AIA Advocate for Absolute Returns : Commodities

Association of Investor Awareness - Week of 11/20/2008

Research & Editorial Staff — Thu, 20 Nov 2008 15:31:00 GMT

In This Issue:

Stocks Search For A Bottom
High Energy Prices Will Return
Commodities Will Also Rebound
Infrastructure Spending Is Likely To Soar
The Bottom Line This Week

Stocks stumbled badly again last week as deteriorating economic news caused another round of investors to throw in the towel. By Friday afternoon, the Dow and the Nasdaq were down an additional 5.0% and 7.9%. The declines left the two indices down 35.9% and 42.8% for the year. Ouch!

This week got off to an equally bad start. Although we had a 151 point gain on Tuesday, it was overshadowed by a 651 point slide on Monday and Wednesday.

Stocks Search For A Bottom

As we discussed in our October 16 issue, each additional market plunge marks another step in the capitulation process that must run its course before stocks can begin to recover. How long the selling will last, and how far the market will fall before the carnage stops, is anybody's guess. For the present, sentiment is overwhelming fundamentals.

What we do know, however, is most stocks are more attractively priced than they have been in over 20 years. We can also say that over a century of stock market history shows that investors will eventually price stocks at their proper values. That means we can start to purchase today's high quality bargains with a lot of confidence that they will pay off at some point in the future.

Three important developments look especially attractive now. We think each of them has the potential to significantly increase the value of your long term portfolio.

High Energy Prices Will Return

Contrary to what Joe and Sally MidAmerica may believe, the energy crisis is not over - it has merely been suspended due to the global economic slowdown. When demand picks up again, the world will go back to the tight supply/demand situation that pushed prices into the stratosphere earlier this year.

The numbers tell the story. Before the economy started to cool off, oil producers pumped 86 million barrels a day. At the same time, the world consumed 85 million barrels a day. The million barrel difference was the tightest supply/demand balance we've ever seen in a major commodity.

According to an article in Forbes, world oil demand has since fallen by 1.1 million barrels of oil a day. That small decline still leaves the supply/demand balance on a knife edge. It would not take a very big uptick in the economy, or a problem with supply, to push the world back into an energy deficit. Every expert we consulted expects to see it happen within a few years. Several analysts think that shortages may reappear by late 2009.

Astute readers might look at the data and wonder how such a small decrease in demand could create such a big plunge in prices. The answer is it couldn't do so by itself. However, during the first half of 2008 suppliers were so worried about a possible delivery interruption that they built up their inventories to record levels. The Saudi's even used retired oil tankers as depots.

As a result, when demand slacked off a few months ago the world suddenly found itself awash in oil, and prices plunged. Once the extra oil is gone, prices will start to move back up again.

Attractive Energy Investments:

We think the tight oil supply/demand situation is a great opportunity for long-term investors. One way to play the rebound is to invest in ExxonMobil (XOM), the world's largest energy supplier. http://finance.yahoo.com/q/bc?s=XOM

ExxonMobil is a highly diversified company that produces both oil and natural gas, much of which it turns into petrochemicals, fertilizers, plastics, and other products. The company also has interests in electrical plants that are fueled with XOM's energy.

Despite ExxonMobil's leading position in its industry, the stock now carries a low P/E of 8.2 and a forward dividend yield of 2.2%. All in all, we think XOM is greatly oversold.

Another company that should do exceptionally well over the next few years is Transocean (RIG), a stock we have recommended in the past. http://finance.yahoo.com/q/bc?s=RIG All the major oil producers report that they need to find additional supplies, and they are willing to spend many billions of dollars to get them. As one of the world's leading exploration and development companies, Transocean should capture a great deal of the new business.

Commodities Will Also Rebound

The outlook for raw materials and commodities is nearly identical to that for energy, and for the same reasons. Particularly with agricultural commodities and some industrial metals, the surpluses are not very large. The supplies will disappear quickly when growth starts to rebound.

Attractive Commodity Investments:

One company that is already bouncing back is Archer Daniels Midland (ADM), an old favorite of ours. http://finance.yahoo.com/q/bc?s=ADM From its 2008 low of $13.53, the stock is back to the mid $20 area - a move that occurred while the economy and stock market were dropping.

The ADM rebound should not be a surprise because many foreign economies are still growing, and so are their populations. Since ADM deals in inexpensive basic foods, including grains and oils, the company should remain on a growth track for as far ahead as we can see.

Yet to recover is another top-performing AIA Advocate pick, BHP Billiton (BHP). http://finance.yahoo.com/q/bc?s=BHP This leading supplier of industrial metals is more sensitive to the economy than ADM, but that means it should rise even more strongly when growth begins to pick up. Meanwhile, BHP has an incredibly low P/E of 5.7 and an eye-popping 5% yield.

Alas, the yield may decline later this year if lower earnings force the company to reduce its dividend. Nevertheless, we believe BHP is an excellent value that will be very rewarding in long-term accounts.

Infrastructure Spending Is Likely To Soar

Last week we discussed how President-elect Obama is likely to affect the U.S. economy. He has since announced that one of his first moves will be to boost spending to upgrade and expand America's woefully out-of-date infrastructure. Besides fixing serious problems, the projects will create countless jobs and pump badly needed cash into the economy.

One of the first projects will be to upgrade and expand our antiquated electrical grid. As many readers may have experienced first hand, the system is so strained that large regions of the country have been plunged into darkness due to relatively minor equipment failures.

Another reason the grid must be upgraded is much of it is unable to handle the additional power that will be produced by the new electrical plants that are scheduled to be constructed. Two solar and wind power projects have already been cancelled because the local grids could not handle the extra loads. This bottleneck must be removed before America can solve its energy problems.

Attractive Infrastructure Investments:

One company that is in the catbird's seat to profit from efforts to improve our electrical grid is General Cable (BGC). http://finance.yahoo.com/q/bc?s=BGC As its name suggests, the company is a major producer of high-capacity electrical wires that are used in power transmission systems worldwide. In addition, the company produces wires and cables that are used within electrical plants. Products are also supplied for many industrial applications.

General Cable looks especially attractive because it has been hammered by the slow economy and the stock market plunge. Its price is down 86% from its January high, which is out of proportion to its earnings decline from $1.11 to $1.07. Such an extreme sell-off can only happen during a market panic. When the sell-off ends, General Cable should move back up.

We also like the outlook for Quanta Services (PWR), a company that installs and maintains electric power transmission lines and power distribution networks. http://finance.yahoo.com/q/bc?s=PWR In addition, the company provides many services to the natural gas, telecom, and cable TV industries.

Quanta is also down sharply from the high it reached when the economy was booming. Although the outlook for continued profit growth this year has dimmed considerably, the stock appears to be greatly oversold for its longer term potential.

The Bottom Line This Week

In the current race for the exits, investors are tossing many high quality stocks aside no matter how good their long term prospects may be. Leading companies in the energy, commodity, and infrastructure sectors are especially attractive. However, we continue to urge everyone to buy stocks a little at a time because prices may go lower before they begin to turn around.

Week of 08/28/2008

Research & Editorial Staff — Thu, 28 Aug 2008 17:25:00 GMT

In This Issue:

Tensions Between The U.S. And Russia Are Serious
Oil And Commodities React To The Threat
Defense Stocks Look Even Better Than Last Week
And So Does The Dollar
Inflation vs Deflation Contest Heats Up
But Inflation Should End Up With The Gold
The Bottom Line This Week

Last week the stock market revealed that it has more underlying strength than world events would seem to justify. If the market is once again acting as a leading indicator of the future, the outlook is brighter than is generally supposed.

Despite the fact that a new cold war seems to be underway, the Dow was only off 0.3% last week. The Nasdaq declined 1.5%. The market dropped 242 points when it reopened on Monday, but it regained nearly half the loss on Tuesday and Wednesday.

Our feeling is that investors want to be buyers and can only be held back by disturbing news. That's a big difference from a bear market mentality when bad news drives prices and good news is ignored.

Tensions Between The U.S. And Russia Are Serious

Investors' underlying optimism aside, the prospect of another cold war is not a trivial concern. Russia has been using very harsh language about what it sees as an American attempt to surround it with NATO states and U.S. anti-missile batteries. There is a chance the arguments could have serious consequences.

Vladimir Putin of Russia promised that his country would respond to the threats, and that is clearly happening in Georgia. In addition, on August 18 Russia sent a large fleet of naval vessels towards the port city of Tartus in Syria. The goal appears to be to obtain an agreement to build a naval facility in the country. If so, it would give Russia its first base on the Mediterranean Sea. Washington won't like that at all.

Russia was also very unhappy with the West's approval of Kosovo's independence from Serbia, a traditional Russian ally. Mr. Putin made it very clear that the argument for Kosovo's independence applied equally well to Abkhazia and South Ossetia in Georgia. On Tuesday of this week, Russia decided to formally recognize the independence of both regions. Now the world is waiting to see what the American response will be to the latest Russian moves.

Oil And Commodities React To The Threat

Although U.S. investors are taking the problems with Russia in stride, the same is not true everywhere. Global markets are finally pushing oil prices up in anticipation that supplies could be cut. That's a sharp departure from the resilience of oil during the early days of the conflict in Georgia.

Gold, industrial metals, and several other raw materials also jumped in price last week after falling sharply earlier this summer. As with oil, investors are nervous that supplies could be disrupted.

The bottom line is that readers should consider the growing problem with Russia as they make their investment plans. There is no need for undue alarm but neither should investors have a cavalier attitude towards the events.

Defense Stocks Look Even Better Than Last Week

One part of the stock market that is likely to profit from increasing global tensions is the defense sector. Our recent recommendation of the Fidelity Select Defense & Aerospace Fund (FSDAX) http://finance.yahoo.com/q/pr?s=FSDAX and Raytheon http://finance.yahoo.com/q/pr?s=RTN could not have been more timely. Both investments stand to gain from the possibility that another cold war may be starting.

Orbital Sciences (ORB) is also in a very good position to appreciate over the next few years. http://finance.yahoo.com/q/pr?s=ORB When the company was formed in 1982, nearly everyone in the aerospace industry laughed at the effrontery of the young firm that thought it could enter the space business from scratch and with only a few million dollars.

The guffaws came to a halt 16 years ago when Orbital Sciences launched its first space vehicle. Since then, the company has delivered over 110 satellites and space-related systems to its customers.

Orbital Sciences' niche is providing small, and often reusable, launch systems. The company is the developer of the unique Pegasus rocket that is released from an aircraft at high altitude and then shoots into orbit. The Taurus series of rockets are ground-based variants of the Pegasus.

The company also produces the Minotaur rocket. It is the only U.S. launch vehicle that can be deployed from all American spaceports, including those operated by commercial interests. Taken together, the company's rockets offer the most efficient means to place small payloads in orbit.

Lastly, the company is a major supplier of interceptor booster rockets that will carry kill vehicles to destroy long-range enemy missiles in midcourse before they reenter the atmosphere. Another system intercepts enemy missiles in the early phase of flight when they are most vulnerable. Both developments are part of the layered missile defense system the government is in the process of placing around the world. The program will be worth many billions of dollars over the next few years.

And So Does The Dollar

At first glance it might seem that the dollar should weaken if America faces a period of rising tensions with Russia. Instead, the dollar has been strengthening.

One reason the dollar is strong is countless people around the world are becoming nervous about the euro, our currency's main competition. That's because many European countries share a border with Russia. In addition, several of them have joined NATO, a move that Russia vehemently opposes.

There is also a purely economic reason for the euro's weakness. The European economy is weakening which means the EU Central Bank is unlikely to raise interest rates as expected. If the European economy slips much more, the bank might even lower rates. The poor interest rate outlook is making the euro less attractive than the dollar.

As with our defense stocks, the PowerShares Dollar Bull ETF (UUP) also looks better this week than it did last time. http://finance.yahoo.com/q/pr?s=UUP The same is true for ordinary dollar accounts, CD's, and T-Bills. The returns from the interest they pay is pathetic, but the dollars themselves are starting to buy more of what you need – especially imported products.

Inflation vs Deflation Contest Heats Up

During the past several years, the biggest monetary threat Americans faced was rising inflation. Although the official rate remained low, the government conveniently took food and energy costs out of the equation to make the numbers look better. For real people who like to eat and keep their homes comfortable, the cost of living has been rising steadily.

However, when the credit crunch began billions of dollars started to disappear from the economy. Every bankruptcy, foreclosure, and layoff reduced the amount of money in our system. The hemorrhage was as least as large as the amount of money and credit the Fed was pouring into the economy.

In July, the money supply actually shrank. Data compiled by Lombard Street Research show that M3 (broad money) fell by almost $50 billion during the month, the biggest thirty day decline since modern records began in 1959. It shows that deflation gained the upper hand in spite of the Fed's efforts to control it.

But Inflation Should End Up With The Gold

In a deflationary environment, the value of money goes up, and that's what we are seeing today with the dollar. At the same time, precious metal prices usually decline, which has also been happening.

If we believed that deflation would continue for any length of time, we would make several changes in the recommendations we made in recent months. However, we think the deflationary period will be brief and inflation will come back. Most likely, the turnaround will occur before the year is over.

If we are correct, you should use this period to buy inflation hedges at today's bargain prices. Gold and silver, for example, are less expensive now than they were earlier this year.

We also think energy stocks will rebound within a few months. Again, if we are right, you should use this time to buy more of the industry leaders while they are cheap. At the minimum, we think you should own the Fidelity Select Energy Service Fund (FSESX) that holds the major exploration and development companies in its portfolio. http://finance.yahoo.com/q/pr?s=FSESX

As we explained last time, the official inflation number should continue to climb for another month or two because it reflects changes that have already happened. It won't be the first time Uncle Sam tells you one thing, and the real world tells you just the opposite.

The Bottom Line This Week

Rising tensions between the U.S. and Russia are having very little effect on the stock market, at least for now. However, if the situation gets much worse we can expect the market to decline. This is a time for investors to be cautious.

One sector that should benefit from the tiff with Russia is defense. The dollar is also benefiting from the threat of a new cold war, and from economic problems in Europe.

Lastly, energy stocks are still very cheap despite the small uptick in oil prices we saw this week. As with the defense stocks, it's time to buy more energy shares.

Until Next Week

The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...

AIA Advocate for Absolute Returns : Commodities

Association of Investor Awareness - Week of 11/20/2008

Stocks Search For A BottomHigh Energy Prices Will ReturnCommodities Will Also ReboundInfrastructure Spending Is Likely To SoarThe Bottom Line This Week

Stocks Search For A Bottom

High Energy Prices Will Return

Commodities Will Also Rebound

Infrastructure Spending Is Likely To Soar

The Bottom Line This Week

Week of 08/28/2008

In This Issue:

Tensions Between The U.S. And Russia Are SeriousOil And Commodities React To The ThreatDefense Stocks Look Even Better Than Last WeekAnd So Does The DollarInflation vs Deflation Contest Heats UpBut Inflation Should End Up With The GoldThe Bottom Line This Week

Tensions Between The U.S. And Russia Are Serious

Oil And Commodities React To The Threat

Defense Stocks Look Even Better Than Last Week

And So Does The Dollar

Inflation vs Deflation Contest Heats Up

But Inflation Should End Up With The Gold

The Bottom Line This Week

Until Next Week

Stocks Search For A Bottom
High Energy Prices Will Return
Commodities Will Also Rebound
Infrastructure Spending Is Likely To Soar
The Bottom Line This Week

Tensions Between The U.S. And Russia Are Serious
Oil And Commodities React To The Threat
Defense Stocks Look Even Better Than Last Week
And So Does The Dollar
Inflation vs Deflation Contest Heats Up
But Inflation Should End Up With The Gold
The Bottom Line This Week