The S&A Digest: Goldman's Profits?

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

As of 06/26/2013

Goldman's profits?... Seabridge's deposit gets bigger and better... H&R Block gets off the hook... China buys Bear Stearns?... Arctic cooling, despite Al Gore's best efforts... Still wrong about the Nobel Prizes... The mind of God...

For the last year, we've been telling Goldsmith that Goldman Sachs (GS) must soon take a huge charge against earnings – more than $1 billion – because of inevitable mistakes made by its trading group and the huge amount of leverage the company employs (debt totals $431 billion).

Young Goldsmith seems to believe that Goldman's traders walk on water... and thinks we're only jealous. But we've lived through a few of these cycles. We already know what Goldsmith will soon learn: Pride goeth before the fall. It is only a matter of time before Goldman admits its excesses, like Merrill Lynch (MER) did two weeks ago, writing off $5.5 billion in profit.

In the last quarter, Goldman Sachs reported trading revenues of $8.23 billion, a 70% increase year over year. But Goldman's cash flow statement shows it lost $18.9 billion on operations and borrowed $23.7 billion during the quarter to stay afloat. We surely don't understand everything about high finance... but we're fairly certain that borrowing more money each quarter and losing it on operations isn't sustainable forever.

Jim Chanos, the famous short seller, wondered aloud at Jim Grant's investment conference last month how Goldman is able to continually report blockbuster profits. Analysts speculate that it is exaggerating the balance sheet value of its illiquid mortgage investments. We can't say when Goldman will come clean, but we do know how: painfully.

The situation at Goldman reminds us of the last big debt bubble – the telecom debt bubble of 1996-2001. Every long-distance company in America was losing money, reams of it, as long-distance prices collapsed. There was only one exception: WorldCom, which continued to report positive earnings even as all of its competitors experienced losses. Investors who bothered to look at WorldCom's cash flow statement saw something quite different than what the company put in its earnings press releases: $11 billion in cash losses during 2000 alone.

After it soared from $250 an ounce to $750 an ounce, we can understand your reluctance to buy gold. But... we think it's cheap compared to most metals. Consider this table prepared by our resident geologist, Matt Badiali...

Speaking of gold... Our firm, led by Steve Sjuggerud, has been unabashedly bullish about the prospects of Seabridge Gold (SA), whose primary asset is a gold deposit high in the mountains east of Vancouver, in British Columbia.

The company released more drilling data today, showing the size of the deposit is bigger than expected and the quality of the deposit is higher than expected. "Assay results from drill hole M-07-35 have confirmed a depth extension of at least 300 meters at the Mitchell deposit with the hole terminating in the highest grade gold and copper mineralization encountered to date. The 682 meter hole encountered continuous mineralization from the surface to the bottom of the hole averaging 0.92 grams per tonne ('gpt') gold and 0.24% copper with the last 100 meters of the hole averaging 1.20 gpt gold and 0.35% copper. The hole was terminated due to depth limitations of the drill rig with the last assay reported at 1.58 gpt gold and 0.77% copper..."

What does this mean for shareholders? Well, it's not bad news. Badiali – who has seen the deposit with his own eyes – says, "My estimate puts the deposit closer to 800m in length and 300m in depth. That results in an added resource of 2.25 million ounces and 180,000 tons of copper. At $140 per resource ounce, that adds $315 million to Seabridge's market cap... or $8.50 per share. I'd add that to the $30 share price, so fair value for Seabridge today, arguably, is $38.50 per share..."

Buffett on the move... Berkshire Hathaway is now dumping its railroads. Buffett cut his stake in Union Pacific to 7.4 million shares from 10.5 million and trimmed his Norfolk Southern stake to 3.76 million from 6.4 million. Yesterday's filing does not mention Berkshire's biggest railroad holding, its 60.8 million shares of Burlington Northern Santa Fe.

Graham Summers, who watches insider trading for us, notes that one of our favorite investors, Mohnish Pabrai, owns 12% of Compucredit (CCRT). CCRT is a sort of legal loan shark that makes consumer loans via credit cards to the lowest-quality borrowers – some of whom lack even a bank account. Unlike Goldman Sachs, this lowbrow lender reports rapidly growing cash flows from its operations – $131 million, $278 million, and $508 million in the last three years, respectively. Also buying shares in Compucredit is Randall Abramson, co-founder of Trapeze Asset Management. Abramson bought 5% of Compucredit in September – the same time Summers was recommending the stock to his subscribers. How good is Abramson? He's shown investors average annual returns of 30% since inception in 1998. That's about as good as you can possibly do in common stocks.

Dan Ferris recommended buying shares of H&R Block (HRB) last year when Eliot Spitzer targeted the company. We thought the charges were trumped up, that H&R Block would refuse to settle, and that Spitzer would lose. In July, a New York Supreme Court justice dropped six of seven charges brought against H&R Block by Spitzer. And a federal judge recently dismissed a class-action lawsuit brought by a union pension fund over similar matters. We wish we'd hired H&R Block's lawyers...

Bloomberg reports today that China Citic Bank made a bid for U.S. investment bank Bear Stearns. Those of you in favor of inflation and a weaker dollar may soon find yourselves paying investment-banking fees to the Chinese...

New highs: streetTRACKS Gold (GLD), Petrobras (PBR), PetroChina (PTR), Provident Energy Trust (PVX), Seabridge (SA), Schlumberger (SLB), ExxonMobil (XOM), KHD Humboldt Wedag (KHD).

In the mailbag – someone had to bring up religion. We spend all day thinking about two of the three topics you're not supposed to talk about in polite company – money and politics. So our readers toss in the third, which we studiously ignore. Don't blame us for this one. Blame us for everything else, here: feedback@stansberryresearch.com.

"I know you only told us what Casey's favorite books were. And I also know from reading the S&A for a while where you stand on God and religion. I actually liked Casey's book choices up until the The God Delusion. Unfortunately he and many others are the ones being deluded into thinking that there is no God. God himself stated in 1 Cor 1:19-21, that He would destroy the wisdom of the wise and the 'wise of this world' He would make foolish. His point is this (not my point which is irrelevant), 1 Cor 1:18-19, 'For the message of the cross is foolishness to those who are perishing, but to us being saved it is the power of God.' The smarter we think we are, the less we think we need God. The truth of the matter is just the opposite, the more we know about man and our depravity, the more we realize how much we really need God. Just look at he world, what's going on and our history."

– Paid-up subscriber Rob Hickman

Porter comment: Yes, Doug Casey is an atheist, thus his taste in religious literature. We don't discriminate against atheists, nor do we edit their book lists to suit our tastes, just as we don't discriminate against people with devout beliefs in God. As for ourselves, we've never discussed our own religious beliefs in public beyond making this simple observation: We don't pretend to know the mind of God, and He does not whisper in our ear. As such, we refrain from making comments about our personal religious views... lest we deeply embarrass ourselves at judgment day.

"I am a new subscriber to The 12% Letter and am thoroughly enjoying it. So far I have bo't MCD and BDV on your suggestions. I wanted to make a comment on your article about PFE. I used to work at Nektar Therapeutics (NKTR) for 5 1/2 years supporting the CEO as his Executive Assistant. I recently left in July 2007 after the CEO retired and a new management team was hired to focus on commercialization. Have you ever heard of inhaled insulin? NKTR invented a powdered insulin that is inhaled through the lungs. NKTR also invented the mechanical device that delivered the insulin to the lungs. We partnered with PFE to bring it to market. It took 15 years! It was a long and hard road for little NKTR (formerly Inhale). It took years to get FDA approval since the idea was so new and innovative. Finally, when it passed FDA approval in 2006, we looked to PFE to market it per the agreement we had with them. The product's name is Exubera. Because of some changes in PFE's management, they bumbled the launch. PFE's marketing team has re-grouped and is now in full swing with print and TV ads. It has yet to take off with the public. But, I know for a fact that it is a potential blockbuster product if everyone knew about it. What diabetic wouldn't rather inhale insulin instead of giving shots to themselves everyday? I have talked to a few people who do take Exubera now (it is readily available via prescription). They say the insulin remains more stable in their systems as compared to taking shots or pills; they feel more energetic; and they've lost weight. If this product ever takes off and is accepted by doctors and their patients, this would be a blockbuster for PFE, in my opinion. I'm going to buy PFE based on your research and the knowledge I have about one of their new products, Exubera."

– Paid-up subscriber Barbara Lawson

"Sorry, you are wrong, and anyhow - right! All the Nobel Prizes are given from the Swedes, apart from the Peace prize which is given from the Norwegian Prize Committee. When Alfred Nobel died and his will was opened, Sweden and Norway was united in a union. So, to honor the Norwegian part of the union, the Peace price is decided and given out in Oslo and all the other prizes in Stockholm on the day Nobel died, December 10th."

– Paid-up subscriber Bjorn

Porter comment: Now we know. Thanks for the clarity.

"You're always challenging us to insult. I tried once before, but you didn't publish. So here I go again! I don't know what's created this in you (maybe your unfortunate experiences with the regulatory authorities), but you really do seem to be an arrogant, cynical and embittered fellow! Most of the rest of the world recognizes the efforts and conclusions, not only of Al Gore, but also of the countless scientists and investigators across the globe involved in the clearly serious global environmental issues - and all Porter can do is stand on the by-lines and belly-ache! Virtually the entire rest of the world can see the problems, even if you can't - though I do agree they may be divided as to what to do about them. (Hey, even the seriously blinkered US administration may now at long last be getting the message - hallelujah!) So, I wonder why Porter can't see it? Perhaps you have access to so much research yourself to disprove all the overwhelming evidence to the contrary? If so, please share. Or maybe you just can't see it because you've had your head in the sand for so long... But, speaking as a layman, the evidence seems overwhelming and persuasive, and it's downright churlish not to give Gore and the countless others involved significant credit for bringing this message across. After all, there's no point in shooting the messenger, is there...? You are certainly entitled to your opinions (however outlandish they might seem). Or perhaps you're just winding us up with your rhetoric? In any event, it keeps us mildly entertained. But I'll certainly continue to follow your and your colleagues' fine recommendations on investment (as I have done for many years), while continuing to take many of your other views with a strong pinch of salt and healthy dose of hilarity..." – Paid-up subscriber Mike

Porter comment: My skepticism and cynicism about "global warming" is founded on two unchanging principles of human nature: 1. Incomplete knowledge and 2. The unremitting desire for political power. You've concluded that Gore's movie is a serious compilation of all the scientific evidence and that the matter is decided. You've never stopped to wonder how anyone could be so certain about something as complex and huge as the earth's weather patterns and temperature changes. But imagine you're a bookie. You've got to set odds on these two outcomes: Gore knows all there is to know about the earth's climate or there's a lot no one knows (or could know) about how the earth's temperature varies over long periods of time. How would you set those odds? As I see it, the odds are overwhelming that there's still a lot we don't know about global warming, which involves a still-unknown number of factors that interact in extraordinarily complex ways. Incomplete knowledge is a fact of the human condition. There are very, very few things we know everything about – which is why I'm always skeptical when people (and especially politicians) act as though they have the definitive "answers."

It's fascinating to watch millions of people, absorbing heavily biased, third-hand information, become persuaded to abandon their common sense. All that seems to be required these days is the mantle of "science." Take, for example, the most recent, fear-mongering report out of the Arctic. The "Arctic Council" – 300 scientists from eight countries with a very impressive sounding name – have made a study of "global warming" around the North Pole. The council released its report a few weeks ago – you probably saw the headlines. The group reported the Arctic region is warming at twice the rate of the rest of the world, and it predicted that all of the Arctic ice would disappear (in the summertime) by 2100 – more than 90 years from now.

Given a report on the weather 90 years from a committee of 300 people you've never met, you'd think that some people would have laughed. Why would anyone expect to be taken seriously trying to predict the weather 90 years from now? But no one laughed... or even seriously questioned the findings. The media didn't think to ask even the simplest of questions, such as: Do we have any historical records that show a similar warming trend? Between 1917 and 1937 (a period of time with actual recorded temperatures, not computer models of what temperatures should have been), the Arctic warmed twice as fast as it did in the last 20 years. And the two warmest years on record in the Arctic? 1937 and 1938. (Reason reporter Ronald Bailey actually thought to ask these questions – see his article here.)

Another oddity... The Arctic Council says satellite measurements show the area in Greenland where ice melts in the summer is expanding rapidly – by 16% from '79 to '02. This is a more serious problem than the Arctic melting, because this water runs from land into the sea, which would raise ocean levels and flood places like New York City, Martha's Vineyard, and Palm Beach. But, in contrast to the satellite data, a researcher on the ground in Greenland, Petr Chylek, from Los Alamos Laboratory, discovered that average temperatures in Greenland have been falling by 2.2 degrees Celsius since 1987 and that average summer temperatures haven't changed in 50 years. Strangely, the Arctic Council didn't even mention Petr Chylek's work, which was published in the peer-reviewed scientific journal Climate Change.

Who is right – the scientists on the ground or the satellite surveys and the computer models of groups like the Arctic Council? Who knows? Any honest, thinking person would throw up his hands at the scope of this question – it's simply beyond our knowledge at this point. But that won't stop our politicians...

"Global warming" is the perfect political problem: It can't be measured (which is why everything from tornados to cold weather is now blamed on "global warming"). And to control carbon emissions, which are reported to cause it, would require a tremendous expansion of government regulations – even across borders. For a politician, this is a dream come true... A chance to regulate all the engines of the world with a mandate to "save the planet!" No wonder Gore was drawn to the controversy.

I have no doubt my grandchildren will easily survive even the most dire forecasts of "global warming," but I'm not sure we can survive the solution our politicians will devise.

Regards,

Porter Stansberry

Baltimore, Maryland

October 16, 2007

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