Wednesday, January 12, 2005


There are certain energy stocks priced to give you nose bleed. For example, Cameco, a large Canadian uranium mining company has gone from $2 to $34 in four years (adjusted for splits). I cannot recommend it but I would praise anyone with the guts to buy it. As I wrote some months ago, when the wells start running dry, it takes a long time to gear up and catch up. It takes a major commitment and years to build a nuclear plant. China has several in the works. The latest designs cost much less to build and operate. After China successfully brings a plant or two on line, high oil prices could convenience other countries to build as well.

Today, I purchased shares in Pride International, INC. (PDE). The company provides contract drilling and related services. It operates 327 global fleet rigs, 35 jack-ups, 30 tender assisted, and 249 land based rigs. In several accounts I already have positioned Rowan Drilling (RDC).

I have said that we are in a sector rotation. However, there are two points I need to make. First of all, energy is in a secular move that will transcend the normal business cycle. In other words, energy is still being rotated into. In a similar fashion, I believe the internet is in a very long-term secular growth pattern and I will continue to hold internet stocks. In the past seven days, the energy sector is the top performing sector, up 3.3%. During the same time, the technology sector was the worst, down 2.7%.

The second point is that for billions of institutional money to rotate it takes weeks of churning action. Again, PAPA JOHN, a wise old World War II navy chief, used to say that it takes a long time to turn around a battleship. PAPA JOHN liked to call the institutions the "big boys". He understood that the "big boys" must allow the "little boys" to make a few bucks trading in and out during a base building period. The "big boys" must accumulate a lot of stock and they may have to accumulate on the way down or they often to set a trap and then load up right before a break-out.

Sometimes I am asked if I am a technetion or a fundamentalist. I am both and neither. I am actually an amateur economist and a market psychologist. We are in a world wide economy that has recently experienced tremendous growth in developing countries. Developing countries have turned into low cost manufacturing power houses. Developing nations now consume almost as much oil as developed nations! In regard to psychology, one should always buy what is hard to buy. If you and all of your friends and even the guy on TV are all excited about a particular stock or industry, run away! This happened to me with SIRI. I bought the stock at $2 and $3 per share and when it ran to the $7 to $9 range, all my readers wanted to ask about was SIRI. I took my profits not because any one of them was wrong but because the stock was pushed up by group think psychology and not by fundamentals.

One can find a number of reasons to buy PDE. The "chart-man" in me particularly likes the way this stock has bumped up against the $21 dollar price a number of times. It is interesting that it is back there with oil at $46. Oil often bottoms in December. We have had a relatively mild winter and yet oil is still at $46 in early January! I am willing to bet the price hits $60 before July 4, 2005 and would not bet against $70.

By the way, a good clue about the price of oil is to watch the professional hedgers. Normally the producers sit in a net short position on contracts because they can fill the contracts with production. Selling a contract is a way for them to presell at an established price. In recent months the professionals are in net long positions and the speculators hold the shorts. The speculators probably made a little by jumping on after the price broke below $55 but by now they are probably trapped in a losing trade. Even when the supply numbers are good, the price per barrel just will not go down.


There is still a lot of confusion (and always will be) about the declining dollar and what it means for America. Today, the trade figures came out at record high deficit levels. The TV guys marvel that the long bond traded up in value. This is no surprise to those of us that look at the dollar in a simple, straight forward and truthful way.

American consumers are number one in the whole world. We buy lots of consumer goods and we buy most of them cheaply from overseas manufacturers. When we pay a dollar for Samsung Cell phone or a pair of Wal-Mart socks, we own a hard good and the seller owns a soft dollar. The dollar is nothing but a piece of paper. If the foreigner holds on to it, America gains an advantage. It is just like me giving you a check for $10 and you decide not to cash the check.

The sellers of the goods have only two things to do with the money, buy American or invest American. When the trade deficit of $60 Billion was announced today, traders understood that foreigners hold $60 Billion dollars and much of it will be invested in US Bonds.

Dollars are just like any other commodity. They trade based on supply and demand. As foreign countries accumulate extra dollars, the excess supply causes the relative value to go down. However, the invisible hand of Adam Smith is always at work. Sooner or later, the foreign countries will see that the soft dollar they are holding will buy real hard goods back from America. America no longer manufactures much in the way of consumer goods. We are not even the biggest agricultural exporter any more. What we offer is high priced services and capital goods. We manufacture cars, tractors, main frame computers, air planes, etc. Our Universities charge stiff prices to thousands of foreign students. Our engineers design sophisticated electronics and get paid well but the manufacturing process is outsourced. Our drug companies develop sophisticated drugs.

During the second half of an economic recovery industrial capacity limits are reached and plants must be expanded at tremendous costs. Big businesses have to tape the capital markets in a big way and inflation begins to grow tall. Inflation usually starts when the labor supply tightens, continues when commodity supply tightens and eventually shows up in the cost of money. In other words, by the end of the cycle interest rates are pushed so high as to put the pinch on the consumer.

Now we have come full circle to what I wrote yesterday. Over the next few years, I expect less refinancing by the consumer and more borrowing by companies. The consumer will continue to buy goods and well run companies in businesses that do not have excess capacity will grow their earnings and the stocks will rise. A stock portfolio must live and breath to attain great results. One must not sell too quickly but adjust gradually. At the current time, when I add money to my typical portfolio, I will buy energy related issues or consumer staples issues. I believe the price of gas next summer will hurt spending for discretionary purposes.