building downtown, bearing their clients' orders and negotiating transactions. It's another world.

 But the reason I went to Africa was because South Africa and Zimbabwe combine to produce nearly 80% of the world's platinum supply. And infrastructure and cultural issues constantly pose a threat to supply. Buying a local platinum stock doesn't make any sense, because in this case, what's good for the price of platinum is bad for platinum companies. It's odd.

While I was there, I did discover my preferred way to play platinum... I'll tell you about it in tomorrow's Digest Premium.

– Kim Iskyan

My thoughts from the ground of this dangerous and racially charged country...

S&A Global Contrarian editor Kim Iskyan recently returned from a trip to Africa.

In today's Digest Premium, he recalls Zimbabwe's unusual stock exchange... and how he learned more about a valuable opportunity in precious metals...

To continue reading, scroll down or click here.

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

As of 02/05/2014

Please note: Securities appearing in the Top 10 are not necessarily recommended buys at current prices. The list reflects the best-performing positions currently in the model portfolio of any S&A publication. The buy date reflects when the editor recommended the investment in the listed publication, and the return shows its performance since that date. To learn if a security is still a recommended buy today, you must be a subscriber to that publication and refer to the most recent portfolio.

Stansberry & Associates Hall of Fame
(Top 10 all-time, highest-returning closed positions across all S&A portfolios)