Icahn on the risks of investing today...

Icahn on the risks of investing today... Blackstone is looking at the energy sector... Oil producers get clobbered... Why royalty companies are better than producers... Dan Ferris: 'I've been preparing for this moment for 20 years'...

 

 In last Friday's Digest, we discussed the recent selloff in high-yield bonds – something we've been warning about for months.

 

In short, high-yield bonds (aka "junk") are the riskiest of corporate credits... And until recently, they were trading at record-high prices. Yet investors continued to leverage up and buy record amounts of junk.

 

In addition, energy companies have become larger and larger issuers of junk bonds. So when oil began its selloff recently, it was partly responsible for sparking the trouble in the high-yield market.
 

 Yesterday, Bloomberg published an interview with billionaire activist investor Carl Icahn – one of the best investors alive today. (He holds a $5 billion-plus stake in Apple in his hedge fund.) Like us, Icahn is still concerned with high yield. When asked what investors' biggest risk is today, he replied...

 

There's still risk in the financial markets, even though the economy looks pretty good. The one area I think is getting to be a bubble is the high-yield market. These bonds are still at way too low an interest rate. In other words, you can borrow money too cheaply if you're a risky company. There are arguments that there's a lot of cash flow to cover the interest payments on the bonds. But some of that cash flow is ephemeral – it's not likely to last. It's a bubble that's going to burst in the next couple of years.

 

 Icahn also agreed the selloff in oil is proof of the risk in the high-yield market... Prices have plunged in the face of a single economic shock. Icahn believes the energy sector will offer huge upside... just not today...

 

Oil will be a great opportunity, but not now. The energy sector is probably in for more problems. Oil prices will probably go down more, and these energy companies, especially oil-service companies, are going to be hurt. But then I think there will be a tremendous opportunity. Oil prices will eventually recover, because worldwide demand will continue to grow and supply will diminish, due to depletion. Additionally, the cost of finding oil is growing. We are not coming up with enough alternative energy that quickly.

 

 We don't agree with Icahn's belief that oil supplies will diminish. We don't buy into the "Peak Oil" argument. We're long human ingenuity. But he's right that the cost of finding oil is growing.

 

 Steve Schwarzman – cofounder and CEO of private-equity giant Blackstone Group – is also looking for good deals in energy.

 

Blackstone is nearly finished raising a new fund for energy investments, which should be larger than $4 billion. As he noted at the DealBook economic conference in Manhattan last Thursday...

 

I think this is going to be a wonderful, wonderful opportunity for us. It's going to be one of the best opportunities we've had in many, many years... This is a wonderful, wonderful time. This is a commodity. It's not patent-protected. Commodities go into undersupply and oversupply.

 

 Oil is down to $56 a barrel today, down nearly 50% from its highs in June. As Icahn and Schwarzman suggest, low prices will crush some producers. Supply will come offline. As supply dwindles (and demand potentially increases), prices will start to rise again. It's the definition of a commodities cycle.

 

We aren't predicting an oil recovery around the corner. But we do believe natural gas prices should bottom soon...

 

In the December 3 Growth Stock Wire, titled "How to Profit From Oil's Price Collapse," Stansberry Resource Report research analyst Brian Weepie explained how to profit from oil's price collapse. Like oil, natural gas prices had also gotten crushed. But Brian said natural gas was close to a rebound.

 

He also shared a chart of five natural gas producers that had been crushed this year. (Note that we've updated it as the price of oil has continued to fall in the two weeks since that essay was published.)

 

 

 Shares of Talisman Energy – one of the most beaten-down natural gas companies on the list – jumped nearly 20% yesterday on word that the Canada Pension Plan Investment Board was considering buying the company. That's on top of an 18% jump Friday after news broke that Spanish energy company Repsol was considering buying Talisman.

 

 While we're not going to waste our time speculating on the specific price movements of oil and natural gas, we are certain we'll see more deals like this...

 

Institutional investors with plenty of cash (like Blackstone) are scouring the beaten-down energy sector in search of great assets at low prices.

 

 But one sector of commodity stocks is actually outperforming the market: royalty companies. Royalty companies have one of our favorite business models, particularly when it comes to oil and gold.

 

Stansberry Resource Report editor Matt Badiali explained the gold-royalty business model in a Growth Stock Wire essay last year...

 

Royalty companies don't actually operate mines. Instead, they own a percentage of a mine's production. Typically, a mining company sells a royalty to raise cash to build the mine. Once the mine is built, the royalty becomes a revenue stream. After the royalty company makes its first payment, the cost of that revenue is practically zero.   That business model allows royalty companies to generate enormous profit margins of 80% to 90%... a heck of a lot better than the average mining stock.

 

 As you can see, gold royalty firms Franco-Nevada (FNV) and Royal Gold (RGLD) consistently outperform gold and the Market Vectors Gold Miners Fund (GDX), which holds a basket of major gold stocks...

 

 

The strength in royalties isn't limited to gold. The chart below shows oil royalties Mesa Royalty Trust (MTR) and Dorchester Minerals (DMLP) plotted against West Texas Intermediate crude oil (the domestic benchmark) and the Energy Select Sector SPDR Fund (XLE), which holds a basket of major oil stocks...

 

 

 As we've long said, royalty companies are some of the best you can own. And their recent strength versus the rest of the commodity market only further proves that.

 

Dan Ferris just recommended a brand-new royalty company to his Extreme Value portfolio. This company owns a rare 7% gross royalty. Over the last five years, it has earned an average of nearly $110 million per year in royalty payments. 

 

This company has also received nearly $90 million in dividends off its equity since the fourth quarter of 2013. And it earns millions of dollars in commission through all of the production, sales, and shipping of its commodity.

 

As Dan summed up in the December issue... 

 

Mining is a terrible business. But owning royalties can be an excellent one.

 

 In an internal e-mail yesterday, Dan told us why "right now is a golden moment for any capital provider in the mining space today, including royalty companies, private-equity firms, and other deep-value investors." As he explained...

 

There's a whole slew of high-quality, small-cap mining companies that will need capital to survive the downturn and take advantage of new opportunities. Some of our favorite resource stocks hold shares in tiny natural-resources companies across the entire energy and commodity spectrum, including oil and gas, coal, uranium, potash, farming, cattle, iron-ore, copper, zinc, gold... you name it.

 

 Right now, these companies' share prices are getting clobbered as the cyclical commodity market continues to pull back. But people are also rushing to the exits to sell so that they can report tax-deductible losses for 2014...

 

Personally, I'm doing the opposite of the tax-loss sellers. I'm buying small-cap natural-resource companies. I've been buying almost every day since Thanksgiving. I even sold out of some of my best equity investments to raise cash for this opportunity. All of that fresh cash is now earmarked to buy small-cap resource stocks. Yesterday, their share prices were down again, just like we expected them to be... and once again, I was buying.

 

 As Dan continued to explain, if small-cap mining stocks are your thing – and we realize they aren't for everyone – now is the time to start buying... 

 

If you can't be a deep contrarian in natural resources – and buy when everyone is selling – you should avoid ever putting a penny into those stocks. If you are a natural-resources contrarian, this is the contrarian moment. In Extreme Value, we've recommended a small portfolio of some of the best contrarian natural-resource stocks around.

 

 The tax-loss selling that happens this time of year is adding more pressure to beaten-up commodities. And on Thursday, Dan is hosting an emergency briefing.

In it, he'll show the historical, cyclical nature of commodities... explain why there's a narrow window of opportunity to buy these companies... and the four things he looks for to separate high-quality resource stocks from the rest of the pack. 

 

Regular Digest readers know Dan isn't a fan of trying to time the market. But the tax-loss selling and pullback in commodities has created a terrific opportunity to pick up high-quality stocks at massive discounts. As he explained in the November issue of Extreme Value, "I've been preparing for this moment for 20 years."

 

We're hosting Dan's webinar on Thursday at 8 p.m. Eastern time. It's completely free of charge. You can sign up by clicking here.

 

 New 52-week highs (as of 12/15/14): Dollar General (DG).

 

 In today's mailbag, we respond to a subscriber isn't satisfied with our performance. Send your complaints, concerns, and compliments to feedback@stansberryresearch.com. 

 

 "Gents, why don't you give a little press to two of your recommendations that I have purchased. Freeport McMoRan, Inc, a trophy stock, that returned a negative 42% and Natural Resource Partners that has a 50% negative return. That would give a more balanced perspective of your stock picking performance." – Paid-up subscriber John

 

Goldsmith comment: As Porter and his team noted in the November issue of Stansberry's Investment Advisory, they stopped out of Freeport for a 10% loss. As they wrote back then...

 

FCX is a great company led by the best managers in the resource business. But we're disciplined investors and when our trailing stops are hit, we move to the sidelines. It's important to step back and wait for markets to settle. For now we reluctantly part ways with FCX.

 

Shares have continued to tumble more than 20% lower since that issue. And we're sorry to hear you didn't heed our advice. But as we often preach, markets can stay irrational for a lot longer than you can stay solvent. That's why we use trailing stops to protect ourselves from taking large losses.

 

As for your other losing position... Natural Resource Partners is one of the few positions showing a loss in the Stansberry's Investment Advisory portfolio... a portfolio that features 28 winning positions versus just three losing positions. The average return in that open portfolio as of yesterday's close is a 38% gain. Taking a few losers with a big bundle of winners is a normal thing in successful investment.

 

Regards,

 

Sean Goldsmith

December 16, 2014