S&A Digest: The end of the world

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

As of 06/19/2013

The end of the world... Poor GM... Goldman's accounting (again)... Rogers on oil... Real venom in the bag... How to get started...

Financially speaking, it might be the end of the world...

Shares of Fannie Mae and Freddie Mac plunged today. At one point, around noon, the stocks were simply in freefall. The collapse happened right after bond traders began marking down the "agency" bonds of both companies. These are packages of mortgage securities guaranteed by Fannie or Freddie.

The spread between agency debt and U.S. Treasuries reached a 22-year high today, which indicates bond traders no longer have confidence in Fannie's or Freddie's ability to guarantee their mortgage securities. If the agency bonds continue to trade lower, it will spark chaos in the financial markets – a kind of global run on the bank. Most U.S. banks hold agency debt as their reserves. Banks would have to sell agency debt (at a loss) and buy U.S. Treasury bonds or else risk falling under the standards for capital reserves.

This is exactly the kind of crisis I warned my subscribers about in my last newsletter:

...most people don't realize how important the U.S. mortgage market has become to global liquidity. Ten years ago, the total U.S. mortgage market was about $3.5 trillion, roughly equal to the U.S. Treasury market. Today, the U.S. Treasury market has grown to $4.5 trillion. But the U.S. mortgage market has more than doubled to about $9.5 trillion.

These mortgages, packaged into securities guaranteed by Fannie Mae and Freddie Mac, make up the reserves of financial institutions all over the world. As these securities fall in price, they're reducing the amount of available outstanding credit globally on a leveraged basis.

– PSIA, June 2008

What should you do? Ideally, if you've been reading my letter, you're already short several of these hemorrhaging financial stocks (not to mention GM), so you're well-protected. The next step is very hard to predict because it's unprecedented. But I believe the U.S. Treasury will act directly to prevent the collapse of Fannie and Freddie from spreading into a global banking panic.

It will take action to support the value of agency bonds. What it will do precisely, I can't know. But when it happens, when the world sees the U.S. Treasury defending the value of agency debt, the dollar will come under tremendous pressure. The price of gold and silver (especially silver) will soar. If you haven't protected yourself by selling short financial stocks, don't wait to buy gold and silver. Do it now.

Poor GM. Now, at the very bottom, it's finally talking about cutting white-collar jobs by the thousands and selling off more of its brands. Whatever GM does now won't matter, as I've been telling you for months. GM can't fix its core problem – huge legacy costs assumed when GM made one out of every three cars in the world. Now, GM only makes about 12% of cars globally.

It can't afford its debts, infrastructure, or unions. And it's not even close. Bankruptcy is inevitable. The sooner it happens, the better for everyone involved.

One other thing everyone seems to have forgotten about GM: It still owns 49% of one of the largest mortgage companies in America, GMAC. Look at the tight correlation between GM's shares and Freddie Mac's over the last three months:

While GM's car business is the anchor drowning the company, it might be the mortgage business that finally kills it.

Here's a bit of GM irony to consider. GM's lead independent director is none other than George Fisher, the same executive who oversaw Kodak's spectacular collapse in the late 1990s as digital cameras destroyed its core business of chemical film. (I was short Kodak, too.)

Goldsmith tells me Goldman Sachs is still doing well... The firm's prime brokerage business (prime brokerage offers back-office services and trade clearing to hedge funds) made a record $985 million in the second quarter – a 36% gain from a year earlier.

The three largest prime brokerage businesses last year were Goldman, Morgan Stanley, and Bear Stearns. After Bear Stearns collapsed, many funds transferred assets to Goldman. And hedge funds with smaller prime brokerages were scared their suppliers could go out of business, so they transferred their assets to Goldman. One prime-brokerage consulting company estimates Goldman is now the largest provider of prime brokerage services.

As you may recall, young Goldsmith and I have long disagreed about the likely fate of Goldman Sachs. As I've pointed out, Goldman's accounting is simply mystical: Cash flows are always hugely negative, but earnings and total debt seem to always grow. My bet is (and has been for some time) in a race between real economics and fishy accounting, fishy accounting will only win for so long.

Goldsmith, meanwhile, seems utterly bamboozled by the reputation of Goldman's traders, who apparently can walk on water while making millions trading securities. When the "Goldman spat" started last October, the investment bank's shares traded hands for around $240. They are now $70 cheaper... which I believe still greatly overvalues the wisdom of Goldman's trading desk.

And on the subject of the Bear Stearns collapse, guess who will take the hit when the value of Bear's troubled assets fall? U.S. taxpayers, of course. The Fed values the assets it accepted as collateral for the $28.8 billion loan it made to JPMorgan at $28.9 billion, down 3.7% from earlier this year. JPMorgan is only responsible for the first $1.15 billion of losses below the value of the loan. The other $27.6 billion goes to taxpayers.

Commodities bull Jim Rogers on why oil prices are heading higher: "Nobody has discovered any major oil fields in over 40 years, while known oil reserves are declining amid a situation that the demand is boiling. Nearly every oil company has declining oil reserves, nearly every oil country in the world has declining oil reserves... the known oil reserve will not last 100 years."

Rogers admits he's no good at short-term trading, but says it's obvious prices " will maintain an upward trend over a longer period."

New highs: none.

In the mailbag... Finally, some real venom. Normally when the market turns south, we get the blame. We've been waiting. At last, just as the indexes finally enter official bear-market territory, the accusations of perfidy have begun. Is it all our fault, dear subscribers? Please, count the ways: feedback@stansberryresearch.com.

"Perhaps Mr. Stansberry could spend less time telling us about his surfing in Nicaragua or sipping wine in Italy and do proper research. Back of envelope calculations of GM's financial expenses and hate mail about Goldman are not a good substitute." – Paid-up subscriber AS

Porter comment: Judging by the success of my short-sell recommendations this year (all of which are trading at new lows today), I should spend more time surfing, sipping, and enjoying myself...

"Porter's analysis of Fannie and Freddie in the June issue is incredible. You clearly make the case for the inevitable debacle facing these GSEs. As usual the mainstream financial media is not sending the same message. In fact I have recently seen many pundits suggest the worst is over in the mortgage market. My question to you is, given your straight forward analysis, why hasn't anyone else been waving this big red flag? Can you tell me how a government bailout of the GSEs will affect the rest of the stock market? Do you think it will just send all financial stocks down or have a negative impact on the entire stock market?" – Paid-up subscriber Steven Angelo

Porter comment: As with my analysis of GM, the facts about the fate of Fannie and Freddie should be obvious to anyone who bothers to look at the numbers. But you can't forget the role vested interests and politics play in what gets reported in the mainstream press. Quite simply, no one in the mainstream media would risk offending such powerful corporations or their supporters. Thus, we newsletter scribblers are afforded the opportunity. And some of us are foolish enough to try.

"I currently have about $225k in my sep-ira. With about $160k in Janus fund and the Janus Growth and income fund. Other mutual fund holdings include about $40k in the Fidelity 500 fund, and about $25k in mutual funds for Canada, Asia, and Google stock, which I bought at $700 per share and I am down $150/share. The lack luster performance over the years has driven me to subscribe to your newsletter. Can you please recommend how I should reposition myself? I am 45-years old and plan on working for the next 15-20 years." – Paid-up subscriber MU

Porter comment: This is a very frequent question, one we've addressed several times before. While we don't provide any individual investment advice, here's how we think everyone should begin using our letters.

First, you have to learn how to avoid losing money before you're likely to be successful. That means, keep the majority of your assets in safe, fixed-income positions while you get to know our analysts and their recommendations. Second, always remember to use good discipline – which means appropriate position sizing and trailing stops. Third, approach our recommendations with a firm eye on risk. Buy the recommendations you believe have the least risk.

Once you've mastered safe investing, you can begin to buy one or two of our more speculative recommendations. I would recommend spending at least one year getting to know our analysts and their recommendations before I would even consider being "fully invested."

One last piece of advice: I believe almost all individual stock investors lose money, nearly every year. And they all fail for the same reason: They put far too much of their portfolio in one or two risky stocks they don't really understand. If you lose your risk-management/position-size discipline, you will most likely fail, no matter what newsletters you're reading. (By the way, if any of our subscribers have learned this lesson the hard way, please let us know. Maybe if we repeat this advice frequently enough with good real-life examples, a few people could benefit from the "tuition" you've already paid.)

Regards,

Porter Stansberry

Baltimore, Maryland

July 7, 2008

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