The S&A Digest: A run on one-ounce Eagles

A run on one-ounce Eagles... Inflation-proof stocks... Airlines, banks, and other people's money...

We received this note yesterday from our own Matt Badiali:

Just got off the phone with Van Simmons (an executive with David Hall Rare Coins). He said there is a shortage of both Silver Eagle coins and 100-ounce bars. He can't get them. He said that, for the first time in his career, a supplier that guaranteed delivery simply couldn't make good on the promise. He also told me that platinum eagles are in serious short supply. I guess that means someone out there is buying up the physical metal in a big way.

The U.S. Mint has run out of one-ounce American Eagle gold coins. And it's been rationing Silver Eagles because of the high demand.

The U.S. mint sold 60,000 one-ounce gold coins this month, up from 47,000 in July and 13,000 in June. When gold fell from the $900s to the $700s, small buyers didn't sell, the way they usually do. They bought.

Abraham Lincoln may have been an even worse president than FDR, but he had one thing right: You can't fool all of the people all of the time. People know the government is destroying their currency, so they're turning it in for gold, which is exactly the right thing to do.

So if gold coins are dear, why are mining stocks so cheap? Today's Heard on the Street column provides a few details on the subject. For one thing, cost pressures are hitting the miners. A Lehman Brothers analyst says inflation accounts for half the increase in the capital spending of mining giant Rio Tinto from 2003 to 2006.

Most people view mining stocks as inflation hedges. But at some point, it becomes illogical to view a highly capital-intensive business that way. Sure, at first, it seems like it's just too expensive to build a new mine or refinery. And that gives existing facilities an advantage.

But over time, given persistent inflation, running those existing facilities will cost more and more. The more it costs to run the existing ones, the more it seems to make sense to build new ones. And the cost increases aren't necessarily passed on. Mining companies don't have any pricing power over their goods. They sell products whose prices are set on the open market, minute by minute, at the whim of the herd.

The only real consistent inflation beater, aside from holding gold coins, is to buy companies like Procter & Gamble, Altria, Philip Morris International, Coca-Cola, and UPS. In good times and bad, these companies are acquired by knowledgeable corporate buyers at around 30 times earnings. As were Gillette, Wrigley, and Anheuser-Busch.

These companies are the greatest franchises on Earth. They're better at beating inflation than other businesses. The products they sell don't cost much to make, nor do they cost much for customers to buy. And the brand names give customers a sense things will remain the same, that you can count on them. So when the price goes up a little here and there over time, the business doesn't suffer. We don't think twice about buying Coke. We pick it up wherever it's cheapest, but we always buy it.

Private equity big-boy Kohlberg Kravis Roberts has "expressed a high level of interest" in buying Lehman's high net worth asset-management division, Neuberger Berman. If Lehman was to sell Neuberger, it would be breaking the No. 1 rule of trading, let your winners run. The division is one of Lehman's last remaining profit centers, and the firm is willing to sell it to cover liabilities – not the best move for Lehman's future. The bank also denied the plot to oust CEO Richard Fuld.

Not only does Lehman not want to let its winners run, it doesn't want to cut its losers. So far, we haven't heard much about Lehman selling distressed assets. That's because if it sells some bad bonds or loans, it may have to mark down other assets it's keeping. According to today's Wall Street Journal:

Firms jettisoning troubled mortgage assets today would likely get worse prices than at any time in the crisis. Bonds backed by Alt-A mortgages and jumbo prime mortgages are trading at record lows, according to Credit Suisse, while subprime loans are only slightly above their mid-July trough.

The one thing Lehman can't afford is for anyone to know the fair value of its holdings. That would tank the stock even harder and make the possibility of raising new capital even less likely than it already is. Lehman could have real trouble surviving.

If you can't make money buying airline stocks now, you never will. Airlines are cutting flights, raising prices, and doing away with superfluous safety features... Jazz, Air Canada's regional affiliate, will no longer carry life vests on flights to reduce fuel consumption. In case of a water crash, passengers will only have their seat cushion for flotation. The vests add about 50 pounds to each plane.

Banks, too, are cutting costs with rigor (although banks aren't placing clients in danger of drowning in a water landing, as far as we know). Citigroup is enforcing "highly efficient" spending including banning off-site meetings among its own employees and limiting color photocopying. Any offsite meetings with clients require approval, the memo said. Citi will remove color copiers from some locations and limit their use to client presentations. The memo didn't say how much Citi will save from these actions – probably not as much as the 14,000 jobs the bank cut so far this year.

We reported James Simons' quantitative hedge fund, Renaissance Technologies, was smashing the market this year, but Goldman's Global Equities Opportunities fund is suffering... The quant hedge fund has fallen from $6 billion under management in September 2007 to around $1 billion today. Of course, Goldman wouldn't comment on the fund.

New highs: none.

In today's mailbag, the key to eating well... go on the dole. Mail your tips here: feedback@stansberryresearch.com.

"I must have been smoking something illicit when I picked up a 2% position in [Corporate Executive Board] for income clients. I like the cash flow story and the valuation is OK... but it seems more propitious to me to hold the cash until we get bit lower gas/oil prices. Gas may not go much lower, so I may have a faster trigger there.

"Sold EXBD today... stuff happens sometimes and it's better to act early rather than late. I'll leave EXBD to Ferris for the time being at least.

"You check out the yield and the chart of AOD? Alpine says that the fund uses earnings to pay the dividend, but just look at the NAV fall since inception. Yield is 18%, dividends paid monthly. They use dividend capture to goose returns and may be holding stocks too long.. Or they blow the buying decision.

"Something isn't working, yet the manager got kudos from Barron's a couple of weeks ago in their Top 100 fund managers section (mgr is no. 49). This being said, only about 40% of the portfolio is hers.. the international stocks are chosen by another guy."

– Paid-up subscriber J

Ferris comment: One of the things I've learned from researching public companies is those that do a good job of handling other people's money are the gold coin of the stock market: rare and valuable. But most people don't know how to recognize them. I've got a short list of the best ones, part of which I've put into a special report for new subscribers to Extreme Value. To get access to the report, click here.

"Thought you all might be interested to know the following... on NPR this morning there was a blurb about how food stamps can now be used to buy organic food at farmers markets across the nation. I was shocked to hear how the 'poor' can now buy some of the most expensive food available at our expense... Many hardworking Americans who don't live off the public largesse can't afford such food!" – Paid-up subscriber CH

Ferris comment: I know what you mean. We're eating hot dogs and spaghetti around here.

Regards,

Dan Ferris

Medford, Oregon

August 26, 2008

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