Agora Financial’s Rude Awakening

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Laguna Beach, California

· What to do when your investments evaporate,
· The ONLY four markets in positive territory for the year,
· Staying the course with long-term trends and more…

Eric Fry, grateful for his daily bread, reports…

If you’re like me, you’re observing the carnage in the global financial markets with a sense of self-satisfied contentment. You are utterly relaxed and at ease. Because if you’re like me, you sold all of your real estate holdings two years ago, and sold all of your US stocks one year ago and re-allocated your capital to selected foreign stock markets…like Tunisia, Costa Rica, Lebanon and Botswana.

I had no way of knowing for CERTAIN that these four stock markets would be the ONLY ones in the world to produce a positive result in 2008, but I just had a good feeling about them. I’m not perfect, of course. I also invested in Slovakia, where I’m nursing a brutal 2% loss.

I’m also lying.

I did not invest a cent in any of the world’s four winning stock markets. I invested in the losing markets of the U.S. and Europe…just like everyone else. Okay, so maybe I lost a little less than most people. I was very bearish, after all. But bearish on stocks usually means bullish on something else. And almost all of the “something elses” have performed as badly as stocks. In other words, the financial markets of 2008 have provided very few hiding places.

It is a war zone out there, as Dan Denning, our colleague from the Australian Daily Reckoning so eloquently explains:

“Yesterday, the world’s central bankers fixed bayonets, smoked their last cigarettes, and checked their Bloombergs. Then, on Ben Bernanke’s signal, they went over the top…straight into no man’s land.

“Markets are now caught between debt deflation and policy attempts to reflate. After Japan’s market fell 9% yesterday and Australia’s 5%, you had to expect some concerted central bank counter-attack. It finally came.

“The Fed, the ECB, the Bank of England and the central banks of Canada, Sweden, and Switzerland all lowered their key lending rates by a half percentage point. The bankers fired a volley of rate cuts into a human wave of selling on the share markets. Some shots found their mark. Others did not.

“The credit markets appeared to advance their front just a little bit after the rate cuts. Credit spreads narrowed somewhat, which means that lenders became a little more willing to lend.

“But negative events are overwhelming good intentions at a breakneck pace. The Fed, for example, is lending another US$37 billion to insurance giant AIG. Some of AIG’s U.S.-based life insurance subsidiaries will post collateral with the Fed in exchange for investment grade bonds. What’s the collateral? Hmm. Let’s hope it’s not credit default swaps.

“Then again, in Ben Bernanke’s fabulous collateral emporium, anything can be pawned in exchange for credits that actually trade. Corporate America’s balance sheet trash is the Federal Reserve’s balance sheet treasure.

“But enough about desperate central bank tactics…Here’s a question: Are stocks over-sold?

“‘We believe a significant rally is set to take place,’ writes Bespoke Investment Group. It released a report earlier this week that said, ‘Only 28 companies in the S&P 500 closed yesterday above their average price in the last 50 trading days.’ The report said that this was a signal that shares were oversold and, therefore, due for a rally.

“We would agree. Stocks are due for a rally. Too bad they don’t know that.”

The stock markets of the world will eventually recover, of course. But bad things might happen between now and then. Thus the decision to buy or sell relies as much upon one’s timeframe as it does upon the merits of a specific investment. Lot’s of stocks are VERY cheap right now. But they might get cheaper.

This tension between long-term opportunity and short-term risk drives most of us crazy…and for good reason. But in the column below, Byron King does a masterful job of examining this tension. Byron is the editor of Outstanding Investments. We hope you enjoy his remarks.

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When Good Investments Turn Bad
By Byron King

If you sold out of the stock market last year, read no further. Take the rest of the day off. But if you still have some skin in the game, let’s talk.

“Markets Routed in Global Sell-off,” was the banner headline of the Financial Times this week. It seems like anything that can go wrong will go wrong. It’s Mr. Murphy’s market, right?

Markets go up and they go down. That’s what markets are all about. Still, it’s one thing to live through a market pullback or correction. It’s another thing entirely to experience a total rout, firsthand. There’s no relief from the suffering.

Evidently, the world wants its money back. In fact, a lot of people want out of the market right now. Are you one of them? I don’t blame you if you are looking for a way to bail out. But before you pull the “Eject” handle, let’s think this through.

Sure, it’s easy to wish that you sold your stocks six months ago. But you didn’t. Neither did I — at least not all of them. Why didn’t we sell? Were we focusing too much on the long term? Did we miss some sell signal? Where’s that bell that they’re supposed to ring at the top of the market? Well, before we get too far ahead, let’s look back and see how we got here.

The global economy does not simply have a chest cold; it has tuberculosis. And it’s a strain of TB that is resistant to all the usual remedies. So here we are. The world economy is sick. And I mean really sick. The markets are coughing up blood. But there’s no magic pill. From here on out, it’s trial and error. It’s hit or miss. And the prognosis is grim.

So should we be buying or selling?

First, I’m certain that it’s painful for you to watch your investments decline. You worked hard for the money with which you bought stocks over the years. And now the value of those stocks is falling. It just stinks.

This market meltdown is not like Goldilocks sneaking into your kitchen and eating your porridge. No, this is like Goldilocks breaking into your house and burning the place down using magnesium flares as accelerants. Years of hard work are just turning into smoke and ashes right before your eyes.

I have to say that declining markets are plenty painful for me. It hurts twice as much because I edit Outstanding Investments. That is, I have both my money AND yours at stake in this process. The last thing I want to do is offer up a bum steer when it comes to helping you make your financial decisions.

Outstanding Investments has a straightforward investment thesis. We invest in energy and resource plays because over time — we believe — energy and resource investments will become more valuable. There are a number of reasons for this, including geological scarcity, past underinvestment and increasing future demand. But it’s a basic idea, and we think it works. At least, it has worked for the past six years or so.

For the past few years, Outstanding Investments has been identifying companies that appear to have bright futures in an era of rising energy and resource demand. And many — most, really — of the investment ideas we suggested did well. Some did very well. A lot of readers made a lot of money. Whether it was oil, gold, refineries, cement or energy infrastructure, it seemed like we were investing in places where the world was going. Right?

But now it seems like the investment locomotive — energy, resources and related infrastructure — has derailed. Energy prices are declining. Energy-related stock plays are down. Commodities are down. Mining and infrastructure stocks are in the dumps. The falling tide is leaving us high and dry.

But does that mean that the whole Outstanding Investments thesis is unraveling? Not so fast, pilgrim. Let’s keep on thinking this through.

Before you do anything capricious — like selling your stocks and stuffing the cash into your mattress — let’s ask a few more questions.

If you sell out now, what price will you get? A low price, right? So if you sell now, you will leave a lot of value on the table. That is, most things in the world of energy and resources are under-priced compared with their intrinsic value. I don’t care how bad the market looks just now (and it looks awful). Go out and try to find an oil field somewhere, or build an oil refinery, or find an ore deposit and build a mine. Can’t do it, can you?

So if you sell out now, just be aware that you will be getting a relatively low value. You will be leaving long-term value behind. If that’s what you want, then that’s what you ought to do. Just understand the point.

Which brings up the next set of issues. How badly do you need the money? How soon do you need it? How scared are you of further declines? How much risk can you handle, especially going forward? What kinds of reassurance do you need?

From what I have seen, the biggest sellers — the market drivers who are taking the express elevator down to the subbasement — are people who have lost control of their money, if not their investment destiny.

People are selling to meet margin calls. The wildest sellers are traders who are just plain behind the eight ball. It’s more than being scared by what is happening. Heck, we’re all scared in some way or another. I wasn’t around in the 1930s, so I have no firsthand experience with the Great Depression. I know only what my parents and other relatives and friends told me. It was pretty bad for a lot of people.

But right now the serious sellers are people who cannot afford to be patient. A lot of the sellers in the energy and resource field are hedge funds. These firms are meeting redemption calls from investors who want out. The hedge funds just plain need cash. They have to sell. And a lot of those funds are throwing everything over the side, even the life rafts and the emergency rations.

When you look in the mirror, is that you? Are you like a hedge fund in panic mode, selling everything just to raise cash? Do you fit into this “sell-sell-sell” model? Don’t feel bad if this is what you have to do. Just be honest with yourself.

Meanwhile, the U.S. — and the world, really — has been dealing with a credit crisis for over a year. Which makes me wonder if there is a turnaround coming sooner, rather than later. I don’t know that. I don’t have a copy of the Financial Times from next March. So I just cannot say if we are closer to the bottom than to the top.

How soon do you need your funds? If you need cash within the next 12-24 months to pay bills like those for college tuition or a nursing home for a relative, then maybe you ought to just take the hit and get out of the market now. There’s no shame in being safe. Look after your needs.

But do you have a longer horizon? Are your “down” stocks in your IRA or 401(k)? You can’t take it out without penalty until you are 59½ years old. Then consider riding it out. And maybe with these low valuations on most stocks, it’s even time to go shopping — but certainly not blindfolded. Nibble away.

Commodities in general have been plunging in price since early July. Will that continue? Can it continue?

There are 6.5 billion mouths to feed on this planet. Even if the global economy slows, the world will still have to produce a lot of materials to satisfy basic demand. For example, the world petroleum industry is expected to lift more than 31 billion barrels of oil this year. Even if world demand dropped by, say, 5% the world would still lift nearly 30 billion barrels. And as the current economic woes cause new projects to slow, annual depletion will more than erase annual new output from new fields. There will be less oil.

Indeed, it will require heroic efforts just to keep global oil output flat in the future.
So this brings us back to that Outstanding Investments core thesis: Energy and resources are getting scarcer and ought to become more valuable going forward. It’s no fun watching the world’s financial system unravel. But at least this dark cloud has a silver lining: Investors get the opportunity to buy good stuff really cheap.

No, I’m not saying that you ought to go out and buy stock with both arms or back up the pickup truck and start shoveling. You need to be very cautious right now. But don’t panic, either.

Sell if you need to sell. Buy if you want to take on the risk. We’re in for some rough economic times. But unless world population starts to die off fast or people develop a taste for living low and being cold a lot, the energy and resource plays are still going to work over the long haul.

[Joel's Note: As we mentioned yesterday, Byron’s Outstanding Investment service focuses on the kind of things that feed Main Street, not Wall Street. Although many of the stocks he recommended are up 100, 200 and 300%, the recent market selloff has created some great discounts in the Outstanding Investment portfolio. These companies, one that lead the field in energy and resources, were considered cheap when Byron first brought them to his readers’ attention. Now, the opportunistic investor can get into them at pennies on the dollar.

There are many great bargains around right now but, as Byron pointed out, you don’t want to jump in blindfolded, not into a market like this. Instead, be honest with yourself and nibble away at cheap stocks with solid long-term outlooks. And remember, the very best investors made their money not by buying when everyone else was, but by getting into strong companies when they were at historic lows.

For a sneak peak at Byron’s portfolio, take a look through this gold report he wrote up for us recently and follow the instructions at the end.

That’s all from us today. We’ll check in again tomorrow from Egypt. Whether you’re unwinding positions today or on the hunt for cheap stocks, do so with clear goals in mind and, as much as possible, a clear mind as one of those goals.

Until next time…

Cheers,

Joel Bowman

The Rude Awakening
aussiejoel@the-rude-awakening.com