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Weekend Edition

The Best of The S&A Digest
Saturday, June 2, 2007

It's a bull market... Despite the 6.5% drop in the Shanghai markets, Mexican, Brazilian, and U.S. exchanges all reached record highs this week.
 
Signs of a market top... The risk premium for junk bonds fell to an all-time low this week, yielding only 2.42% over Treasuries. The spread is now half of the five-year average of 5% and is down from a 10% spread in 2002.
 
The New York Times reported that financial institutions are buying timber. The paper said that institutions now own 5% of U.S. forests and the number will probably grow. This must sound familiar to our subscribers: In 2004, Steve Sjuggerud recommended timber REIT Rayonier (RYN). Readers made 64% before a stop loss trigger in 2006.
 
Microsoft (MSFT) introduced a coffee-table-shaped computer. The "surface computer" has an embedded 30-inch touch-screen table monitor that allows users to move icons with their fingers. Right now, it costs more than $5,000.
 
Extreme Value editor Dan Ferris is one of the few analysts who's been betting big on Microsoft. He calls Microsoft "the textbook definition of a safe stock." Dan believes the company is one of five stocks that can literally pay for your retirement. And he's challenging any money manager in the world to beat the performance of his top five picks. So far? No takers.
 
From a subscriber: I purchased 1,000 shares of Abitibi on your recommendation. It appears that I will have about 63 shares of AbitibiBowater when the merger goes through. With so few shares of the newly formed company, it doesn't appear that future gains will be very beneficial to me...
 
I published this note because it's a good demonstration of one of the most prevalent and powerful biases among individual investors – the share count bias. Most individual investors think of their positions in terms of share count, rather than total capital allocated. As a result, they prefer owning more shares of low-priced stocks. This is entirely illogical. While it's true that low market capitalization stocks have a higher average return than large capitalization stocks, nominal share price is utterly meaningless. The number of shares you own is NOT a factor in your future return or future loss.
 
The amount of capital you invest should be determined by your risk management approach and the overall size of your portfolio. But the number of shares that amount of capital will buy is completely irrelevant.
 
Along with Jim Rogers, Chris Weber, and Steve Sjuggerud, Wilbur Ross is one of the very few investors we know of who has never been wrong about a major investment thesis. He got his start working for the Rothschild family (not too shabby) and then founded his own firm, WL Ross & Co. in 2000.
 
His first big bet was that, despite the precarious state of the steel industry's balance sheets, the world would need more steel – sooner or later. Ross bought up bankrupt steel companies between 2001 and 2003, paying pennies on the dollar. He sold his steel holdings (International Steel) for $4.5 billion a few years later to Mittal Steel. Ross has yet to sell a single share of Mittal.
 
Last week at Ira Sohn's charity investment conference, Ross made the case for coal... Appalachian coal, specifically. Appalachian coal is one of the only resources in the world that hasn't been bid up by the energy boom of 2003-2007. In fact, Ross says the price of Appalachian coal has fallen 33% over the last seven months. Nevertheless, Ross sees:
 
1. The build-out of sulfur-dioxide mitigation equipment by eastern utilities favors Appalachian coal over coal from Wyoming's Powder River Basin.
 
2. The federal Energy Information Administration is forecasting 41% growth of total electricity use by 2030.
 
3. Given this growth in electricity use, power generators would have to build 35-40 new nuclear-powered plants for that fuel to sustain its 20% market share. None has been built in more than 30 years.
 
4. Meanwhile, power companies are planning to build 48 new coal-fired power plants by 2010.
 
Ross is putting his money behind his faith in coal. He consolidated a number of flagging coal producers under his International Coal Group (ICO). Which was Dan Ferris' first pick for the S&A Penny Letter.
 
Regards,
 
Porter Stansberry




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