The S&A Digest: Shocked: Inflation is rising

Shocked: Inflation is rising... Big money starting to buy gold... Weber explains: not a regular bull market... Famine possible?... Insiders buying mortgage insurance stocks... When not to use trailing stop losses... Time to buy Cuba?... Are we front running?...

The big news today was about inflation...

Consumer prices (at least as they are measured by our government) are now increasing 4.3% annually. Considering the yield on our government's two-year bond is only 2.1% annually, lending to the government guarantees you a loss in real terms.

The same is true, to some extent, all the way out to the so-called yield curve. Ten-year government paper is only yielding 3.9%. Who, we wonder, would lend to the U.S. under these terms?

You probably don't spend much time thinking about the real rate of inflation... or about the consequences of a paper money regime that's unable to withstand the size of its outstanding obligations. You probably have much better things to do with your life. At least, I hope you do. On the other hand... perhaps you, like us, have an endless fascination with human folly. How long will people believe in the nonsense of central banking and paper money?

The whole idea that the Fed is attempting to save the value of our currency is absurd. Not only is the Fed the cause of inflation, our system will inevitably require more and more inflation. Inflation has the twin effect of both raising taxes (more wage-earners will end up in higher brackets) and silently eroding the value of the debts our government owes. It is the perfect political solution to our country's vast economic problems. Like all political solutions, all you have to be willing to do is ignore the terrible long-term consequences.

And so... the real question is not whether or not inflation will increase – of course it will – but instead how long the charade will be allowed to continue. How long will America's creditors tolerate the never-ending abuses of our Treasury and central bank? As we remind you regularly, God does not whisper in our ear. It is not given to us to know the future. All we can do is watch carefully for signs about how the tides might be changing. And one slowly growing – but very powerful – change is people's interest in gold as an alternative to paper money...

A good friend of mine is an investment banker. In fact, he was part of the team that took Microsoft public many years ago. That and several other giant deals left him an extraordinarily wealthy... and knowledgeable... man. For the first time ever, he contacted me about gold this week. What should I buy, he asked?

The idea that gold should replace our paper dollars hasn't been seriously discussed in a mainstream financial publication for longer than I've been doing financial research. And yet, in this week's Barron's, columnist Gene Epstein cited Greenspan's famous 1966 essay, which defended gold as the protector of an economy's stability. Epstein explains the timeless allure of gold as money:

"A gold standard will protect the economy from 1) the business cycles that have long burdened it and 2) the rapid price inflation that Greenspan sees as a future plague. It also will 3) prevent the government from raising funds through the unilateral expansion of money and credit that Greenspan used to regard as a plague on our freedom."

Finally, my old friend Chris Weber, who probably knows more about the history of gold and silver than any other living newsletter writer in the world, thinks the time is coming again when gold and silver will be the only trusted forms of money. From his latest letter:

"I think that this is a bull market different from others like in stocks. I simply view gold and silver as real money. And more importantly, I think in the coming years the rest of the world will come to view it likewise. I can foresee a time when the nature of international payments and the global monetary system will be very cautious about any paper that is not backed by a real asset like gold. This will be the result of years of inflating those paper monies, or securities of institutions that get into real difficulties with debts or are otherwise insolvent..."

The only way for the U.S. economy to survive its debt load is to destroy the dollar as the world's reserve currency. What will replace the dollar? My bet is gold and silver – something I've believed for a long time. But for the first time in my career, I'm seeing other people saying the same thing. The tide is turning toward gold. Slowly... but surely. I'm seeing big money – institutional size accounts – starting to buy gold and rare gold coins. If you don't own gold yet, you've made a mistake. But it's not too late. Imagine the impact of a Democratic president and a Democratic Congress on our national balance sheet...

Also fueled by inflation – agriculture. Ethanol production and booming Asian demand are pushing corn, wheat, and soybean prices to record levels, and they're probably going higher. William Doyle, CEO of Potash Saskatchewan, the world's largest fertilizer producer, said, "If you had any major upset where you didn't have a crop in a major growing agricultural region this year, I believe you'd see famine." Global grain stockpiles fell to a 53-day supply last year, the lowest level since record keeping began in 1960.

Yesterday, we reported on Credit Suisse's $2.85 billion accounting mishap. Today, we show you what's happening with Switzerland's largest bank, UBS. Lehman Brothers estimates UBS has $97.3 billion in subprime exposure on the books and expects to see a $9.1 billion writedown this year. Other analysts wouldn't be surprised if UBS lost a quarter of its mortgage-backed assets. UBS is coming off an $11.4 billion loss.

Bond insurer MBIA is down more than 80% since last year, and yesterday the company replaced CEO Gary Dunton with former CEO Joseph Brown. We've reported extensively on the credit problems surrounding MBIA and Bill Ackman's massive short position in the company. Despite all the negativity, two company insiders have put a combined $600,000,000 in shares over the past month. Brian Heyliger covers this and other insider opportunities in his latest Inside Strategist, coming out tonight.

New highs: Anworth Mortgage (ANH), PowerShares DB Agriculture (DBA).

In the mailbag... The Digest isn't what it used to be, according to some. How have we failed you, dear subscriber? Let us know here: feedback@stansberryresearch.com.

"I want to invest in Jeff Clarks financial advisory and must talk to Jeff or a person affiliated with his organization. I have several questions I must get answered before I can move forward. How do I contact and communicate with a HUMAN in Jeff Clarks group?" – Paid-up subscriber Teresa Falcone

Porter comment: If you'd like to speak with a human about Jeff Clark's options trading service, S&A Short Report, please call our customer service department at 1-888-261-2693. They will help you with any questions you may have and process your order for Jeff's service.

All I can say about Jeff is that in the past month, he has made 156% buying Citigroup calls and 147% buying D.R. Horton calls. He is, without a doubt, navigating this turbulent market better than any other editor at S&A. And the big gains aren't over. He pounded his chest today, telling us, "I can't possibly construct a portfolio with more potential than what we have right now. Just about every position looks like it's on the verge of a major move."

If you're interested in learning more about the Short Report, click here... We're running a special on the service that ends tomorrow night at midnight.

"You editors have many talents, but daily writing in an engaging, provocative, educating, and entertaining style is not one of them. It is your business and your decision on whether or not to continue editing Digest, but I am fairly certain that without your involvement, it will go back to what the daily e-mails used to be - rehashing of tiresome platitudes. As a member of the Alliance program, I have plenty of reading materials coming from S&A, yet I used to open Digest first. Not any more..." – Paid-up subscriber AK

"What is going on with Verizon? I was a little late getting in, but after Porter said, 'You can't call yourself an investor without owning this stock' I bought in and am now several dollars down on this stock. Can you tell us something you know that we don't?" – Paid-up subscriber Joe

Porter comment: Wall Street is panicking over the idea that Verizon and AT&T will engage in a price war, because both firms recently announced $99 per month, flat-rate wireless calling plans. While I'm sure that wireless prices will continue to fall, I also know that increased usage will make up for the lower prices. I also know the fiber infrastructure Verizon has built over the last three years (fiber to the home) will ensure its business continues to perform strongly, as it will continue to take market share away from the cable operators.

As more and more video moves to the Internet, Verizon will become the top consumer choice for Internet access. I would repeat, empathetically, my earlier statement: You shouldn't consider yourself an investor if, upon seeing Verizon trading for less than five times pre-tax cash flow and with a yield around 5%, you didn't buy the stock.

"I purchased TMA and ACAS a couple months ago when it appeared that things were about as bad as they were going to get. Unfortunately, they got worse. The recommendations to buy these two companies were solid and I believed in them wholeheartedly. I was in it for the long haul, but I was reminded of your 25% stop loss rule. In January I stopped out on both trades. Although I was tempted to buy more at such ridiculously low prices, I followed your rule and sold both at a huge loss only to watch them soar back past what I bought them for a couple of months earlier. When is it okay to ignore your strict stop loss policy? Don't get me wrong, there is no blame here. I just want to know when it's okay to ignore that rule and I would love to here someone put in their news letter that it would be wise to ignore such a rule in certain cases like these. Now I'm looking at getting back into these 2 stocks and I'm left wondering if I'm just making the biggest mistake of all: buy high, sell low and turn around and do it all over again! Again, I know you use the rule of don't buy the same stock for at least 6 months after stopping out." – Paid-up subscriber Todd

Porter comment: You shouldn't follow the trailing stop loss rule in those cases when the shares bounce back strongly and immediately go on to post higher and higher prices. We thought everyone knew this....

"I am a Canadian subscriber. I have been to Cuba as a tourist... but this winter I am going to Cuba EVERY week as an airline pilot. The scenery is lovely. The weather is beautiful. The Cubans I have been in touch with (in Cuba) are very nice people. I am very fascinated by this island nation: they have one of the highest literacy rate in the world, they have fought wars in many foreign countries, they have managed to survive the US embargo, GSM cell phones work in many cities, they have a thriving tourism industry (tourists from everywhere except Africa, Asia and the USA), their music and dancing is legendary, they were ready to send hundreds of medical doctors to the USA in the aftermath of Katrina (but the USA told them they were not welcome!!!), they have many qualified professionals in all fields, US made cars and goods are all over Cuba (imported via Mexico, Canada, Bahamas...). Cuba has almost 20 international airports... and on our flights we carry many Americans who are happy to visit a unique and interesting country. As a gesture of appreciation for the American citizens who chose to be tourists... the Cuban authorities will NOT stamp their passport. I chose not to express my opinion regarding the revolution and the Castro regime... but in a nutshell Cuba is a gem in the rough." – Paid-up subscriber YM

Regards,

Porter Stansberry

Baltimore, Maryland

February 20, 2008

Are We A Bunch Of Crooks?

By Ian Davis

"One of the most frequent accusations S&A receives is that we're a bunch of no-good front-running a-holes. Our stocks jump up before we release the info to the public.

"I think it's ridiculous... where are the complaints when the stock goes down 3% before we recommend it?"

Our editor in chief, Brian Hunt, e-mailed me this question last week... along with a request to research the price movements of our recommendations before they go out to the public.

(For those of you who don't know, front running is an illegal practice in which a broker takes a position based on information he gets before clients do, or ahead of a buy recommendation by his brokerage. In our case, it would mean an editor or analyst buying a stock before he recommends it, or releasing the information ahead of his recommendation.)

Can statistics help us disprove our angry readers?

I needed to find out... and that meant doing what I love to do, gathering some data and running numbers.

How I Set Up the Study

I looked at 121 stock picks made by our editors over the past 12 months. I picked stocks that are still open today.

Although this is not a complete list of our picks, it's an unbiased sample. It includes picks from all of our publications. It also includes picks that are brand new, as well as longer-term holdings.

Here is what I looked for...

1) Abnormal volatility prior to publication.

There is often a flurry of activity as our readers race into a new trade. As a result, the price and trading volume of the stock increases, and the volatility increases.

This has a cascading effect as other investors react to the stock's abnormal behavior. Some decide to take profits, and others decide to purchase more stock as they attempt to ride the momentum.

In this study, I looked for any abnormal volatility that occurred prior to releasing a recommendation.

2) Abnormal rallies prior to publication.

If someone were front-running one of our recommendations, the price of the recommendation would climb in the days before we released the issue.

In general, a stock is likely to rise about 55% of the time on a given day and fall about 45% of the time. If this ratio is positively skewed (i.e. if our recommendations tended to rise 65% of the time rather than 55%), it could be one sign of front running.

I examined the daily price movements of our recommendations each day starting five days before an issue was published and ending two days after it was published. So, did I find what I was looking for?

The Results of the Study

It is difficult to summarize a study like this without using a lot of math-speak. However, I'll try to be gentle.

First, let's look at volatility.

Standard deviation is a mathematical measure of volatility. It describes how wildly a stock moves over a given period.

Roughly 68% of the time, a stock will move less than one standard deviation from its average change in price each day. About 95% of the time, it will move by less than two standard deviations from its average.

For example, let's say we have a stock that goes up by an average of 0.2% each day, and it has a standard deviation of 2%. That means, roughly 68% of the time, the stock will move by between -1.8% and +2.2%. Also, 95% of the time, the stock will move between -3.8% and +4.2%.

The following chart shows the actual number of our picks that moved within one standard deviation of their mean each day. The bottom axis shows the number of days elapsed since an issue was published.

Number of Stansberry Recommendations with Normal Volitility

(should be about 68%)

As you can see, the number of picks that moved a normal amount is almost exactly the number you'd expect if the daily stock movements were completely random. The only exception was when one day had elapsed... The stocks were unusually volatile the day after an issue went out.

Furthermore, although you'd expect to see the stocks move by more than two standard deviations from the mean about 5% of the time, there was not a single case of a stock moving more than two standard deviations from its mean.

When looking at volatility, there was no statistical evidence of front running.

Now, what about positive skew?

Roughly, the same number of stocks rallied going into a recommendation as fell. The following chart shows the percentage of our recommendations that rallied. The bottom axis shows the number of days elapsed since an issue was published.

Number of Stansberry Recommendations Rallying Before an Issue

(should be about 55%)

As you can see, the percentage of stocks that rallied each day stayed fairly close to the expected 55%. In fact, if anything, our recommendations fell slightly more than expected leading up to the publication date.

As a final test, I analyzed each publication separately, to see if any particular editor has been front running in small amounts. However, using the same two measurements, I found no evidence to support even localized front running.

The following chart shows the average percent change of 10 True Wealth stocks prior to their recommendation. Again, the bottom axis shows the number of days elapsed since an issue was published.

Normal Stock Behavior, Followed By a Post-Recommendation "Bump"

As you can see, the price movement is normal leading up to the recommendation date. The day after the recommendation, the stock prices spike.

The other Stansberry Research publications had very similar charts.

In conclusion, I found no evidence of front running. However, if you are following our recommendations, I would caution you against placing a market-order the day after one of our issues is published.

Until next time...

Good investing,

Ian Davis

Stansberry & Associates Top 10 Open Recommendations

Stansberry & Associates Hall of Fame

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

As of 06/24/2013