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The Commodity Investor Q&A

With Matt Badiali, editor, S&A Resource Report
Wednesday, October 29, 2008

Q: Is it fair to say the natural gas pipelines other S&A editors have been highlighting will be relatively immune to the swings in natural gas prices? Are the big dividends they pay "safe"? – E.M.
 
A: That depends on how much of the company's revenues come from pipeline transport and how much come from other segments.
 
You can think of pipeline revenues as tolls on a toll road. It doesn't matter what the price of gasoline is... If you want to ride on the road, you have to pay the toll. Those revenues are free of commodity risk. You make that money regardless of the price of oil or gas.
 
But because oil and gas prices kept going up and up (until this July) some of these pipeline companies wanted to get in on the bull market. In other words, many pipeline businesses also collect revenues from divisions that are exposed to commodity risk.
 
Kinder Morgan Energy Partners is one of the largest oil and gas pipeline companies. About 10% of its revenues will fluctuate with oil prices. The company collects the other 90% of its revenue from its pipelines. That insulates the company from commodity prices, both higher and lower, and should keep its dividend steady.
 
Here's how Kinder stacks up against its peers in the pipeline business...
 

Company

Sym
Market Cap
Non-Pipeline Revenue
Yield

Kinder Morgan

KMP

$13.2 bil

10.0%

8.0%

Enterprise Products

EPD

$10.0 bil

12.9%

8.7%

Energy Transfer

ETP

$5.2 bil

50.0%

9.9%

Boardwalk Pipeline

BWP

$3.2 bil

12.0%

9.0%

Magellan Midstream

MMP

$2.1 bil

48.0%

8.9%

Data from Bloomberg
 
As you can see, the dividend yields tend to reflect your risk – you get paid more to take on more commodity risk. In the current market, I'm not looking for that extra risk. I want a safe place to park my money and earn a solid dividend. That's what makes some pipelines a great place to invest for income.
 
Q: In his interview with Porter, Rick Rule sounded pretty bearish on metals prices. So why's he so excited? – A.H.
 
A: Rick Rule spent 30 years learning how commodity markets work. His main investment focus is the Canadian juniors, small to tiny exploration companies listed in Toronto. Last week, he told Porter he expected the Toronto Venture Exchange to be in a "grinding bear market" for years. But he's practically drooling at the opportunities.
 
That's because bear markets allow smart investors make absurd gains. Rick already knows the best managers and the best assets... All he's waiting for now is the prices.
 
He knows prices will fall to ridiculously low levels because emotion, rather than intellect, will rule the bottom of the market.
 
In the last big bear market in junior mining stocks, from 1998 to 2002, the sector shed about 90% of its value. Almaden Minerals, a well-run junior exploration company, saw its shares fall steadily from around $5 in November 1994 down to around 20¢ in December 2000.
 
Almaden survived the downturn, and shares began to rise in January 2002. They peaked at $3.40 in 2006 for a 1,600% return on your investment in four years. That's why Rick Rule is so excited about the current bear market. It doesn't take many winners like that to seriously pad your retirement account.
 
As Rick pointed out, this bear market should end in about six months for the top 5% of resource stocks. The other 95% will continue to sink for years to come.
 
The question is, which resource companies will join the "stealth" bull market and which will fizzle out?
 
Rick's looking for "cash boxes" – companies selling for as much as 45% below the cash they hold. He's also eyeing likely takeover targets in the Canadian oil and gas sector. I think sound management should be first on your list... Start with companies that made it through the last big bear market.
 
Good investing,
 
Matt




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