Looking Up for Energy and Resource Stocks

Swiss investor, Marc Faber, still hates America, but he has a good track record for market prediction. So, I paid attention when I read this in Barrons today, in the Investor Roundtable Part 3:

Faber: When volatility diminishes (in the next few months), you want to be in cyclical industries. Among the most cyclical stocks are resource producers. They were driven up by incremental demand from China, and then collapsed. In the next six months they could have significant upside. I like Rio Tinto, BHP Billiton and CVRD [Companhia Vale do Rio Doce].

The financial crisis and collapse in commodities will keep supplies out of the market. Nobody is exploring now. There is no money, and projects are being postponed. Whenever the recovery comes, in five or 10 years, resources stocks will go ballistic from today's low levels. If you're optimistic about the next six months, too, when the news may be slightly better than today, you should own them. Freeport McMoRan Copper & Gold fell from 127 to 15 and is now 26. Xstrata, in Switzerland, is another one. A lot of these stocks are more attractive than gold, because gold is at a 20-year high relative to industrial commodities.

Scott Black: Rio Tinto's balance sheet isn't in good shape. They have a refinancing issue.

Faber: Worst-case, the Chinese government could buy them out. China has taken a big stake in the company. Meryl recommended Kaiser Aluminum [KALU] earlier today. I would add Alcoa.

Felix Zulauf: You're not saying this is the beginning of a big bull market, but of a base-building process from low levels.

Faber: Correct, but when stocks decline by the magnitude seen in resources shares, or the Nasdaq after 2000, a base-building period follows that can extend for several years. When you print money, you can get an artificial bull market (in cyclical and resource stocks) that exceeds everyone's expectations.


And this is a quote from Scott Black, another on the Barrons Roundtable of great investors (and a disciple of Benjamin Graham and value investing). He makes the case for XTO. But the arguments and metrics can be applied just as well to the Canroys (though it appears XTO did a much better job of hedging than PWE or PGH):


BLACK : My next pick is an old favorite, XTO Energy, in Fort Worth. The stock is 37.58, there are 577 million fully diluted shares, and the market cap is $21.6 billion. The company did a smart thing by hedging approximately 77% of its natural-gas production in 2009. They have locked in 1.6 Bcf [billion cubic feet] of gas at $8.94 per Mcf [thousand cubic feet], and 62,500 barrels a day at $118.85 per barrel. Production has been growing dramatically, and should average about 2.67 Bcf per day in 2009, up 18% year over year. About half the increase is from drill-bit growth, the rest from acquisitions. XTO bought Hunt Petroleum last year for $4.2 billion, figuring it could triple reserves, which are now 80% gas, 20% oil. It has 12 Tcfe [trillion cubic feet-equivalent] of gas and 500 million barrels of oil.

BARRONS: What are you pricing reserves at?

Black: I value the gas reserves at $3 per Mcf and the oil at $8 per barrel. Breakup value is about $44 a share, so the stock is selling at 85% of breakup value. My 2009 revenue estimate is $9.86 billion -- slightly higher than the Street's -- which converts to $4.50 a share in earnings. Return on equity is 15.5%, return on total capital 10.3%. Free cash flow is $2.28 billion. XTO has cut its capital-spending budget this year, to $3.8 billion from more than $5.3 billion. They are wed to the notion of knocking $1 billion to $2 billion of debt off the balance sheet.

Their finding and development costs were $1.45 to $1.50 per Mcfe in 2007, and $1.65 in 2008. This year they could fall to $1.50. XTO is one of the few energy companies with rising earnings, because of hedging. They will earn about $3.75 to $3.80 a share for 2008, and $4.50 for '09. The stock sells for 8.3 times earnings and 3.6 times discretionary cash flow. It is extremely cheap. You've got asset and earnings protection. And they are in every major field in the U.S. -- the Barnett Shale, Fayetteville and so forth. Energy is a controversial investment today, but XTO is the cream of the crop.

Schafer: If they hedged this year, does that mean next year's earnings will be down?

Black: No, because they hedged 2010, too.

Gheit - Oil Price Forecast for 2009

Fadel Gheit has a very good record of predicting the direction and level of oil prices, similar to Boone Pickens in accuracy. He is pointing to higher prices for oil in 2009 and thinks the sell-off is overdone. All this has good implications for the CanRoys. They are very much oversold right now. Pennwest, as an example, can be profitable and cash flow positive at $40 oil. Its costs will come down in 2009 as demand for oil services drops hard. Its fixed cost overhead is not very high (for administration only) and its debt load is reasonable with maturities out several years (much better than American companies like Chesapeake which is in real trouble after taking on too much debt).

The past couple years, it has become popular among the CanRoys to minimize the monthly distribution and instead direct a lot of cash flow to capital improvements and acquisitions. PWE and Daylight have been down around 50% of cash flow directed to distributions. The historical average is closer to 80%. PWE has announced it is drastically cutting back on capital projects in 2009 and selling some properties, so it can preserve cash flow to maintain distributions at the lower oil prices. This is more the historical model.

The lower oil prices should also discourage the Canadian national government from going through with taxing profits on royalty trusts. Oil is not the big treasure chest it was perceived to be by some in Parliament. We may see the Liberal party take control of Parliament soon and then change the terms of the taxation program, either lowering to 10% or maybe eliminating the Harper - Faherty program altogether.

It seems very possible by the end of 2009 the Canroys can recoup the cash flow they had in 2006 and rebound to the prices they were trading at when oil was at $60/barrel in late 2006 (after the Halloween Massacre), when stock price was around $30 for Pennwest (PWE), for example, and $17 for Pengrowth. Also, most of the Canroys are highly hedged for 2009, which will aid cash flow. Pengrowth (PGH) has an 50% of its oil sold forward at $80 for 2009 and 50% of its gas production at $10. The other Canroys have similar hedging programs in place which will stabilize dividends. The market has not factored this in by driving prices down 70% and yields up by 300%.

Here is what Fadel has to say:

MONDAY, DECEMBER 29, 2008
ELECTRONIC Q&A


How to Profit on Oil's Comeback
By NAUREEN S. MALIK

Oppenheimer's Fadel Gheit is big on independent energy producers.


OIL AND BASEBALL -- NAMELY the Yankees -- are two passions that are remarkably similar for Fadel Gheit.

While he makes his living off the first and is an avid fan of the second, the managing director of energy at Oppenheimer says both markets are subject to the "bubble." Crude-oil prices have collapsed and salaries by baseball's A-listers could be next?

"Unfortunately the sports bubble hasn't burst yet, and it will, mark my words it will," says Gheit, who thinks Alex Rodriguez should be making $3 million, not $50 million, for a job some people would take for free hot dogs.

Manager's Bio
Name: Fadel Gheit
Title: Managing director and senior analyst covering the oil and gas sector, Oppenheimer & Co.

Education: B.S. in chemical engineering, Cairo University; MBA in finance, New York University

Hobbies: Watching sports, mainly the Yankees, but also watches the Mets, Giants and Jets.As for oil, Gheit, who was a skeptic as oil breached $100 a barrel earlier this year, has turned positive while others are decidedly negative about energy at the moment. Oil prices rallied to $145.29 in early July before recently falling to the low $30-range.

Gheit, an Egyptian with chemical-engineering training, joined Mobil Oil in 1980 as oil prices touched record highs due to escalated tensions in the Middle East. He traipsed around the Arabian dessert examining oil production before jumping to Wall Street.

Gheit has seen crude oil go up because of war, revolution, and other major global events. Oil supplies in particular have been impacted, but this downturn "has to be one of the worst" because it is a global economic issue.

Oil "is not a free market," says Gheit pointing to Wall Street speculation. He has repeatedly testified in front of Congress, urging the government to create an energy plan and a better regulatory framework to oversee the market.

While that regulatory framework will take time, Gheit sees plenty of reasons to bulk up on energy stocks now.

Barron's Online: Do you think oil is sustainable at these levels?

Fadel Gheit: No, I never thought that oil prices are sustainable above $100. I never thought they were sustainable at $30 either. The global economy will recover, whether in a year or two or three. Two years of higher prices usually bring additional investment and will expand supply and curtail demand and consumption as companies and consumers try to become more energy efficient. The flip side of the coin is the exact opposite. When you have extremely low prices, that will dry up investment and it will take years for the industry to go back on track. That's why you create feast or famine because of the lack of coordination between producers and consumers, the lack of transparency in the financial market [and] basically the lack of government supervision either because of indifference or corruption.

Q: What could per-barrel oil prices go and what is a suitable level?

A: I think oil prices over $60; $65 would be pushing it. We don't need it.

Q: Do you think OPEC is going to cut production even more?

A: Absolutely, OPEC will cut production and we will feel the impact within six weeks of production cut. These people cannot balance their budget at $50 per barrel and so they are hurting pretty badly. One of the reasons I don't want to see $30 per barrel is because I really do not want to see major disruption, regimes could be thrown out.

Q: What does this mean for profits and the marginal cost of production?

A: To operate, the cost [for oil producers] has increased by almost 16%-20% annually over the last five years. It was one of the sharpest inflationary periods in recent history and the reason is that everybody, because of the increasing oil prices, was chasing limited capacity of services, so oil-service companies were basically gouging the industry. We are hoping that the costs are going to go down, but we are talking about 10%, 15%, 20%, not 40%, 50% or 60%. We are also going to see more technology advancement because people will pay more attention to efficiency and cost efficiency.

Unless oil prices recover sharply next year, or we believe that oil prices will average $40 next year, it means that there will be about a 40%-50% drop in earnings and cash flow. Most companies will limit their capital spending to availability of funds , which may be coming from cash flow, so that means that capital spending will be down by as much as 40% [in 2009]. Longer-term projects do not get derailed once they start because any delay becomes counter productive. But new projects will be delayed.

Q: You have been touting large integrated-oil companies such as Exxon Mobil (ticker: XOM) throughout the year. Are they still a good bet?

A: Integrated oil is very simple. We believe that the dividends are safe. Companies like Shell (RDS-b) and BP (BP) offer 6%-plus dividend yield. Both stocks are down significantly this year. Shell in its history only suspended its dividend once during the Second World War. Now if you don't trust the market, but believe oil prices will not go above $40-$45, then you should own Exxon.

A company like Exxon has been underinvested for five years, not because they are stupid because they were smart. They didn't chase barrels for exorbitant price and cost. They have $40 billion cash. They can buy any independent-oil company and pay them a 30% premium without going to the bank. They can buy Apache (APA), Chesapeake Energy (CHK), Devon Energy (DVN), EOG Resources (EOG), Noble (NE). The market value of Exxon treasury stock is $205 billion. That is higher than the market value of BP, Chevron (CVX), Royal Dutch Shell (RDSA) and Conoco Phillips (COP).

Q: What about natural gas?

A: The rule of thumb is natural-gas is traded at one-tenth-to-one-eighth the price of oil. Gas is stuck in a way, because what determines where gas prices go include winter demand. The other thing is most natural-gas producers in the U.S. cannot maintain production if gas prices go below $6 per cubic feet.

Q: What are your top oil and natural-gas stock picks?

A: Right now I think the upside potential will be the independent producers. They have much higher beta. They gain the most when oil prices rise and they lose the most when oil prices go down. I think we are at or close to the bottom of commodity prices. When prices move higher, Exxon doesn't gain as much as Anadarko Petroleum (APC) or Apache or EOG or Devon.

These stocks will do much better than the S&P 500, but more importantly, we think they [will meet] the threshold of 20% returns in 12 months for an Outperform [rating]. Most of them are onshore natural-gas plays in the U.S. The exception is that Apache has 45% of its operations outside the U.S. But believe it or not, these stocks respond to oil prices.

The best asset play is Devon. Occidental Petroleum (OXY) and Devon have the strongest balance sheets. The companies most undervalued in the group, I would say are Anadarko and Pioneer Natural Resources (PXD). Chesapeake's debt level is double the size of the company. Anadarko has $10 billion debt, which they are trying to bring down as fast as they can.

Q: Refiners have been beaten badly throughout the year. Why are you now positive on names like Sunoco (SUN) and Valero Energy (VLO)?

A: The biggest upside potential is going to be in the refiners over the next two years. These stocks are down so far this year about 65%. I put a Sell rating on the refining stocks in January and they went down 75%. A few weeks ago we raised our rating on them to Outperform. The stocks so far are up about 20%.

Q: Thank you.

Will Liberals Finally Unseat Tories?

Those of us in America with investments in Canroys have been more than disinterested bystanders when it comes to the Canadian Parliament. PM Harper's Tory (Conservative) party decided in October 2006 to break promises to its constituents and begin taxing the profits of Canadian Royalty Trusts. This devestated the valuations of all Canroys. The oil and gas trusts, which are also treated as non-taxable trusts in America (under the concept of Master Limited Partnerships), were especially hard-hit as there was no precedent for taxing the income of asset trusts.

Those of us invested in Canroys were outraged, though the Americans among us could do nothing about it. But the Canadians can, and apparently will. In today's Globe and on the CBC website, I found an article that the Liberal and NDP (New Democratic Party) parties have agreed to form a coalition that will force out the ruling Tory party, Finance Minister Flaherty and PM Harper. While there is no guarantee that the Liberals will roll back the law change regarding taxation of Canroys, there have been indications that the taxes will at least be modified. At this time of decreasing oil prices, we need all the help we can get to support the price of Canroy shares.

Here is the article in total:

http://www.cbc.ca/canada/story/2008/11/30/canada-coalition.html?ref=rss

Investing in Canroys for Long Term Success

From Jake:
Brian I am still not fully invested in the oil group, with the commodity bubble expected to bust I have invested lightly in this area. Any suggestions? Maybe short term? I have CANROYS but wanted to invest more before the run up but did not want to be taken out in a couple of months. I know hard to answer but any thoughts.
Otherwise a great day for me positioned well in all areas! Thank you!


My Response:
I think the Canroys will do very well short term and long term. In the mid term (2 mths to 12 mths) I am expecting a commodities correction. I think there is a lot of hot money in commodities that is parked there while the recession worries play out. I think that hot money (traders and hedgies) will move back to U.S. equities once the all-clear is called for the market. I expect that to happen anytime from June this year to March next year, sooner more likely.

Short term (next 2 months) I think Canroys will benefit from the hotness of the energy market. The Canroys hedge some of the product forward, but not all of it. So, they are benefiting from the higher energy prices on a daily basis, as they sell some production into the spot market. Also, as futures contracts expire, they will write new futures contracts at the current higher prices to lock in this level. So, there cash flow will dramatically increase the next 12 months, way above their budget forecasts, which are mostly in the $60s for oil and around $7 for gas (this info is in their annual reports).

Regardless of market concerns over the Canadian tax consequences, eventually, the value of this cash on the books must be rewarded. There could be a large special dividend, an acquisition which would increase future revenue and cash flow per share, or a takeout, which would result in a large premium on the stock price. I expect a 50% increase in price in the stocks if not taken out. If one of the small Canroys, like Daylight or Baytex for example, are taken out, they could double in value over a couple of days.

So, I think this is a great entry point for the Canroys, though it would have been even better a month or two ago (Daylight has gone from $6 in mid-January to $10 today, for example)

Regarding the Long term, 12 months to 10 years or more in the future, oil and gas will get more and more expensive as demand increases and supply stays flat if we are lucky. After 10 years, I expect alternative technologies to began increasing energy supply in general, shifting demand. I think solar will become a much bigger factor as new technology improvements drive production costs down. Wind, geothermal and wave energy will also be increasingly important. As fuel cell and battery technology improves, more vehicles will operate on electricity which can be produced by solar sources (wind and wave energy is indirectly derived from the sun, as is hydro power from rainfall into reservoirs). I expect biofuels like ethanol to become less and less important. They are very inefficient to produce and compete with the food supply.

I think Solar will be the most immediate winner in alternative energy and I am working in this industry, so can keep an eye on it up close. Today I am buying a small tracking position ($1000) in a new ETF for solar energy called TAN. Solar has had a big run and might pull back quite a bit in the likely coming commodity correction. So, I will buy more gradually looking for a better point to add a big position.

Those Overlooked Canroys!

Yesterday it was reported that Apache Petroleum had made a huge new discovery of gas deposits. Its stock price shot up to new all time records. Any where was this big new discovery?

You guessed it, in Canada, in the Northeaster BC shale oil deposits, where all the Canroys already operate and have large lease blocks on their books, along with plenty of current production.

So how is it that Apache, dealing with the same provincial taxes / royalties and a 40% American income tax rate (according to its own documents), but only a 0.6% dividend yield, is shooting up in price, while the Canroys tread water? This is a huge anomaly in the investment world that must be resolved at some point. The Canroys are only paying out 50% of their cash flow currently (on average), and are reinvesting in acquistions and organic growth so that their growth rate is on par with Apache, Chesapeake, XTO, etc.

This development effort is building large tax loss reserves that they can use to offset future income (some are stating they will have no tax affect until 2015 with the reserves that are in place). The development programs create depreciation and tax credits that are available for exploration. Both the development credits and depreciation can be carried forward many years in Canada so that any future tax change can be put off for years into the future.

If anything the Energy E&P Canroys are getting cheaper all the time in comparison to their American counterparts.

November and the Market is Ugly

Brian, Today was wild! Do you think we test the lows on the S & P? Does someone step up and buy a Canroy? Oil to mid 80's, old to 760?. VIX to 37?, Candian dollar down 2.3%. Any thoughts on the future?

My gut is this is just a correction but all fundementals are in place for lower dollar, higher gold, higher oil and another buyout of a Canroy...

Jake, I agree this is a pretty ugly market and another leg down in what began in July. Amazing how all the gains of 3 months (since the recovery in mid-August) can be wiped out in a week. This is not a very confident market. People are looking for any reason to sell and are sure getting out now. There is a lot of fear about the housing and financial markets taking down the economy.

I think this market action is showing a rotation from real estate to consumer durables to finance to retail and now on to tech and commodities, including oil and gold, as fear of a global recession spreads (though not much evidence of that). The good news for our commodity plays is they are all high yield, which makes this whole process easier to deal with. The finance stocks bounced a little today and were up against this lousy market. The home builders are also kind of washed out, though I think there must be another leg down for them and I wouldn't get close to them until there are some bankruptcies, signalling the end of the collapse (as supply is taken off the market).

I definitely think we will test the lows of August in the Dow and S&P, which aren't that far away now. We could break through and fall back to the March lows. But I don't think the environment is nearly bad enough to fall to the 2002 lows (7500 on the Dow and 800 on S&P). The financials will establish the bottom and lead the market back, maybe within the next 3-4 months. They always lead the market back.

The big question is do we go into recession and if so, how big a recession? If the rest of the world continues to grow and doesn't collapse, it will help pull the US stock market out by continuing to purchase our goods keeping our exports strong and helping the industrial base build employment.

I think the bigger banks will end up consuming the weaker banks once most of the trouble is on the table. But we still don't know how bad the trouble is, so all the banks are getting whacked. I have picked Citibank and Bank of America to survive and eventually thrive. But they are both hurting now and I was early on them, so it has hurt me. But their 6% yields make it a little better.

The good news in all of this is that the market P/E never got that high in this cycle (20) and has come down now to around 16. If we hit 11,500 on the Dow and the earnings just stay flat (no growth), we will be back under 14 for the first time since the early 90s. That was a good time to be investing in the market since the Dow was only about 3000 then (1992) and is now 4x higher.

I don't know where all the commodities could go if we get the R word going. There is a lot of fundamental reasons for gold and oil to go higher in the long term (growth of demand in the BRIC economies and ever more expensive to produce or limited supply). But over a period of a year or two, reasons for price are more technical and speculative in nature. I think 760 is the minimum pullback, but 650 is a lot more likely. If you do a chart on gold for seven years, you see that the bottom of the uptrend channel is about 650 right now.

Same thing with Oil, you can look at the channel (http://www.chartsrus.com/chart1.php?image=http://www.sharelynx.com/chartstemp/free/chartindCRUvoi.php?ticker=FUTCL) and see the lower trend line is about 65. Oil stocks, like drillers, could go down 35-40% (I am cutting my exposure to drillers) and the Canroys could go down 15-20%, though the dividend should keep them from falling too far. I am looking at writing (selling) more puts on PWE if the price gets down to $27, which it might the next couple of days. I would try to get a $1.50 premium on the $25s (maybe on the March contract). That offers me protection down to 23.50. I think the chance of the dividend on PWE getting cut is very small, so that price would be super secure since the annual dividend is over 3.00, putting the yield when the price is at $25 a t over 12%.

When VIX hits 37-40, that is the bottom, as it was last time (in August) and almost every correction before. That shows a lot of volatility that can only happen when there is some "sell-off" panic in the market. VIX was at 31 today, so on its way.

If you really want some excitment and have your options account set up, try buying at-the-money calls on your favorite names, especially if they are high volatility. Citibank (C) and BAC would be two good ideas. Cisco is another one. You can buy the March 08 $35 C call for $3 right now. That means the break even is $38 on March 17. If the stock goes back above $41 between now and then, which it definitely could, it will be a double on your bet (and if it got back to $44, it would be a triple $9 divided by $3). But if it ends up less than $35, you lose the investment.

The Trouble with Canroys

Brian, I have one question that keeps coming up on all the boards about CANROYS. The comments are that since the CANROYS pay out such a large dividend, and if they are not able to increase their production capabilites that the stocks will reduce in price over time as all the dividends are paid out. (or something close to this). Do they have a point or is this true for all oil and gas companies.

Jake, It is true that Canroys (and REITS and Master limited partnerships or MLPs in the States) are valued based on their dividend payout which is closely related to cash flow. In the States, REITs and MLPs must pay out 95% of income by law. In Canada, it is left to the royalty trust what percent to pay out.

This is an important distinction in my mind. The additional flexibility in Canada allows the Canroys to use a larger percent of income to make acquisitions to replace or expand production. You will see this is happening with the better trusts we invest in when you read the quarterly and annual reports of the trusts. PWE reinvests about 40% of its income in production, either making acquisitions (like the recent C1 Energy acquisition) or investing in additional wells on existing leases or rehabbing old wells. American trusts (MLPs and REITs) do have a problem with reinvesting in production and must issue more shares (diluting current owners) to raise money for acquisitions or expansions.

The metric that is used to measure how likely Canroys are to keep producing is Reserve Life. I look for a reserve life of at least 10 years. This doesn't mean the trust becomes worthless in 10 years, but that is how much "proven reserves" are available to last at current production rates. Each trust also has "probable reserves" which are normally many times the proven reserves. Probables are on leases that have yet to be tested, but are known to have oil and/or gas. So, as long as the trust doesn't run out of oil / gas, it will continue to produce and pay dividends.

The only other thing that can go wrong is a collapse in the price of oil and gas. Most of the trusts have a business model that generates current dividends well below current prices. (PWE's dividend model is around $40 a barrel). If the price of energy goes below that level, then profitability declines and they may start "shutting in" wells to eliminate marginally profitable pumping. But I am betting againsts that happening anytime soon. It would require a lengthy global recession to significantly reduce global energy demand.

So, in short, if we stick with the big trusts like PWE or PGH, I don't think there is much to worry about. If the trusts are acquired by a private company, then we will get a nice one time appreciation, but will lose the long term dividend. So, I am hoping the trusts remain independent and the Canadian gov't backs off on the tax change.

Market Strategy - May 2007 Checkpoint

I am still sticking with my original forecast for 2007, though the timing has changed a little. I always disclaim any timing calls because there is no way even the most educated, smart people get this right every year. There are just too many variables, especially now that we are in a world economy. But my general thesis is based on history repeating in some ways. Value is value, so that remains constant and is the basis for all other decisions. I had suggested that the first half of the year (through the summer) would see declines, followed by a rally at the end of the year into 2008 leading up to the elections. The year before presidential elections is almost always good for the stock market.

When the market corrected by 6% on Feb. 27, I thought I had this call nailed. But then the market came roaring back to new alltime highs on the Dow 30 the past month. I still think this summer will be weak and the decline could start any day. However there is a big BUT and that is global liquidity (many years of good profits in raw materials) and the China expansion prior to the Beijing Olympics. Our economy is now global and what worked in the past for American markets, is now influenced by global markets. So, maybe the Melt-Up continues. Here are the arguments for both directions, up and down:

1. The market is neither cheap nor expensive at around a P/E of 16 for the Dow and around 20 for the S&P (which has smaller cap companies). This makes direction difficult to choose. It is why my own portfolio is somewhere in the middle with about 67% equity and 33% cash and almost no bonds, since it is possible interest rates will go up from here as the dollar devalues (to attract money back to the dollar, the Fed can raise interest rates). Of the equity portion of the portfolio, most is in "value" or low P/E stocks like Health Care/Pharma (now historically cheap), Energy or Basic Materials. You know I am heavily in the CanRoy oil trusts both for their value and their large dividends. The big dividends provide the income and diversity that bonds would otherwise provide. Dividends provide a cushion against a potential market downturn.

While attractive from a fundamental, world growth, point of view, materials stocks like FCX and BHP have become more expensive on an absolute historical basis. But, their profits are growing almost as fast as their stock price, keeping relative value almost constant. The potential demand from China and Asia for infrastructure development has the potential to dwarf anything the world has ever seen. Materials companies with operations in that part of the world (both FCX and BHP have big operations in Australia and/or Indonesia) will benefit for years to come. That is unless the China economy were suddenly to come to a halt or collapse. This is possible over the next 12 months as the big push for the 2008 Olympics in Beijing comes to a close. There is a lot of risk in the China economy right now as it is growing at historically unsustainable rates (for a national economy) of over 10% a year for the past 5 years. It makes sense that once the artificial, government led push for the Olympics is done, that the Chinese market will cool off, and maybe cool off the entire world economy.

2. Other than the Olympics thesis, it is not possible to know for sure what might change the current global synchronized economic expansion. Various war scenarios are speculative, they may but probably won't happen. There really is no precedence for this global economy. There was a 20 year period before World War 1 that saw global peace and prosperity with lots of free trade. And again in the 1950s, during the reconstruction after World War 2, there was a 20 year period of the same (Korea in the 50s notwithstanding). But during those periods, there was no internet or global communications. It was also before the era of global air freight and the fast movement of goods and people around the world. So, the expansionary period since the last big recession from 1990-1992 is exceptional. The current environment that favors industrial goods and basic materials is also without precedent (the construction of industrial infrastructure in the USA took 100 years and America is only 20% the size of China by population). High demand and short supply for raw goods could continue for another decade or more, until global infrastructure development slows, or materials production facilities dramatically increase supply.

3. We are now officially in a bull market from the lows in 2003. We did not know this for sure until earlier this year when the Dow went past 11,700 surpassing the previous high from 2000 (the S&P500 has not yet confirmed with a new all-time high, but is only about 2% away at 1510). Bull markets tend to have 5 distinct segments: up for several months to a year, then a 10-15% correction; up for another several months, then another 10-15% correction, and then a final up move which can have a big "melt-up" at the end before it collapses from its own prosperity and exuberance. This was the pattern from 1992 into 2000.

It could again be the pattern, with the correction last summer of 10%, now followed by the up leg which may be "melting up" right now. Note that the every day public investor like you or me is typically the last to get into a bull market (even though we all probably have mutual funds investing on our behalf all along the way). People who follow such data professionally say that the public is still on the sideline and never got back into the market after the 2001-2002 collapse. Until that money comes in, the market can't make a true bull market top. By definition, tops in stocks or in stock markets happen when everyone who ever will buy has already bought. Then, there is no one left to buy at a higher price, so all that can be done is to sell, driving the market lower (into a bear market).

The way we can know a major market turn as average people without access to industry data that shows this action conclusively, is to watch major magazines and newspapers. When the media headlines start talking about a New Era and featuring great riches earned (or lost), we know we have either a market top or bottom. You may have noticed a year ago that all the talk was about how EVERYONE was making money flipping real estate. That was the sign that the top had been reached in that market. Same thing was true in 2000 with all the talk of the Internet changing the world and creating a new era and people day-trading tech stocks that had no earnings.

So, if in the next few months, everyone gets in, then that will spell the top of the market. Since that time is hard to see until it has passed, it is probably good to have one foot in and one foot out of the pool. At this stage of the cycle, investments should be defensive (lower P/E and non-cyclical necessities of life) with a lot of dividends to provide a foundation for the stock should there be a correction.

4. The dollar continues to weaken against world currencies. Fewer nations are using the dollar as a benchmark. Japan still does, but says it may not in the future. China is gradually moving away from the dollar as its standard, slow enough not to hurt its export economy. As the world moves to other currency standards (or "baskets of currencies"), and the US goverment continues to run big deficits, the dollar MUST continue to devalue. This will move the price of all world raw goods, especially precious goods like gold and silver, higher in dollar terms, even if the prices stay constant in other currencies. Gold, then, is a good hedge against devaluation, as are energy plays like the Canroys or the other Materials stocks like BHP or FCX. In fact, the first quarter's supposed "earning surprises" to the upside were mostly a result of currency translation by the big multi-national companies issuing those earnings reports. When the dollar goes down against the Euro, then all profits from Europe earned in that currency will appreciate by the amount of the decrease in the dollar. The dollar decreased by about 8% in Q1. That was about the same as the "earnings increase" reported on average. So, on a weighted basis, profits in real dollar terms may have only increased by 2-3%, not the 8% reported. This will eventually catch up as year over year comparisons do not benefit from currency translations in the future (if the dollar stops sinking).

If you are looking for an idea, other than precious metals / gold (VGPMX) or the CanRoys I recommended in January that you bought, I am now buying and recommending BDJ and DHG. BDJ is a twist on "Dogs of the Dow" investing. It buys the highest dividend Dow 30 stocks and does so with borrowed money which leverages the return. It also uses a Covered Call options strategy to further enhance payouts. Covered Calls are a good defensive strategy and easier to execute on large cap Dow stocks when working with big money in a fund like this (options fees are high compared to the available returns on these big name stocks for average investors). The return is currently around 8.3% with a monthly payment. The payment has been steady for a couple years at a little over 10 cents a share per month. Share price is right around $15. If the Dow goes up, so will the price of BDJ, as its portfolio appreciates. But it is a closed-end fund, so underlying value (NAV) and the market price can be and usually are different. Make sure you don't buy at a premium to NAV. It is a small discount right now, so a good time to buy.

Another closed end that I have started buying is DHG with a dividend return around 7.8%. This is more of a commercial paper (short term loans to companies with high interest rates) and a high dividend fund specializing in deep value stocks (including some CanRoys). It is run by Dan Dreman's fund company. Dreman is a renowned value investor. This one is brand new and so has had a pretty spastic market price as a closed-end can, even though the NAV has hardly changed at all.

Both the above benefit from a lot of diversity. It is unlikely either will get hammered in a market selloff on NAV (market price MIGHT get hurt, but would quickly rebound. The payout probably won't change, so the yield would provide some drag on the selloff: as price goes lower, the dividend yield goes higher if payout is constant). As long as high yielding investments are in tax deferred accounts, there is no tax impact from the payments and they will continue to compound if reinvested in the CE funds.

www.etfconnect.com is a good place to research closed end funds and see the history of discount versus premiums