The S&A Digest: Breweries Benefit in the Worst of Times

Squirrels and inflation… Richard Russell on gold… Another elephant oil field discovery… Abitibi-Bowater merger details… Lehman's earnings beat estimates… Recession with a beer back…

We assume that by the time you read this, the Fed will have cut interest rates by 50 basis points. Maybe it will only be 25 basis points, but the details hardly matter: The Fed will cut, and it will continue to cut, because its mandate is to protect the banks. (Yes… I know… its legal mandate is officially "price stability," ha, ha, ha… I'm talking about its actual mandate, though.) Having made hundreds of billions in bad loans, the banks – once again – need to be bailed out.

We pay for such actions through inflation, an invisible tax on the economically illiterate. My friend Bill Bonner says central bankers look at inflation the same way squirrels watch a bank robbery. They see the whole thing and understand none of it. One thing I bet Greenspan's new book won't mention: The dollar lost half of its purchasing power during his tenure.

On the other hand, like geese that feel the winter coming even when it's still warm outside, wise investors have watched the credit bubble build and have flown to gold. Anyone with any sense has long since bought gold – as we've been preaching regularly since 2003. Soon, the kind of investors who like to chase performance (a short-lived, but sometimes influential group) will jump into gold, too. That's when you'll know it's time to take some off the table…

But judging from informal surveys at cocktail parties and airports, we are a long way from that point. Says Richard Russell about the ancient metal: "Gold has now advanced to within easy distance of its May 2006 high. Will gold break out to new highs above 750? I'm thinking that it will. More consolidation may be needed following gold's latest spurt – but my guess is that the gold-bull will win. I say this because fiat money is a fraud, and in the end, honest money will win over fraudulent money. Gold represents timeless wealth that can't be manufactured, while fiat money represents a man-made unit of exchange that can be created at any time in any quantity."

** There's a new "elephant" off the coast of Brazil – the Tupi Field – according to our oil analyst, Matt Badiali. Petrobras (PBR), one of Matt's top recommendations in the S&A Oil Report, is the proud papa. "Frank Chapman thinks the discovery is between 1.5 and 10 billion barrels," writes Matt. "He's the CEO of BG Group, one of Petrobras' partners, which holds 25% of the discovery." But what about "peak oil" – the idea that all of the big oil fields have been found? This elephant was hiding under a salt layer. As Matt explains, "In the past, imaging oil under salt was difficult and few companies would drill a deep, expensive exploration well just to see what was down there. However, improvements in computation capacity and imaging technology allow companies to see through salt better. The result is Tupi, at least a billion barrels of new oil…"

For those of you wondering about the merger of S&A Penny Letter pick Abitibi (ABY) with papermaking peer Bowater (BOW)… The companies issued a press release saying the deal will now close in the fourth quarter.

So far so good… Lehman Brothers (LEH), the largest U.S. underwriter of mortgage-backed bonds, announced better-than-expected third-quarter earnings. Net income fell 3% to $1.54 per share, beating estimates of $1.48. The bank offset a $700 million loss on leveraged loans and mortgage holdings by earning record merger revenues and boosting equity-trading revenue by 48%. Shares jumped 7%.

"To get through these uncertain times, we have to recognize that we all have a stake in one another's success..." says OBAMA! Uh oh. I know where this going...

What OBAMA! really means is that my neighbors have a right to their share of my success... and I have the right to pay them off. Calling his plan a tax cut for the "middle class," OBAMA! intends to raise capital gains and dividend taxes and redistribute the $85 billion in $1,000 bonus checks to "working families." Maybe someone will ask OBAMA! what "middle class" he's really talking about. Seems to me the middle class is overwhelmingly invested in the stock market with 401k plans and IRAs... which means it's the middle class that will actually fund this tax. If I were running for president against OBAMA! I'd use marketing that was easier to understand. My slogan would be: Hey Poor Slobs: Vote For Me and I'll Pay You $1,000!

New highs: Alnylam (ALNY), Covance (CVD), streetTRACKS Gold (GLD), Vector Group (VGR).

The feedback e-mails are slowing. Are you bored with us? Have we not touched on your hot topic? Why don't you give us some suggestions: feedback@stansberryresearch.com.

"I think I understand why Dan Ferris and the Extreme Value newsletter has a short membership period. I joined in February and out of his last 8 picks, 7 of them are down; some significantly. And now I get my newest monthly letter and he spends 8 pages telling me that. I didn't sign up for a review of failure. We didn't even get a pick this month. What's up with that?"

– Paid-up subscriber Brian Davis

Porter comment: We're cheered by e-mails like the above. Brian is right, of course. Value investing doesn't follow a calendar period (great ideas don't pop up monthly, on cue) nor do the shares you buy care about your price expectations. If it was easy and felt good all the time, everyone would buy value stocks… and there wouldn't be any opportunities left for people like us.

Meanwhile, one glance at Dan's long-term performance (either on the back page of Extreme Value or on our Top 10 List) tells you the man knows what he is doing, and maybe… just maybe… a review of his ideas that are now more attractive than when he first recommended them is worth your attention.

"I just went through the Detroit airport, and couldn't help thinking about Porter's GM analyses. In the first-class cabin, I was joined by all the 'blue-collar' people at the gate, people proudly advertising their union affiliations on caps and workshirts. I confess that I eavesdropped on many of their conversations, and it was apparent to me that the UAW see themselves, and act accordingly, as a group of VERY highly skilled, almost indispensable, group of quasi-professionals: in essence, the men and women who give us the crap out of Detroit are not factory workers, but highly-skilled (and apparently in-demand!), picky primadonnas, who can choose (!) to work anywhere! I thought: 'What planet are these people living on??' Then, I remembered PS's pieces, and I understood Rick Waggoner's frame of reference: he is trapped in this fantasy world, and of his own accord. Why SHOULDN'T he continue this charade? He makes an extremely good living, just playing along. The UAW makes absolutely SCANDALOUS wages, etc... The real loser is always the holder of the common stock… There is currently no end in sight for the decline of the American auto industry. I will NEVER buy another American car! They are utter crap, made by idiots, and sold for utterly unrealistic prices. Health care costs per car? Puhleeeeze!" – Paid-up subscriber RR

"I am a great fan of your publications and research and am a long time Alliance member. I enjoy all your publications and have benefited greatly from your excellent research. I do not often make comments but feel compelled to warn other subscribers that your latest publication Advanced Income is misleading at best and most likely highly dangerous to the majority of your subscribers, who do not have a deep understanding of options trading. [Editor's note: Advanced Income is Jeff Clark's last research publication. It uses a "covered call" strategy to produce high annual rates of income.]

"I have traded options for about 25 years now, and was at one point Managing Director at one of London's largest proprietary trading desks, so I have some knowledge and experience. The strategy you are recommending first of all limits the upside and leaves unlimited downside… While this strategy has some merit theoretically, I never use it as I believe it leads to a false sense of security. To apply it to one of the most volatile commodities on the day… seems dangerous. To describe this as 'Income' in some sense, is highly misleading. To call this a 'No-brainer' is just absurd. I hope that you will rethink what you are doing here, and even if you disagree I hope you will publish this in The Digest so that your subscribers will get the benefit of an alternative viewpoint, which may save their bacon!" – Paid-up subscriber Chris Belchamber

Porter comment: The negative opinion on covered calls is not new to me. I recall one of the first things Steve Sjuggerud taught me about trading back in the mid-1990s when we first began working together was to never, ever buy/write covered calls (buy a stock and then sell calls on it). Steve's logic was the same, essentially, as Chris Belchamber's: Owning stock exposes you to a potential loss that's much larger than the premium you can earn selling call options. For years and years, I believed this orthodoxy. Back in 2001, I watched a colleague buy/write a large position in WorldCom all the way down to zero. He'd made $15 in call premium… but lost $50 per share in stock. That's a disaster I knew we'd want to avoid.

On the other hand, a few smart people I know kept pointing out to me that, like any strategy, buy/write can work very well in some markets and in some situations. Slowly, real-world facts began to open my mind to the possibilities. I saw, for example, the highest-returning/lowest-volatility ETF of the last 10 years was a buy/write ETF on the S&P 500. I heard from subscribers who had used buy/write strategies on their core portfolio holdings to create significant amounts of income – as much as 15%-20% a year.

With volatility finally up enough to earn decent call premiums, we decided now was an appropriate time to buy/write covered calls. We also know using a buy/write strategy effectively calls for employing stringent risk-management tools. When your upside might be capped at 10% or 15%, it's even more important that you avoid risky stocks and that you manage your risk very tightly.

I believe we can do this for our subscribers in a number of ways. For example, in my recent buy/write recommendation on Moody's, I picked a stock I'm 100% certain cannot go bankrupt, whose shares I want to own for the extreme long-term, and whose shares I'm fairly certain won't go up much at all for at least six to 18 months. Using a buy/write strategy will allow us to generate income in the position to offset our short-term paper loss, while adding significantly to our long-term gains in the stock. In situations like Moody's, I believe writing covered calls doesn't increase our risk and will add significantly to our returns.

Finally, Jeff Clark – the editor of Advanced Income – is the best options trader I know. His 20-year track record proves his ability to manage risk and produce positive returns.

Does Sjuggerud endorse the idea? I don't know. We'll have to put him on the spot at our upcoming S&A Alliance Conference in November.

Regards,

Porter Stansberry

Baltimore, Maryland

September 18, 2007

Breweries Benefit in the Worst of Times

By Ian Davis

If you needed a stiff drink to get you through your brokerage statement in the post dot-com days, you weren't the only one...

Americans steadily increased their consumption of alcoholic beverages throughout the late '90s and early '00s as the S&P peaked and then plummeted.

The following chart shows the earnings of Anheuser-Busch (BUD) between 1999 and 2004. As you can see, this beermaker's earnings steadily climbed throughout the recession proving that, for most consumers, a cold brew was not a discretionary expense.

And here's a look at how some of the major alcohol distributors performed during the dot-com crash… Clearly Budweiser wasn't the only brand benefiting from these hard times.

The beermaker's stellar performance during the dot-com recession isn't unique. Looking back over the past four recessions, Budweiser has outperformed the S&P 500 by about 39% during these market downturns.

So the next time market blues have you reaching for a cold brew, you might consider buying the brewery instead.

Good investing,

Ian Davis

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