Tuesday, 19 April 2011

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More Sense In One Issue Than A Month of CNBC
The Daily Reckoning | Monday, April 18, 2011

  • S&P adjusts outlook for the US...but remains sturdy on AAA rating,
  • From worthless commodities in the ground to "mountains of gold,"
  • Plus, another look at the CRB Index's biggest loser of the past two years...
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A Few Laughs Courtesy of Standard & Poor’s
Why S&P’s Official Statement is Nothing But a Joke
Joel Bowman
Joel Bowman
Reporting from Leblon Beach, Rio de Janeiro...

You want a good laugh, Fellow Reckoner? We've got a great joke for you, courtesy of Standard & Poor's Ratings Services Inc. But first, the news...

We had other notes prepared for you this morning, but then this headline crept across our screen:

"S&P Moves US Outlook to Negative"

The Wall Street Journal provides some details...

"Standard & Poor's Ratings Services Inc. cut its outlook on the US to negative, increasing the likelihood of a potential downgrade from its triple-A rating, as the path from large budget deficits and rising government debt remains unclear."

Stock markets, which apparently still hold faith in the ratings agencies' foresight (despite the agencies' best efforts to avoid deserving it), promptly reversed course from their ever-and-always upward trend after the news. The Dow, for its part, fell a couple hundred points at the open. The S&P 500 and the NASDAQ were last seen bleeding from similar sized wounds.

Could it be the impending breech of that looming debt ceiling that has the ratings gurus spooked?

"Given the fact the US government is 28 days away from bumping up against the $14.3 trillion debt ceiling," wrote Addison in today's edition of The 5, "we suspect the question of Uncle Sam's ability, let alone political will, to pay is too obvious to ignore."

Even the most "aggressive" cuts to the budget would still require heretofore-unimaginable levels of new borrowing and/or money printing. Continues Sr. Wiggin:

"The current White House budget plan requires lifting the ceiling to $20.8 trillion by 2016. Wisconsin Rep. Paul Ryan's plan, passed by the House on Friday, would require a ceiling of $19.5 trillion, according to figures compiled by Bloomberg."

Of course, even Rep. Ryan's plan is likely to fall flat in the Democrat-controlled Senate. But aside from all that, the debt ceiling story is hardly anything new, as Addison's letter to deaf ears, penned way back in January, shows.

[Ed. Note: For readers interested in the end of debt supercycles and how they change everything, may we suggest John Mauldin's book, Endgame: The End of the Debt SuperCycle and How It Changes Everything.

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Whatever their reason for the outlook adjustment, S&P is still, for the moment, committed to maintaining the US's AAA rating. Of course, readers will do well to remember the appalling track record of the three, government-anointed agencies before and during the last (and, in many peoples' opinions, ongoing) financial crisis. All of the so-called "Big Three" - S&P, Moody's and Fitch - were trotting out AAA ratings for the most toxic MBSs on Wall Street right up until their collapse brought us, in one frantic politician's words, "to the edge of the abyss," back in 2007-08.

What's the point of having a fire alarm if it only goes off when your house is burned to the ground? We have no idea. To us, putting reason where there is none seems as futile and misguided a task as slapping AAA ratings on the backs of those who don't truly deserve them. Something's gonna come unstuck.

But just for entertainment value, let's take a look at what S&P had to say for themselves regarding their defense of the US's current AAA status. (And herein lies today's promised joke...)

From S&P's official statement:

"Our ratings on the US rest on its high-income, highly diversified, and flexible economy, backed by a strong track record of prudent and credible monetary policy. The ratings also reflect our view of the unique advantages stemming from the dollar's preeminent place among world currencies."

"...prudent and credible monetary policy..."? That's what we're calling unabashed, bald-faced money-printing these days?

"...the dollar's preeminent place among world currencies..."? That's what we're calling the temporary though fast-eroding kindness-of- strangers-borrowing-scheme?

Oh stop it, S&P...our sides are splitting!

The agency, barely clinging to any demonstrable comprehension of reality, goes on to note:

"Although we believe these strengths currently outweigh what we consider to be the US's meaningful economic and fiscal risks and large external debtor position, we now believe that they might not fully offset the credit risks over the next two years at the 'AAA' level."

Tough talk, indeed.

Fellow Reckoner, at the end of the day, it's probably worth recognizing these announcements for what they really are: Johnny-come-lately, sideshow distractions. Usually, by the time the ratings agencies have arrived on the crime scene, the perpetrator is already over the border, enjoying a few daiquiris under a far away palm tree. If their analysis is to be taken seriously at all, it is surely more useful in the post- mortem stage than in any kind of predictive capacity.

Dots
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The Daily Reckoning Presents
The Story of Timothy Bancroft
Chris Mayer
Chris Mayer
Let me tell you the story of Timothy Bancroft. It's a good one, and if you haven't heard it, I think you'll like it.

Bancroft was a smart and shrewd investor. He dodged the Panic of 1857, which he said was due to "easy money policies" and "overconfident speculation in the railroads and farmlands of the Western states."

Instead, Bancroft said you should "buy good securities, put them away and forget them." He thought the best investments were those "dealing in essential commodities that the Union and the world will always need in great quantities."

When Bancroft died, he left an estate of $1.3 million. As Adam Smith (George Goodman) points out in his book The Money Game - from which this tale comes - "If you remember that those are untaxed mid-19th- century dollars, and that a full eight-course meal at Delmonico's cost less than a dollar at the time, that is quite a fortune."

What did Bancroft own? He owned good stuff from the earth. He owned Southern Zinc and Gold Belt Mining. Hard assets. (Although he did own a couple of questionable things that, I am sure, seemed like good ideas at the time, like American Alarm Clock.)

Sounds smart, right?

It wasn't. And here is where Bancroft erred.

He made it so his heirs couldn't touch that portfolio for a time, because he wanted them to hold onto these investments. By the time they could access the estate, it was worthless. Zero. Zip. Nada.

Bancroft's tale reminds us that nothing is a good idea all the time.

Commodities in the ground are worthless...unless there are people that can extract them and sell them at a profit. It is men and machines that give commodities their value. Commodity businesses should be treated as businesses first and commodities second. And no business is immune to market forces, which, at times, can smash them to smithereens. Poor old Bancroft seems to have forgotten this when he socked away his gold and zinc companies.

The point is that you must stay flexible on your thinking. Fall in love with no commodity. And no matter how much you like a commodity, before you invest in a producer, be sure to think hard about whether it is a good business or not.

Natural gas makes the point as well as any commodity. Natural gas has been, for the most part, a lousy investment during the last few years. In fact, it is the only commodity in the CRB Index of commodities to post a negative return during the last 24 months.

But natural gas might be on the rebound...

Two weeks ago, Chevron came out and said US gas prices need to rise. The Financial Times reported: "George Kirkland, Chevron's head of oil and gas exploration and production, said the industry needed prices 'in the $6s and $7s' in the long term to cover the cost of investment."

I agree with him. In fact, I've been saying this for a couple of years, and I've been wrong about natural gas for a couple of years. I would've thought it would be in the $6s and $7s already.

Contango Oil & Gas (AMEX:MCF) is a stock I recommended to the subscribers of Capital & Crisis back in January 2009 when gas was in the $5s. The stock has not set the world on fire, but it has done pretty well considering the fact that natural gas prices have been going nowhere but down.

I still consider Contago an excellent play on a natural gas recovery. The company would mint money if gas got into the $6s and $7s.

In the meantime, Contango is a good enough business that it can still do all right at low natural prices. I am currently looking at new natural gas ideas for our portfolio. Compared to nuclear, natural gas looks real good. That's where the private money is going.

Natural gas utilities are much cheaper in upfront costs. The payback on your investment is much quicker. They are perceived as safer. Natural gas is also a clean-burning fuel. We also have lots and lots of cheap gas in North America.

Finally, as I've written a lot about before, the global LNG trade is set to expand greatly over the next several years. LNG is liquefied natural gas. It's what will take natural gas from being a local commodity to a global one. The long-term opportunity is tremendous for North American gas producers. They can sell nat gas in Europe or Asia for prices more than double what they get at home.

The LNG story is already out and unfolding, as shown by the 156% rise in the stock price of Chart Industries (NASDAQ:GTLS), which puts together the Erector Sets of the LNG trade. But North American natural gas itself remains a cheap commodity against a backdrop of solid demand and the opportunity of exporting it in large quantities in the future.

It's time to buy natural gas, again. Natural gas may not hit $13 again for a long time, but $6-7 natural gas prices seem a likely scenario, and there are a host of stocks that will be worth two or three times the price at such levels.

Also, as our experience with Contango shows, the downside is low if you pick stocks that are low-cost producers and that make money even in a low-price environment. No matter how I feel about the commodity, I always come back to looking at these things as businesses. They have to make sense as is, or no dice. Preferably, without government support.

And I always remember the tale of Timothy Bancroft. In markets, nothing is good enough to put away and forget. An investor must keep his head in the game. When the facts change, so must his opinion.

More soon...

Regards,

Chris Mayer,
for The Daily Reckoning

Joel's Note: As readers of his Mayer's Special Situations research circle well know, Chris is somewhat of a master at unlocking value in resource stocks that go mostly ignored by the mainstream. In fact, it's that "under the radar" type of investment where Chris often picks up his best bargains. Right now, he's got his eye on a tiny, $2 penny stock that is sitting on a "mountain of gold."

If you want Chris to email you his special report on the stock and why he thinks it's heading north, you'll find all the info you need right here.

The NEW El Dorado - A Mountain of Gold Trading at a Fraction Of Its Value

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Dots
And Bill's still out and about, checking in on his "sand fed" cattle, last we heard. Word is, he'll be back online later this week. We'll let you know.

In the meantime, if you want to pick up a copy of his brand new book, Dice Have No Memory: Big Bets and bad Economics from Paris to the Pampas, you can head along to our Laissez-Faire Books outlet for a copy.

Regards,

Joel Bowman,
for The Daily Reckoning