The S&A Digest: Moody's president resigns

Moody's president resigns... the commodities boom... China magically transforms... Don't blame Americans for being stupid...

 Brian Clarkson, the president of PSIA pick Moody's, is stepping down. Clarkson was the driving force behind Moody's push into rating risky mortgage-related securities.

Moody's has 50% operating margins or higher. It made $600 million of free cash flow on negative tangible capital and little capital investment. Few businesses have that kind of pricing power and earnings power. My guess is Moody's will get some more headlines like this as the mortgage crisis continues to play out (and it's far from over). It'll get a wrist-slapping. But without its basic business, the financial world comes to a standstill.

 William Doyle was rich when he was earning $780,000 a year to head Potash Corp of Saskatchewan and held $7 million in stock options at the end of 2003. Then the agriculture boom hit, and fertilizer prices soared. Potash prices have gone from $100 a ton four years ago to more than $600 today, and some forecasts call for $1,000 by year's end. The company's share price followed suit, quadrupling in the last 16 months. Now Doyle's stock options are worth almost $600 million – a number never before seen by an executive of a Canadian public company.

This has become a very familiar sight, hasn't it? It makes me wonder... Who'll be the poster child for malfeasance in the commodities boom? Who'll go to jail? Who'll become the Bernie Ebbers or Ken Lay of commodities? Will there be one for each commodity?

 And what about China? Does anyone really think that, poof, overnight all the corruption in communist China just evaporated, and now you can trust everyone in China? Maybe that's the way it is. I don't know. I've never been there. Maybe I'd see the plain truth if I went there myself. To hear Jim Rogers tell it, everyone in China has had a simultaneous epiphany about capitalism... or maybe it was really in their blood the whole time. Yeah, that's it. Maybe one of the most xenophobic cultures on Earth, which cut itself off from the world centuries ago, is suddenly trusting and open and not at all afraid of foreigners.

No wonder Carlo Cannell of Cannell Capital is shorting Chinese reverse mergers. I know him a little. I've spoken with him a few times and visited him in San Francisco. I know his short strategy. He doesn't stalk through the woods, tracking his prey. He finds it wheezing on the side of the road and shoots it in the head. That's how bad some of the Chinese stocks look to him.

 Anyway, when I see oil & gas and other commodity-related stocks flying out of the chute like this, I start looking ahead. My experience tells me that, because of our inherently inflationary economy, we will have to live through one massive misallocation of capital after another, inflating and popping like new champagne bubbles on New Year's Eve... and creating hangovers by the millions when everyone wakes up on New Year's Day.

I was born in 1961. I've lived through massive misallocations in blue-chip stocks, gold, junk bonds, emerging-market stocks, tech stocks, real estate, and small cap/value stocks. Now commodities are getting the manic money. China and other emerging markets are a little manic these days, too.

 George Soros – the guy who watched $2 billion evaporate when his No. 1 lieutenant put it in tech stocks in late 1999-early 2000 – says don't be fooled by China's price-to-earnings multiple of 40... Chinese managers are creating a lot of value.

I see, George. So what you're saying is... "This time, it's different."

Maybe it'll be okay for awhile. Maybe everyone will become like the old Soros, who says you should ride the trend whose premise is false and jump off before it's discredited. (He sure didn't jump off in early 2000. I wonder if he'll jump off China in time?)

But I don't think so. I think that, once again, the great mass of people with some amount of money to invest won't invest. They'll gamble it all away in hopes of a quick, easy buck. And for a fleeting moment, they'll seem scintillatingly smart at cocktail parties, and all their friends will envy them. What they won't do is think about risk or conduct research. Research and thinking cost something up front. By not doing them, they'll just pay later, instead of sooner.

 The one and only thing about rising commodity prices that makes perfect sense is that they're priced in U.S. dollars. And U.S. dollars are worth the paper and ink they're made of and nothing else. The lower interest rates go, the more liquidity injections and backstops the Federal Reserve executes, the more dollars there'll be sloshing around, looking for a mania to get into.

 I read an article in the Financial Times today that starts, "The US and Europe now have a united desire to see the dollar strengthen against the euro..." It comes as little surprise to us that central bankers on one continent wish to collude with those on another, to the detriment of their own currency. Central bankers the world over are in the currency-debasing business.

The dollar and the euro are both destined to go to zero at some point, since zero is their intrinsic value. While neither outcome is anywhere near imminent, history indicates they are inevitable. Meantime, we're using a lot less cash. In fact, there's a whole new currency out there...

For the first time ever in 2008, this currency will see more use than the cash in your pocket. Paper money has been on its way out for years. And 2008 is the watershed year of its demise. I'll have details for Extreme Value readers in the upcoming issue. Click here to read more about Extreme Value.

 Whatever its source, the ag boom is making people very rich, and Tom Dyson found the best way to play it. His latest International Strategist recommendation is another potash mine. If we assign a forward P/E multiple of two to Tom's pick, it's worth $2 billion. Right now, the stock trades for just over $500 million.

Meanwhile, Potash Corp trades for 43 times earnings (a tad rich, perhaps?). When you buy Tom's stock, you get an energy, timber, and metals business for free. To learn more about International Strategist and receive Tom's latest pick, click here...

 Oil has "outbubbled" the tech stocks of 2000. This chart, which we got from Bespoke Investment Group, shows oil has run longer and higher than technology stocks.

 We first pointed out the MACROshares Oil Down (DCR) ETF last month. The fund, which moves inversely to the price of oil, fell 60% when oil fell 8%. That's because of a special clause in the fund's prospectus... "[If the] Applicable Reference Price of Crude Oil rises to or above $111.00, at which level the underlying value of the Down-MACRO holding trust will be equal to 15% or less of the assets it holds on deposit and, in either case, the Applicable Reference Price of Crude Oil remains at that level for three (3) consecutive price determination days."

Now DCR is trading for $2.60 a share, but the net asset value per share, according to the company, is $0. The fund is liquidating on June 25.

 New highs: U.S. Natural Gas (UNG), Covidien (COV), International Coal Group (ICO), Stone Energy (SGY).

 Do you think this time is different? Let us know at feedback@stansberryresearch.com.

 "I never hear you mention Ron Paul when you write about the sad state of our Union. You should have gained some idea of his politics from the limited exposure he was allowed to have early on in the Republican debates. Obviously enough hackles were raised that his participation was limited more and more in each successive debate. Sadly, he doesn't present the image that most Americans want in their President but, if you've watched HBO's presentation of John Adams, neither did he. I, for one, will 'write-in' Ron Paul come November 4th." – Paid-up subscriber John Haupt

Ferris comment: I hope your candidate wins. I like Ron Paul. I've known about him for decades, since he was serving in Texas. But things just aren't right in our country for a guy like him to get elected. Elections are about one group attempting to vote itself a share of what the other group owns. Ron Paul doesn't talk about redistributing wealth on a massive scale, so he has no chance of getting elected.

I don't blame voters in America for their stupidity, though. We're all stupid about something, some more so than others. That's just human nature. You must accept it in yourself and others to be a happy human being. And American voters are only human. Like other humans, they love to be sold. They love to be told what they want to hear.

Also, I think living in a wealthy country comes with the risk that you get lazy and substitute spending money for thinking about things. Effective marketers, for example, often start not with products, but with price points, because they know people feel like they're more serious about something if they spend a lot of money on it. They're literally just looking to meet the bare minimum requirements for getting you to hand over $20 or $200 or $2,000.

And what's cheaper than a vote? You pull a lever, get some time off from work, and voila! You've just got yourself a piece of someone else's wealth. Not bad for a few minutes leisure.

Good investing,

Dan Ferris

Medford, Oregon

May 8, 2008

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