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A Supply Crunch Is Setting Up the Next Biotech Boom

By Larsen Kusick, analyst, Phase 1 Investor
Friday, October 15, 2010

The biotech industry is disappearing.
According to a recent report by the Biotechnology Industry Organization, the number of public biotech companies is down by a full 25% since the end of 2007.
Over half of the companies that disappeared were acquired. Nothing unusual about that. What's interesting is the IPO market didn't keep up – only 14 biotech companies have gone public in the past two years.
In short, the supply has shrunk A LOT. And I think that means good things for buyers today.
But that's just one side of the equation. Demand for these little companies is heating up...
Sanofi-Aventis is currently going after Genzyme. OSI Pharmaceuticals, Abraxis, Crucell, and Zymogenetics are just a few prominent small-caps that have been acquired in the past five months.
Big Pharma companies like Pfizer and Merck are sitting on tons of cash. They've never had a problem spending a few billion dollars to pick up a small biotech company with some promising drugs.
Meanwhile, low interest rates and other Federal Reserve policies are aimed at pushing companies to put cash to work. Big Pharma companies have less incentive than ever to sit on their cash.
I expect this simple supply/demand problem to put a floor under biotech stock prices over the next year or more... and push up premiums for smaller biotech and pharmaceutical stocks.
Investors who want to ride the biotech boom over the next year have plenty of exchange-traded funds to choose from...
One to avoid is the Biotech HOLDRs (BBH). It puts almost 80% of investors' money into the top three biotechs by market cap – Amgen, Gilead, and Biogen. The higher concentration means higher risk. And these three giants are more like Big Pharma than the little biotechs we're looking for.
My favorite pick is the S&P Biotech Fund (XBI). No single stock accounts for more than 4% of the fund. This diversified approach is the exact reason ETFs were created. You get broad exposure to dozens of small-caps.
The PowerShares Dynamic Biotech & Genome (PBE) is also a great play. This fund includes genome-related companies such as Illumina, a "picks and shovels" company I believe is a great long-term holding.
If you're looking for the chance to double your money quickly, individual names are the way to go. There are a lot of promising chart setups in companies that have massive potential catalysts such as clinical trial results, potential FDA approvals, and the biotech investor's best friend – the takeover announcement.
But if you want easy, one-click exposure to this trend, XBI and PBE are the way to go.
Good trading,

Further Reading:

Biotech booms and busts with the best of them. "Whenever a breakthrough in cloning, genetic engineering, or stem-cell treatments bubbles up out of a lab and finds itself on the front page of a newspaper," Ian Davis writes, "investors go temporarily insane."
Over the past three decades, the biotech sector has exploded for triple-digit gains three times and quadruple-digit gains once. (It's also lost more than half its value four times.) See the shocking chart here: Biotech Is Setting Up for Another 1,347% Rally.

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Market Notes
Silver continues hot streak, breaking above $24 an ounce… Silver Wheaton up 47% since August 1.
BHP Billiton, Freeport McMoRan jump to two-year highs as companies race to secure resources.
Education stocks plummet to new lows as bellwether Apollo withdraws 2011 guidance… shares drop 25%.
Earnings today... General Electric (conglomerate), Infosys (Indian IT giant), Charles Schwab (brokerage).
Market Watch
Symbol Price
S&P 500 1176.19 +0.2% +7.3%
Oil 35.47 -1.5% -11.1%
Gold 133.68 -0.8% +30.0%
Silver 23.75 -1.2% +39.2%
US-Dollar 76.78 -0.2% +1.8%
Euro 1.40 -0.7% -6.5%
Volatility 19.03 -4.3% -12.4%
Gold Stocks 522.61 -1.5% +17.6%
10-Year Yield 2.58 +3.6% -25.7%

World ETFs
Symbol Price
USA 117.70 +0.2% +7.3%
Canada 29.08 -0.7% +9.5%
Russia 20.10 -0.5% -1.6%
India 38.63 -0.9% +26.1%
Israel 16.78 +0.2% +17.7%
Japan 10.14 -0.8% +1.6%
Singapore 13.86 +0.4% +24.5%
Taiwan 13.59 +0.0% +8.5%
S. Korea 55.64 +0.4% +16.7%
S. Africa 69.54 -0.9% +19.2%
China 46.20 +0.7% +4.6%
Lat.America 52.39 -0.3% +10.9%

Sector ETFs
Symbol Price
Oil Service 120.09 +0.8% -6.8%
Big Pharma 66.50 +0.0% -1.5%
Internet 67.11 +3.3% +29.5%
Semis 13.63 +1.0% +8.6%
Utilities 31.90 +0.3% +7.8%
Defense 17.74 +0.4% +8.0%
Nanotech 9.56 -0.5% -12.0%
Alt. Energy 10.29 -1.3% -7.4%
Water 17.38 -0.2% +3.5%
Insurance 15.66 +0.1% +10.6%
Biotech 20.21 +0.6% +17.2%
Retail 17.94 +0.6% +12.1%
Software 23.17 +0.4% +16.4%
Big Tech 51.49 +2.1% +19.6%
Construction 12.22 -0.1% +0.0%
Media 12.95 -0.2% +18.7%
Consumer Svcs 62.80 +0.7% +16.1%
Financials 52.31 -1.4% -4.7%
Health Care 64.46 +0.3% +7.2%
Industrials 59.55 -0.6% +14.5%
Basic Mat 68.36 -0.1% +17.2%
Real Estate 55.05 -0.1% +27.7%
Transportation 84.68 -0.3% +16.9%
Telecom 21.90 -0.1% +17.7%