Two Possible Reasons for the Rise in 10-Year Treasury Notes

December 8th, 2010

Somehow, we don’t think this is what Ben Bernanke had in mind when he launched another round of easy money five weeks ago.

Indeed, he promised us lower long-term interest rates. But this morning, the yield on a 10-year Treasury note just reached its highest level in more than six months – 3.28%.

Highest Yields of 10-Year Treasury Notes Since May

There are two possible explanations…the benign one, and the more likely one.

The benign one, pimped by Deutsche Bank, zeroes in on the cut in payroll tax that’s part of the Grand Bargain between President Obama and congressional Republicans. Deutsche figures that’ll add 0.7% to GDP during the next two years.

The more likely one is evident even to the always-late-to-the party analysts at Moody’s and Fitch: The Grand Bargain is just digging Uncle Sam into a bigger hole.

The rating agencies reckon that with no spending cuts as part of the deal, it’ll add another $1 trillion to the national debt – above and beyond what’s already baked into the cake.

Treasury plans to auction $21 billion in 10-year notes today. Could be interesting.

But really, should anyone be surprised? After Bernanke launched the first round of “quantitative easing” in March 2009, the rate on the 10-year spiked from 2.5% to over 4% within three months.

Our call: Look for 4% by early February. But we’ll go a step further.

“Every streak must come to an end,” says our income-investing specialist Jim Nelson. “On Nov. 17, that truism hit home in the bond fund world. It was the first week in the previous 100 that saw a net outflow of money.

“Investors, after nearly two years of manic consumption, are finally leery over the future of bonds.”

Net Flows into Bond Funds

That outflow continued in the week ending December 1, according to a report from EPFR Global analysts. Few sectors were spared…

  • Global bond funds suffered their second outflow in 3 weeks
  • Redemptions on high-yield funds hit a 6-month-high
  • Emerging-market bond funds saw 2 consecutive weeks of outflows for the first time since April 2009.

There’s no shortage of reasons, Jim says. “Start with QE2…then add Ireland’s new massive bailout…throw in the new permanent bailout fund for the eurozone. And what do you get? Panicked and confused investors.

“Now, that’s not to say they won’t forget about this in another couple of days and pile right back into bond funds. But if this is a true turning point, we might soon see some discount opportunities – something we haven’t had in quite a while.

“But,” Jim reminded his Lifetime Income Report readers recently, “even as the rest of the world struggles with tough issues, we still find ourselves in a pretty good place. We have a number of solid, undervalued plays that have plenty of capital and growing dividends.”

Ah, dividends. That’s going to be the key for income investors if the 28-year bull market in bonds is really over. Say this much for the Obama-GOP Grand Bargain: It leaves the tax rate on dividend income alone, at least for two more years.

Addison Wiggin
for The Daily Reckoning

Two Possible Reasons for the Rise in 10-Year Treasury Notes originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Two Possible Reasons for the Rise in 10-Year Treasury Notes




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

Investors to Silver: “Let’s Get Physical”

December 8th, 2010

The scramble for physical gold and silver is intensifying. People increasingly want to own the real thing, and not some paper substitute, all of which comes with counterparty risk. This conclusion is apparent from the fact that the futures prices for gold and silver have moved into “backwardation.”

Allow me to explain…

Because gold is money, gold almost always trades in “contango,” meaning that the future prices – i.e., forward prices – are higher than the spot price. The percentage difference between gold’s spot and forward price is gold’s “interest rate.” So in this regard, gold is not different from other moneys, except gold’s interest rate is lower than those of national currencies.

But supply and demand dynamics also influence the differential between the spot price and forward prices. And this is where our story gets interesting…

If the forward price is lower than spot – a condition called backwardation – you can sell your metal in the spot market, invest the dollars you receive to earn interest, and then buy your metal back in the future at a lower price and profit the difference. But there is another important factor to consider outside the math of this formula.

If you sell your physical metal in the spot market and at the same time agree with someone to buy it back at a future date, you are now holding someone’s paper promise instead of physical metal. In other words, you have counterparty risk, which, of course, is avoided when you hold physical gold or physical silver.

Normally, few people worry about counterparty risk. So bullion dealers and other institutions that deal in the precious metals watch for opportunities to profit from backwardation, with the result that gold rarely trades in backwardation, which explains why the chart below is so extraordinary.

The Backwardation of 6-Month Gold Futures Contracts

Gold for 1-month and 3-months forward has been mainly in backwardation for more than one year. Even more exceptional is that gold 6-months forward has been in backwardation since November 5th. To show how rare this event is, I checked the LBMA database, which goes back to 1989. There is not one instance of 6-month forward gold being in backwardation, which confirms my own experience. I’ve been trading the precious metals since the 1970s, and I can’t recall any time before this year when 6-months forward gold was in backwardation. The current and continuing backwardation is truly incredible.

12-month forward gold is also approaching backwardation. These downtrends make clear that the demand for physical gold is intensifying.

The picture is even starker in silver. Silver 6-months forward has been continuously in backwardation since June 2nd and mainly in backwardation for more than one year. What does it all mean?

In a word, it is bullish. The only way the increasing demand for physical metal can be met is with higher prices. The higher price will at some level entice people to sell their metal and hold a national currency instead.

Some skeptics may argue that there is no backwardation apparent from COMEX settlement prices. Aside from the fact that COMEX recently changed the method to determine settlement prices from a market-driven basis to instead allow a manual override, which now makes backwardation on the posted COMEX settlement prices virtually impossible, one has to first recognize that COMEX is first and foremost a market for paper-gold and paper-silver.

Therefore, a piece of paper can promise virtually anything, without regard to the underlying reality of how physical metal is actually trading. In other words, COMEX shows March futures in contango, when they should in reality be in backwardation. Thus, if you are buying March silver or April gold futures, you are overpaying. This overpayment is no doubt going into the pockets of those banks that are perennially short and use their size to control the paper market. They can, after all, always conjure up whatever paper they want out of thin air, which of course they cannot do with physical metal.

Any way you look at it, the backwardation in gold and silver is a truly rare event and an exceptionally bullish one too. So be prepared for an upside explosion in the price of both precious metals as the scramble for physical metal intensifies even further, and investors increasingly choose to hold the metals themselves, instead of paper promises.

Regards,

Frank Holmes
for The Daily Reckoning

Investors to Silver: “Let’s Get Physical” originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Investors to Silver: “Let’s Get Physical”




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Commodities, Uncategorized

Congress Growing up, Putting Away Childish Things… Sort Of

December 8th, 2010

The co-chairmen of President Barack Obama’s National Commission on Fiscal Responsibility and Reform — former Wyoming Senator Alan Simpson and University of North Carolina President Erksine Bowles — have called for increasing taxes and cutting spending in order to trim some $4 trillion from the nation’s budget over the next ten years.

Predictably, the plan will never see the light of day, as the commission failed to get the votes required for Congress to even take a look at the recommendations. At least both parties can come to an agreement on some matters… such as the “adult stuff” highlighted below.

This cartoon came to our attention via The Mess That Greenspan Made, in its post on how now both sides are talking about the deficit.

Congress Growing up, Putting Away Childish Things… Sort Of originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Congress Growing up, Putting Away Childish Things… Sort Of




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Uncategorized

J.P. Morgan and the Great Silver Caper

December 8th, 2010

There’s a lot of rumor, buzz, innuendo, chitchat and scuttlebutt about the precious metals markets these days. Most of the chitchat is about J.P. Morgan and silver. Rumor has it that J.P. Morgan has amassed a whopping short position in silver.

The scuttlebutt, according to SFGate.com, is that “J.P. Morgan holds a giant short position in silver. Furthermore, some observers are accusing the bank of acting as an agent for the Federal Reserve in the market…I.e., a lower silver price helps maintain the relative appeal of the US dollar…

“By selling massive amounts of paper silver in the futures market,” SFGate continues, “J.P. Morgan has been able to suppress the price of the precious metal. It is believed that these short positions are naked (i.e. they are not backed by any physical silver).”

If the silver price were falling, Morgan’s (alleged) short position would be lauded as a stroke of genius. But since the silver price is soaring, Morgan’s (alleged) short position looks much less laudable.

“In recent days,” SFGate notes, “rumors have been swirling on the Internet that J.P. Morgan’s massive short position is about to blow up in its face in the form of an almighty short squeeze and potential COMEX default, as large traders demand physical delivery of silver that COMEX does not have in its vaults.”

Based on some of the latest conjecture, Morgan’s short position totals a whopping 3.3 billion ounces. If, therefore, the buzz about J.P. Morgan and silver is even half true, the prestigious investment bank could be cruisin’ for bruisin’.

For perspective, 3.3 billion ounces is roughly equal to:

1) One third of all the world’s known silver deposits;

2) Two times the world’s approximate stockpiles of silver bullion;

3) Four times the annual mined supply of silver;

4) 30 times the inventory of silver at the COMEX.

To repeat, short positions – even titanic ones – are no big deal, as long as the price of the underlying asset is falling. But if, inconveniently, it is rising, the spaghetti can hit the fan in spectacular and gruesome fashion.

The silver price is rising…a lot. From less than $10 an ounce two years ago, the silver price has more than tripled. Therefore, if J.P. Morgan does, in fact, hold a 3.3 billion ounce short position, every one-dollar increase in the silver price would produce a loss of $3.3 billion…at least on paper.

Unfortunately, Morgan cannot simply unwind this trade with a couple of mouse-clicks in an E*trade account. The position is too large, both in relation to the world’s physical supplies of silver and in relation to the paper “supplies.” (Morgan holds almost half of all short positions on the COMEX, which is essentially a “paper market” – participants rarely take delivery of physical silver).

To make matters even more dicey for Morgan, the supplies of physical silver are disappearing rapidly from the marketplace. Increasingly, the kinds of folks who invest in precious metals are also the kinds of folks who distrust intermediaries. These precious metals investors want to know that the shiny stuff is in their personal possession.

Meanwhile, the ETFs that hold precious metals are soaking up massive quantities of physical metal. Over the last 12 months, the silver ETFs around the globe have increased their holdings by nearly 100 million ounces – or almost as much silver as the entire inventory of the COMEX. The trend in gold is identical.

Total Known ETF Holdings of Silver

Therefore, as a result of soaring demand from both individual investors and ETFs, the physical stockpiles of gold and silver are atrophying in relation to the paper claims on both metals. This is not a pleasant picture for a short seller of silver.

Furthermore, the kinds of folks who tend to buy gold and silver are also the kinds of folks who have contempt for Wall Street…and for Wall Street banks like J.P. Morgan. So it should come as no surprise that a grassroots campaign has formed – the sole purpose of which is to punish J.P. Morgan for its attempted manipulation of the silver market.

“A viral campaign (Crash JP Morgue Video [below]) to buy a physical silver and ‘crash’ the bank is now spreading like wildfire on the Internet,” SFGate reports. “Just Google, ‘Crash JP Morgan Buy Silver’ [to learn more about it]… Those who wish to participate in squeezing the living daylights out of J.P. Morgan, may want to consider buying physical silver, silver futures and SLV.”

Maybe this story about J.P Morgan’s short position in silver is mere innuendo. Maybe not. But two facts are irrefutable:

1) J.P. Morgan is already under investigation by the CFTC for manipulating the silver market. “The investigation into the bank can be traced back to November 2009,” SFGate reports, “when London metals trader and whistleblower Andrew Maguire contacted the CFTC to report market manipulation prior to it actually occurring.”

2) Precious metals investors are increasingly keen to get their hands on physical gold and silver, rather than mere paper facsimiles.

Eric Fry
for The Daily Reckoning

J.P. Morgan and the Great Silver Caper originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
J.P. Morgan and the Great Silver Caper




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Commodities, ETF, Uncategorized

Water ETFs Poised To Grow

December 8th, 2010

Both macro and microeconomic forces suggest that the global water sector is destined to see exponential growth paving the path to opportunity for the PowerShares Water Resources (PHO), the PowerShares Global Water (PIO) and the Guggenheim S&P Global Water (CGW).

From a macro perspective, incomes in developing nations are expected to rise and populations around the world are expected to continue to expand pushing up demand for water. In fact, at current growth rates, it is expected that demand for water will grow by nearly 6 percent annually. This growth is expected to be most prevalent in emerging Asia, where India is expected to see its water demand more than double and China’s to rise by more than 30 percent over the next 20 years.

Further price support in the essential commodity is likely to be driven by a deficiency in supply. Of the water that can be found around the world, a mere 1% can be used for agricultural purposes and human consumption. Additionally, research suggests that soil moisture levels on Earth are declining which could potentially lead to depletion in fresh water tables around the world.

Global supply constraints are further being enhanced due to rapid growth that has been seen in Asian nations which has lead to contamination of rivers and lakes and polluted groundwater. In fact, the World Bank estimates that China’s growth is expected to result in a supply shortfall of nearly 200 billion cubic feet within the next two decades.

In a nutshell, a monumental supply and demand imbalance is developing in the water sector which will likely result in water scarcity and force an influx of investment into the sector on both the domestic and international stage. As mentioned above, some ways to capitalize on the water sector include the following:

  • PowerShares Water Resources (PHO) which boasts environmental services giant Veolia Environment (VE) and flow control equipment specialists Flowserve Corporation (FLS) in its top holdings.
  • PowerShares Global Water (PIO) boasts French-based Suez Environment, which specializes in producing, distributing, treating, and recovering water as well as wastewater treatment specialists Kemira Oyj in its top holdings.
  • Guggenheim S&P Global Water (CGW) holds Swiss-based Geberit AG, which specializes in water sanitary systems and the transportation of water through piping systems.

Disclosure: No Positions

Read more here:
Water ETFs Poised To Grow




HERE IS YOUR FOOTER

Uncategorized

Emerging Markets and Commodities: Where Stimulus is REALLY Going

December 8th, 2010

“It was a debt of honour, so-called, which I had to pay, and I used money which was not my own to do it, in the certainty that I could replace it before there could be any possibility of its being missed. But the most dreadful ill-luck pursued me. The money which I had reckoned upon never came to hand, and a premature examination of accounts exposed my deficits.

“The case might have been dealt leniently with, but the laws were more harshly administered thirty years ago than now, and on my twenty-third birthday I found myself chained as a felon with thirty-seven others convicts in the ’tween decks of the barque Gloria Scott, bound for Australia. “

– Sir Arthur Conan Doyle, The Adventures of Sherlock Holmes

Imagine going from England to Australia on a sailing ship, shackled ’tween the decks. The convicts must have been happy to finally get here.

Imagine getting sent to Australia for failing to pay a debt (even one that was never intended by the creditor)! That would discourage you from spending money that is not your own!

It was a tougher world back in 1855. The “laws were more harshly administered” then.

Now, the laws aren’t administered at all. The culprits are in so tight with the feds you’d need some WD40 to get them loose. The banks seem to have taxpayer money on tap. As much as they want. 24/7. On/Off. And the feds spend money that is not their own…and promise to replace it. That replacement money will never come to hand. And an examination of the feds’ accounts exposes immense deficits – about 20 times the entire annual output of America’s private sector.

And along comes Washington with word of a deal. The bargain was struck yesterday. The rich get to hold onto their money for another two years. And the poor get another 13 months of unemployment benefits.

Win/Win, right?

Are you kidding? The feds’ accounts show a deficit of $1.3 trillion. Tax cuts and further spending? Lose, lose, lose…

Well, why not? Give everyone a Christmas present – whether you can afford it or not. Stocks will probably go up today. The papers are reporting that the extension of the Bush tax cuts may be all the economy needs. No further stimulus may be necessary. Because if rich people can look forward to the same tax rates next year…

…what exactly is it they will do? Invest more money? Yes…in India! And China! And commodities! And even gold!

Yes, that’s where the stimulus has gone so far.

We don’t like the looks of it. This market. This economy. Or this political situation.

We don’t like any part of it. It’s all based on hype, fraud and hallucination.

So, we’ve got our “Crash Alert” flag out.

Most likely, of course, it won’t be necessary. Things usually muddle forward. And most likely, they’ll muddle forward like they did in Japan in the 1990-2010 period…or in Britain from the end of WWII to the Thatcher years. Sluggish economy…high unemployment…falling house prices…and foolish government intervention.

We should see falling stock prices too. Investors have made no money in stocks in a dozen years…but stocks are still pretty pricey. We’d like to see them fall to about half to a third today’s level. Then, maybe we could get excited about buying them. As it is, we presume they still face their rendezvous with the bottom. Until it is behind us, it is still ahead of us.

Giving good financial advice is really very easy.

Buy investments that are going up.

“But what if they don’t continue to go up?” you ask.

Then don’t buy them.

See how easy it is?

Bill Bonner
for The Daily Reckoning

Emerging Markets and Commodities: Where Stimulus is REALLY Going originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Emerging Markets and Commodities: Where Stimulus is REALLY Going




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Commodities, Uncategorized

Market Psych Offers Language-Based Fear Index

December 8th, 2010

Aside from the VIX, there are quite a few fear indices out there. Just a couple of months ago, for example, I was extolling the virtues of the St. Louis Fed’s Financial Stress Index.

One of the more interesting ones that I have not seen get much in the way of media attention is the Market Psych Fear Index. This index is constructed by using a 10-day exponential moving average of the percentage of “fear” words in the U.S. financial news. In the chart below, the Market Psych Fear Index is the solid blue line and the candlesticks are the NASDAQ-100 index (QQQQ).

As the construction of this fear index is based on language in the financial media, the fear index makes it possible to compare market-based fear measures such as the VIX and other volatility indices with the degree of public concern or perhaps even fear mongering found in the media.

One would expect that the Market Psych Fear Index and stocks to generally move in opposite directions, just as is the case with the VIX and stocks. While this is the case more often than not, the chart below shows that in the last month or so, as stocks have been rising, the movements in stocks and the Market Psych Fear Index have been positively correlated. What does this mean? Perhaps all the talk of the European sovereign debt crisis and North Korean aggression is starting to wear thin. Perhaps the media is not quite able to stir up fear like it has in the past. Of course, perhaps Occam’s razor would say that investors are being naïve.

In any event, VIX futures are predicting that the VIX will rise almost 50% by the middle of 2011.

At a minimum, I think the divergence between market-based and language-based fear indicators bear further watching.

Finally, the Market Psych web site has some interesting content, not the least of which is sentiment-based analysis of stocks and ETFs, but also an excellent collection of free personality tests for traders and investors.

Related posts:


[source: MarketPsych.com]
Disclosure(s): neutral position in VIX via options at time of writing



Read more here:
Market Psych Offers Language-Based Fear Index

ETF, OPTIONS, Uncategorized

Sorting Out the Tax Cut and Unemployment Benefits Extensions

December 8th, 2010

When I turned on the currency screens this morning, I saw that the euphoria of a currency rally, which we had talked about yesterday, had dissipated. I said to myself that it’s a case of “another day, another currency direction”… It all began mid-day yesterday, with gold and silver once again leading the way…only this time the way was down! UGH! Gold was down $24 as I left for the day… It’s down another $5 this morning…

I had read a blurb that came across the screens yesterday that once gold got to $1,430, the orders to take profits flowed like a river that swells from the spring rains! Was it just profit taking, though, that drove the shiny metal down $24? Probably not, as the program trading usually accounts for a sell off like that, when the fundamentals say the opposite.

The opposite is that the “Bernank” has publicly stated that they want to “inflate the economy.” Commodities are used to offset the damage that inflation does to one’s pocketbook… It’s that simple… Now… I don’t want you to think that I believe that gold is the only way to combat inflation… Gold is a commodity, but in reality, gold is the “uncertainty hedge.” It can act as an inflation hedge, but when you see hold screaming higher and higher all the time it is really an offset to the dollar… In fact, you may recall seven or eight months ago, when the euro (EUR) was losing ground daily, I said that the risk to the euro was that it could lose its position as “offset to the dollar”… I think that’s still working its way through and gold has taken over what the euro has lost…

The same can be said for silver…

Well… This back and forth on the dollar looks to me as though the markets are still attempting to digest the news that the Bush Tax Cuts were extended, along with the unemployment benefits. I’ll tell you one asset class that isn’t having any problem whatsoever digesting that news…and that’s bonds! Yesterday morning the 10-year Treasury was 3.01%…but by day’s end it was 3.19%! WOW! You don’t see moves like that in Treasuries very often… And for you newbies to bonds, let me say that the price and yield of a bond have an inverse relationship. In other words…when yields go higher, the price of the bond goes down, and vice-versa… So, Treasuries got rocked yesterday… But, it hasn’t just been yesterday… This has been going on for a month now…on November 10th, the 10-year’s yield was 2.63%, which was a bond price of 99 29/32’s (bond trade in 32nds) So, very close to par or 100, right? Well, that 3.19% yield is equal to a bond price of 95 9/32’s…

So almost a 5-point loss in 10-year Treasuries in the past month, and when you take into consideration the commission the broker charged you, it’s a 5-point loss easily! So what, you probably say? Gold lost $24 yesterday… Ahhh grasshopper… The difference is that bonds are not held in small amounts like gold…

But… The thing I want to point out here is that Big Ben is losing his battle to keep mortgage rates down… I think maybe the old “bond vigilantes” are alive… But they’ve got a lot more work to do! The bond vigilantes are bond market investors who protest monetary or fiscal policies they consider inflationary by selling bonds, thus increasing yields.

So… Since, in the bond market, prices move inversely to yields… When investors perceive that inflation risk is rising, they demand higher yields to compensate for the added risk. As a result, bond prices fall and yields rise, which increases the net cost of borrowing.

Now… You normally don’t see a rallying dollar when bonds are getting sold… But that’s another of the market movements you could depend on, before the financial meltdown in 2008… Everything we knew, changed… Will they come back? I sure hope so… I’m too old of a dog to teach new tricks to!

But in this case… I think this dollar strength versus rising yields are going on because the markets truly believe the bull about these tax cuts and extended unemployment benefits giving the US better growth prospects… Oops, did I say that out loud?

If the economy were to really grow (minus government spending) then that would reduce the need for Big Ben’s quantitative easing, eh? But… Here we have our Central Bank Chairman on 60 Minutes, and after watching some of it, did you notice his lip quivering like I did? At this point, I’m not sure my lips wouldn’t be quivering, if I were in his shoes! Anyway, what I was getting to, was a pointed comment that he believes that we do need more quantitative easing… And the markets are saying no… This should be interesting, eh?

Well… The Bank of Canada (BOC) left rates unchanged yesterday… I had thought that, of the four central bank meetings this week, the BOC was the only central bank that had a slim chance of hiking rates… But it looks like slim left town… So, rates remained unchanged… And the price of oil fell $2 yesterday, (again, another inflation fighting commodity…) So… Put the two together, and the Canadian dollar/loonie (CAD) lost 1-cent…

The Aussie dollar (AUD) also lost 1-cent in yesterday’s trading, and is off another 1/4-cent this morning… There were rumors circulating yesterday that China was going to announce another rate hike, in their never-ending attempt to cool down their economy. Whenever China announces anything that could slow their economy, the Aussie dollar takes a hit… But soon after, all’s forgotten, and the Aussie dollar continues to shine…

The Reserve Bank of New Zealand (RBNZ) will be the third central bank to meet this week, and the third central bank to leave rates unchanged… New Zealand received some bad news yesterday… It seems that in the northern part of the North Island, a drought has been declared… This region is the largest milk producing region in New Zealand, so… This is not good… Not only for the lost production in the milk industry, which could cause a hit to GDP, but also to the hydroelectric dams that produce power… The New Zealand dollar/kiwi (NZD) has sold off 1-cent too!

Tomorrow, the European Central Bank (ECB) will make it four in a row, for central banks leaving rates unchanged this week. The euro has seen some pressure this morning from a surprising weaker export report from Germany for October… Exports fell 1.1% in October, from September’s 3% gain… There are a number of reasons for German exports to weaken like the problems in the region, but the most compelling reason is that the euro was much stronger in October!

Someone asked me yesterday why I call the Fed Reserve the cartel, and most recently the “Bernank”… It’s just my way of trying to call it something closer to what it really is… There’s nothing Federal about it, and there are no reserves… And in the end… you should read the book… The Creature Form Jekyll Island

Then there was this… OK… So… I was thinking about the extension of unemployment benefits yesterday… and besides all the things I don’t like about it (and I’m not insensitive to being unemployed, I have been unemployed for more than six months before, and know what it was like…during which time, by the way, I never applied for unemployment, (not that there’s anything wrong with doing so!) but instead lived on savings… a novel approach, eh?)… The thing that will make people uneasy going forward is the fact that the unemployment rate will remain high, and… Probably move higher, because, as you know from being an astute reader of the Pfennig, after benefits run out, the unemployed are dropped from the BLS’s list of “unemployed”… So… In January, when 2,000,000 unemployed people were going to have their benefits expire, the rate would have fallen… But now… It will not…

The other thing this does, is allow people to spend more for the Christmas season… That sure gets the masses lathered up when retail sales are strong, even though we as a country spend more than we make…

To recap… The dollar selling ended mid-day yesterday, and a rally took place with dollar buying across the board, with gold losing $24 on the day! 10-year Treasuries got smacked hard with a nearly 20 basis point move higher in yields… Seems the bond vigilantes are at work! The Bank of Canada left rates unchanged and oil dropped $2, leaving the loonie down 1-cent from yesterday.

Chuck Butler
for The Daily Reckoning

Sorting Out the Tax Cut and Unemployment Benefits Extensions originally appeared in the Daily Reckoning. The Daily Reckoning, offers a uniquely refreshing, perspective on the global economy, investing, gold, stocks and today’s markets. Its been called “the most entertaining read of the day.”

Read more here:
Sorting Out the Tax Cut and Unemployment Benefits Extensions




The Daily Reckoning is a contrarian e-letter, brought to you by New York Times best-selling authors Bill Bonner and Addison Wiggin since 1999. The DR looks at the economic world-at-large and offers its major players – investors, politicians, economists and the average consumer – some much-needed constructive criticism.

Commodities, Uncategorized

This Could be the First $1 Trillion Stock

December 8th, 2010

This Could be the First $1 Trillion Stock

The day will come when a public company becomes worth $1 trillion. It's a big number to swallow, but I think it's possible…

When I say a company will one day become “worth $1 trillion,” I'm referring to when a company reaches a market capitalization, or the number of shares outstanding multiplied by its stock price, of $1 trillion. Frequently, record-breaking market capitalizations coincide with a huge market run up or stock market bubble. Many Japanese firms had the largest market caps in the world when the Nikkei exchange reached its peak in December 1989. After that, it started a steady downward slide.

A couple of companies have come close in recent years. PetroChina (NYSE: PTR) boasted a market cap of more than $700 billion back in 2007, while Microsoft (Nasdaq: MSFT) posted an eye-popping market cap of almost $600 billion back in 2009. Both companies currently sport market caps less than half of those peak levels.

The first trillion dollar firm could stem from a future bubble, but it very well could result from a company that gets there the old-fashioned way — by growing sales and earnings. Stock prices follow fundamentals over the long haul, so the only way a firm is going to get there is by improving operations and investors taking notice.

One massive firm that could potentially get there is the Brazilian energy giant Petroleo Brasileiro S.A. (NYSE: PBR). Better known as Petrobras, the company has very ambitious expansion plans and recently completed a nearly $67 billion capital raise campaign by issuing shares on both the Sao Paulo Stock Exchange in Brazil and New York Stock Exchange here in the United States.

Petrobras bills itself as the fourth largest energy firm in the world. The company reported $116 billion in sales and nearly $16 billion in earnings last year. Its current market capitalization is just over $200 billion — so it would need to grow five-fold to get to $1 trillion. But I think it could get there.

That's because the word “ambitious” could be an understatement for Petrobras' growth plans. The company expects to invest an astounding $224 billion during the next four years to grow its exploration and production capabilities in Brazil. This is projected to push annual oil production to 3.9 million barrels by 2014. Natural gas production will also rise to meet the demand it expects to reach 130 million cubic feet per day in Brazil by 2014.

Petrobras is controlled by the Brazilian government. In many cases, government intervention is seen as a drawback, as it can place political interests ahead of a purer profit motivation that shareholders demand. However, in this case the government serves as a backstop should Petrobras run into any snags as it develops its vast base of reserves. A partner with basically unlimited capital is also a bonus, provided the company earns an acceptable return on its investments, of course. The government was the primary purchaser of stock in the current share offering, which means its interests are firmly aligned with shareholders. It also means Petrobras can basically operate a monopoly in Brazil — last year it accounted for almost 99% of oil and natural gas production in the country last year.

Petrobras' production and exploration activities are also in or very close to its home turf. It operates along Brazilian coastal basins, and the Brazilian federal government has granted Petrobras full access to drill and explore in the coastal regions it controls. Management refers to this as “privileged access,” which it certainly is. Dominance in one of the largest and fastest-growing emerging markets in Brazil is also an important privilege that will allow Petrobras to expand rapidly.

Petrobras' current reserve base is the primary basis by which the company can expand. It will need to grow by nearly five times to achieve a $1 trillion valuation, but this is doable given it estimates 12.1 billion barrels of oil equivalent in reserves. More than 95% of these reserves are in Brazil and it represents about 14 years of production. Better yet, management thinks there is plenty more oil and gas to discover.

Action to Take —> Petrobras will soon begin extracting some of the largest oil finds ever. With an existing market cap of $226 billion, it won't take much for it to reach $1 trillion within a decade — it may take less if growth continues in the double digits for three to five years.

Petrobras already accounts for about 20% of the world's deep-water production and should increase its global share given the vast reserve base. Sales and earnings have expanded at a +26% average annual clip in the past five years and should grow at a similar level in the coming five years as the company ramps up its production capabilities to match its massive reserve finds.

Current company projections call for annual production to double within the next four years. This could put annual sales close to $250 billion and profits well over $30 billion. A similar level of growth in the subsequent four-year period means Petrobras has a good chance at having a market cap of $1 trillion within the next decade. This is obviously a long-term call, but it implies appealing annual returns of about +20% for investors.

– Ryan Fuhrmann

A graduate of the University of Wisconsin and the University of Texas, Ryan Fuhrmann, CFA, adheres to a value-based investing viewpoint that successful companies…

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This Could be the First $1 Trillion Stock

December 8th, 2010

This Could be the First $1 Trillion Stock

The day will come when a public company becomes worth $1 trillion. It's a big number to swallow, but I think it's possible…

When I say a company will one day become “worth $1 trillion,” I'm referring to when a company reaches a market capitalization, or the number of shares outstanding multiplied by its stock price, of $1 trillion. Frequently, record-breaking market capitalizations coincide with a huge market run up or stock market bubble. Many Japanese firms had the largest market caps in the world when the Nikkei exchange reached its peak in December 1989. After that, it started a steady downward slide.

A couple of companies have come close in recent years. PetroChina (NYSE: PTR) boasted a market cap of more than $700 billion back in 2007, while Microsoft (Nasdaq: MSFT) posted an eye-popping market cap of almost $600 billion back in 2009. Both companies currently sport market caps less than half of those peak levels.

The first trillion dollar firm could stem from a future bubble, but it very well could result from a company that gets there the old-fashioned way — by growing sales and earnings. Stock prices follow fundamentals over the long haul, so the only way a firm is going to get there is by improving operations and investors taking notice.

One massive firm that could potentially get there is the Brazilian energy giant Petroleo Brasileiro S.A. (NYSE: PBR). Better known as Petrobras, the company has very ambitious expansion plans and recently completed a nearly $67 billion capital raise campaign by issuing shares on both the Sao Paulo Stock Exchange in Brazil and New York Stock Exchange here in the United States.

Petrobras bills itself as the fourth largest energy firm in the world. The company reported $116 billion in sales and nearly $16 billion in earnings last year. Its current market capitalization is just over $200 billion — so it would need to grow five-fold to get to $1 trillion. But I think it could get there.

That's because the word “ambitious” could be an understatement for Petrobras' growth plans. The company expects to invest an astounding $224 billion during the next four years to grow its exploration and production capabilities in Brazil. This is projected to push annual oil production to 3.9 million barrels by 2014. Natural gas production will also rise to meet the demand it expects to reach 130 million cubic feet per day in Brazil by 2014.

Petrobras is controlled by the Brazilian government. In many cases, government intervention is seen as a drawback, as it can place political interests ahead of a purer profit motivation that shareholders demand. However, in this case the government serves as a backstop should Petrobras run into any snags as it develops its vast base of reserves. A partner with basically unlimited capital is also a bonus, provided the company earns an acceptable return on its investments, of course. The government was the primary purchaser of stock in the current share offering, which means its interests are firmly aligned with shareholders. It also means Petrobras can basically operate a monopoly in Brazil — last year it accounted for almost 99% of oil and natural gas production in the country last year.

Petrobras' production and exploration activities are also in or very close to its home turf. It operates along Brazilian coastal basins, and the Brazilian federal government has granted Petrobras full access to drill and explore in the coastal regions it controls. Management refers to this as “privileged access,” which it certainly is. Dominance in one of the largest and fastest-growing emerging markets in Brazil is also an important privilege that will allow Petrobras to expand rapidly.

Petrobras' current reserve base is the primary basis by which the company can expand. It will need to grow by nearly five times to achieve a $1 trillion valuation, but this is doable given it estimates 12.1 billion barrels of oil equivalent in reserves. More than 95% of these reserves are in Brazil and it represents about 14 years of production. Better yet, management thinks there is plenty more oil and gas to discover.

Action to Take —> Petrobras will soon begin extracting some of the largest oil finds ever. With an existing market cap of $226 billion, it won't take much for it to reach $1 trillion within a decade — it may take less if growth continues in the double digits for three to five years.

Petrobras already accounts for about 20% of the world's deep-water production and should increase its global share given the vast reserve base. Sales and earnings have expanded at a +26% average annual clip in the past five years and should grow at a similar level in the coming five years as the company ramps up its production capabilities to match its massive reserve finds.

Current company projections call for annual production to double within the next four years. This could put annual sales close to $250 billion and profits well over $30 billion. A similar level of growth in the subsequent four-year period means Petrobras has a good chance at having a market cap of $1 trillion within the next decade. This is obviously a long-term call, but it implies appealing annual returns of about +20% for investors.

– Ryan Fuhrmann

A graduate of the University of Wisconsin and the University of Texas, Ryan Fuhrmann, CFA, adheres to a value-based investing viewpoint that successful companies…

Uncategorized

The Last Remaining Bargains in the S&P 500

December 8th, 2010

The Last Remaining Bargains in the S&P 500

With the S&P 500 touching another 52-week high on Monday, investors need to be increasingly careful. Any new stock buys could be coming in the later stages of a mini-rally that began around Labor Day weekend. So it pays to move down the risk curve by focusing on cheaper stocks that still possess upside but are also more likely to hold their own in any market pullback.

Even with the recent rally, roughly 15% of the stocks in the S&P 500 still trade for less than 10 times next year's earnings. Some deserve to trade on the cheap, yet others are simply out of favor now but would fare better as the economic cycle builds. Let's take a closer look…

Cheap — and will probably stay that way
I excluded insurance and financial stocks from the stock screen you see in the table above. Right now, it's hard to make a case for stocks in either of these sectors. I also eliminated oil and gas plays from the list, as they are never going to be “big multiple” stocks.

Other individual stocks are likely to perpetually sport single-digit multiples. Dean Foods (NYSE: DF), GameStop (NYSE: GME) and Lexmark (NYSE: LXK) are all examples of companies that have simply run out of organic growth prospects, and it's hard to know what might get growth going again. Other companies such as defense contractors General Dynamics (NYSE: GD), L-3 Communications (NYSE: LLL) and Raytheon (NYSE: RTN) are buckling down for possible cuts in defense spending and few expect that situation to reverse until our budget deficits have been tamed.

We've covered some of these names recently. For example, near-term headwinds may explain why shares of Ford Motor (NYSE: F) still appear cheap on a price-to-earnings (P/E) basis. [Read my analysis here for an explanation]

And what I wrote about Gannett (NYSE: GCI) back in June still applies today. Lastly, I recently noted that Dell (Nasdaq: DELL) executives are well aware of their stock's dowdy valuation.

So where else does value lurk?

Jabil Circuit (NYSE: JBL)
Jabil is the world's third largest contract manufacturer, making a wide range of electronic components, devices and systems for major tech companies like Cisco Systems (Nasdaq: CSCO), Apple (Nasdaq: AAPL) and Research in Motion (Nasdaq: RIMM). It's not an especially sexy business, as Jabil and its peers need to settle for wafer-thin profit margins if they are to win business. But Jabil has a plan: Slowly migrate into newer industries such as medical devices and clean energy technology while also offering more advanced manufacturing services — all of which now appear to be pushing the company onto a path of higher profit margins.

Those efforts are already bearing fruit: Operating margins are now rebounding at a steady clip after wilting the past five years. Goldman Sachs believes they'll exceed 4% in the current fiscal 2011 year (for the first time in its history), and should approach 4.5% in fiscal 2012. Throw in a forecast of rebounding sales growth, and Jabil should become a solid earnings growth story.

Sales grew +15% in fiscal (August) 2010, and should grow by a similar amount this year, thanks in large part to new customer wins (to make products that carry higher margins). That should help boost earnings per share (EPS) more than +30% this year, north of $2. In subsequent years, sales and profit growth should moderate. Assume sales growth in the +5% to +10% range, and profit growth at twice that level. Shares, which trade for around eight times projected 2011 profits look quite appealing in that context.

Whirlpool (NYSE: WHR)
Demand for washing machines, dishwashers and dryers has been in a slump ever since the housing bubble was pricked. Consumers are hanging on to them longer, fixing instead of replacing whenever possible.

Whirlpool saw its sales slump in recent years and is only now again back above the $18 billion revenue mark, a figure last seen in 2006. But the company is vastly different since then, with a much leaner cost structure, better exposure to more dynamic emerging economies and a far cleaner balance sheet.

Uncategorized

The Last Remaining Bargains in the S&P 500

December 8th, 2010

The Last Remaining Bargains in the S&P 500

With the S&P 500 touching another 52-week high on Monday, investors need to be increasingly careful. Any new stock buys could be coming in the later stages of a mini-rally that began around Labor Day weekend. So it pays to move down the risk curve by focusing on cheaper stocks that still possess upside but are also more likely to hold their own in any market pullback.

Even with the recent rally, roughly 15% of the stocks in the S&P 500 still trade for less than 10 times next year's earnings. Some deserve to trade on the cheap, yet others are simply out of favor now but would fare better as the economic cycle builds. Let's take a closer look…

Cheap — and will probably stay that way
I excluded insurance and financial stocks from the stock screen you see in the table above. Right now, it's hard to make a case for stocks in either of these sectors. I also eliminated oil and gas plays from the list, as they are never going to be “big multiple” stocks.

Other individual stocks are likely to perpetually sport single-digit multiples. Dean Foods (NYSE: DF), GameStop (NYSE: GME) and Lexmark (NYSE: LXK) are all examples of companies that have simply run out of organic growth prospects, and it's hard to know what might get growth going again. Other companies such as defense contractors General Dynamics (NYSE: GD), L-3 Communications (NYSE: LLL) and Raytheon (NYSE: RTN) are buckling down for possible cuts in defense spending and few expect that situation to reverse until our budget deficits have been tamed.

We've covered some of these names recently. For example, near-term headwinds may explain why shares of Ford Motor (NYSE: F) still appear cheap on a price-to-earnings (P/E) basis. [Read my analysis here for an explanation]

And what I wrote about Gannett (NYSE: GCI) back in June still applies today. Lastly, I recently noted that Dell (Nasdaq: DELL) executives are well aware of their stock's dowdy valuation.

So where else does value lurk?

Jabil Circuit (NYSE: JBL)
Jabil is the world's third largest contract manufacturer, making a wide range of electronic components, devices and systems for major tech companies like Cisco Systems (Nasdaq: CSCO), Apple (Nasdaq: AAPL) and Research in Motion (Nasdaq: RIMM). It's not an especially sexy business, as Jabil and its peers need to settle for wafer-thin profit margins if they are to win business. But Jabil has a plan: Slowly migrate into newer industries such as medical devices and clean energy technology while also offering more advanced manufacturing services — all of which now appear to be pushing the company onto a path of higher profit margins.

Those efforts are already bearing fruit: Operating margins are now rebounding at a steady clip after wilting the past five years. Goldman Sachs believes they'll exceed 4% in the current fiscal 2011 year (for the first time in its history), and should approach 4.5% in fiscal 2012. Throw in a forecast of rebounding sales growth, and Jabil should become a solid earnings growth story.

Sales grew +15% in fiscal (August) 2010, and should grow by a similar amount this year, thanks in large part to new customer wins (to make products that carry higher margins). That should help boost earnings per share (EPS) more than +30% this year, north of $2. In subsequent years, sales and profit growth should moderate. Assume sales growth in the +5% to +10% range, and profit growth at twice that level. Shares, which trade for around eight times projected 2011 profits look quite appealing in that context.

Whirlpool (NYSE: WHR)
Demand for washing machines, dishwashers and dryers has been in a slump ever since the housing bubble was pricked. Consumers are hanging on to them longer, fixing instead of replacing whenever possible.

Whirlpool saw its sales slump in recent years and is only now again back above the $18 billion revenue mark, a figure last seen in 2006. But the company is vastly different since then, with a much leaner cost structure, better exposure to more dynamic emerging economies and a far cleaner balance sheet.

Uncategorized

The Federal Reserve Just Green-lit This Sector for 2011

December 8th, 2010

The Federal Reserve Just Green-lit This Sector for 2011

Eight times a year in Washington, D.C., a dozen men and women sit down to vote on the economic fate of the United States.

They come representing regions around nation — rural and urban, rich and poor — and the power they wield is unmatched. Together, they make decisions that can put people to work, move the entire stock market, and change how American consumers and businesses spend their money.

This is the significant and very real power of the Federal Open Market Committee (FOMC), the group responsible for setting our monetary policy. Its power is humbling, and it even sometimes conjures fear and resentment that such a small handful of people can wield such enormous power over such a gigantic nation.

But the fact is, if you're a savvy investor, you can use the cabal's power to your advantage. And at this point, the FOMC has all but sent up fireworks to announce a decision that will mean huge opportunities in one particular sector.

Creating the ideal environment
The committee made arguably its biggest move of the year just a few weeks ago. You no doubt heard about the second round of quantitative easing, designed to inject cash into the system, lower borrowing costs, stimulate bank loans and other economic activity.

Essentially, the Federal Reserve plans to create money out of thin air and loan it back to the government by buying Treasuries. That money then provides funding for various government agencies (many of which rack up even more debt). How can this do anything but depreciate our currency and stoke inflation?

That's why it is actually creating the ideal environment for commodities, which are usually priced in U.S. dollars. A weaker dollar usually leads to higher commodities prices, all other things being equal.

You might have noticed that everything from soybeans to copper and from corn to gold have taken off recently. (In fact, gold hit a record high of $1,422 per ounce on Monday.) And companies involved in growing, mining and distributing commodities have been on quite a run as well.

You see, the Fed is trying hard to stave off deflation with its moves. Official measures show inflation near 1% — a historically low level. But if you've been to the grocery store… or bought gasoline… or invested in oil… you know that 1% inflation rate is deceptively low from what most of us are seeing.

Add the Fed's loose monetary policy — and don't forget the continued Asian and emerging market growth — and you can see while I'm so bullish on the commodities sector.

Action to Take –> In fact, I've been positioning my Market Advisor newsletter portfolios for a commodities run for months. Silver Wheaton (NYSE: SLW) has been one of the biggest winners for my readers. I added the shares to my holdings a year ago and have seen a +135.8% run. Silver Wheaton is aptly named — it's heavily tied to silver prices. Given that and its run, it is a riskier stock to buy.

If you want a more conservative way to profit from a rise in commodities, I mentioned PowerShares DB Agriculture (NYSE: DBA) last week. This fund is built around an index of the most liquid and widely-traded agricultural commodities (corn, soybeans, wheat, cattle, coffee, etc.). If inflation keeps hitting food prices, you better believe this fund will follow suit.

Now the commodities markets have been heated; I wouldn't be surprised by a pullback from the incredible rally we've seen. But I see this as likely a simple pullback, not a correction. Commodities are where I want to be going into 2011.


– Nathan Slaughter

Nathan Slaughter's previous experience includes

Commodities, Uncategorized

The Federal Reserve Just Green-lit This Sector for 2011

December 8th, 2010

The Federal Reserve Just Green-lit This Sector for 2011

Eight times a year in Washington, D.C., a dozen men and women sit down to vote on the economic fate of the United States.

They come representing regions around nation — rural and urban, rich and poor — and the power they wield is unmatched. Together, they make decisions that can put people to work, move the entire stock market, and change how American consumers and businesses spend their money.

This is the significant and very real power of the Federal Open Market Committee (FOMC), the group responsible for setting our monetary policy. Its power is humbling, and it even sometimes conjures fear and resentment that such a small handful of people can wield such enormous power over such a gigantic nation.

But the fact is, if you're a savvy investor, you can use the cabal's power to your advantage. And at this point, the FOMC has all but sent up fireworks to announce a decision that will mean huge opportunities in one particular sector.

Creating the ideal environment
The committee made arguably its biggest move of the year just a few weeks ago. You no doubt heard about the second round of quantitative easing, designed to inject cash into the system, lower borrowing costs, stimulate bank loans and other economic activity.

Essentially, the Federal Reserve plans to create money out of thin air and loan it back to the government by buying Treasuries. That money then provides funding for various government agencies (many of which rack up even more debt). How can this do anything but depreciate our currency and stoke inflation?

That's why it is actually creating the ideal environment for commodities, which are usually priced in U.S. dollars. A weaker dollar usually leads to higher commodities prices, all other things being equal.

You might have noticed that everything from soybeans to copper and from corn to gold have taken off recently. (In fact, gold hit a record high of $1,422 per ounce on Monday.) And companies involved in growing, mining and distributing commodities have been on quite a run as well.

You see, the Fed is trying hard to stave off deflation with its moves. Official measures show inflation near 1% — a historically low level. But if you've been to the grocery store… or bought gasoline… or invested in oil… you know that 1% inflation rate is deceptively low from what most of us are seeing.

Add the Fed's loose monetary policy — and don't forget the continued Asian and emerging market growth — and you can see while I'm so bullish on the commodities sector.

Action to Take –> In fact, I've been positioning my Market Advisor newsletter portfolios for a commodities run for months. Silver Wheaton (NYSE: SLW) has been one of the biggest winners for my readers. I added the shares to my holdings a year ago and have seen a +135.8% run. Silver Wheaton is aptly named — it's heavily tied to silver prices. Given that and its run, it is a riskier stock to buy.

If you want a more conservative way to profit from a rise in commodities, I mentioned PowerShares DB Agriculture (NYSE: DBA) last week. This fund is built around an index of the most liquid and widely-traded agricultural commodities (corn, soybeans, wheat, cattle, coffee, etc.). If inflation keeps hitting food prices, you better believe this fund will follow suit.

Now the commodities markets have been heated; I wouldn't be surprised by a pullback from the incredible rally we've seen. But I see this as likely a simple pullback, not a correction. Commodities are where I want to be going into 2011.


– Nathan Slaughter

Nathan Slaughter's previous experience includes

Commodities, Uncategorized

My 3 Favorite Small Cap Stocks for 2011

December 8th, 2010

My 3 Favorite Small Cap Stocks for 2011

Off the radar — but only for a little while longer. That's the investment thesis I look for when searching for stock ideas. Good companies, doing all the right things, getting set to pop up on more investors' radars in the coming year.

These three companies look set to garner appreciation in 2011 for steps they are taking in 2010.

A holiday season play — and then some
Roughly a decade ago, Leapfrog (NYSE: LF) was the hottest name in the children's toy space, thanks to a line of products called LeapPad, a tabular reading software platform that allowed children to read along syllable by syllable. The product was an instant smash, quickly selling millions of units. Word of mouth among moms proved at least as important as advertising. But the company was never able to follow up on that success: from 2003 to 2009, sales fell by more than -40%, and shares, which were once richly-valued, lost more than -95% of their value.

Yet as any parent that has recently browsed the toy aisles will tell you, Leapfrog is quickly becoming relevant again. In recent quarters, LeapFrog's newest products are again gaining traction with parents and kids. Sales, which fell below $400 million in 2009, should exceed $450 million this year and top $500 million next year.

The seeds of a turnaround appeared in 2008 when the company introduced Tag, a pen-based computer system that can upload and download information. That summer, management also rolled out three new product lines, including an upgraded version of the original LeapPad. Those products are finally finding appeal with consumers.

That sales momentum should be in evidence this holiday season as Leapfrog's products have been gaining all kinds of buzz among industry watchers. Most importantly, this shouldn't be a one-time fad. As analysts at Imperial Capital recently noted, “The Leapster Explorer has been an early success thus far, generating the highest presale orders of any LeapFrog product in its history. Since its launch, it has been featured on many top holiday gift lists and has created significant buzz amongst retailers and consumers. We believe this bodes well for the holiday season and the long-term brand positioning and growth of LeapFrog.” Shares have rebounded from $4 to $6 as word of the rejuvenated Leapfrog has spread, but shares could hit $8 or even $10 if the holiday season is as strong as some suspect it will be for this erstwhile highflyer.

eResearch (Nasdaq: ERES)
This company would like to put 2010 behind it. It pulled off a savvy acquisition that is boosting sales and profits, yet its stock has drifted lower as investors have seemingly lost interest. In coming quarters, though, investors in eResearch are likely to re-visit this impressive growth story, pushing back the stock up to and beyond its 52-week high of $9.

I first profiled this clinical testing data provider back in May, soon after it pulled off a big acquisition. [See my article here]

Shares have fallen -20% since then. Though it's wise to cut your losses on stock ideas that don't pan out, an investment in eResearch in 2010 simply looks like bad timing, not a bad stock idea.

So what went wrong? The company announced in November that it filed a shelf offering to raise an additional $150 million. Management has subsequently told investors that it has no interest in raising fresh capital after its shares lost -25% of their value in the last month. In addition, the company has been operating without a permanent CEO, though that post is likely to be filled in the next few months.

If and when those issues move off the table, investors will again squarely focus on what is a solid growth story. The above-noted acquisition is set to boost revenue nearly +50% this year and another +30% in 2011. More importantly, EPS is rising at a +50% clip. Beyond 2011, eResearch will likely need to pull off another deal — perhaps in the field of “Automated Algorithms,” which has become a new testing approach among Contract Research Organizations (CROs) — as it further extends its platform to become a one-stop shop for Big Pharma customers. While CRO rivals such as Covance (NYSE: CVD) and Charles River Labs (NYSE: CRL) trade for more than eight times projected 2011 EBITDA, eResearch fetches just 4.5 times 2011 EBITDA.

KVH Industries (Nasdaq: KVHI)
Once a ship is out at sea, a phone call home — or simply watching satellite TV — can be quite costly. After many years selling navigation equipment to commercial and military ships, KVH is using its expertise to also deliver a full suite of reasonably priced communications and entertainment services for those out at sea. The company's TracPhone is being used on an increasing number of ships, generating high-margin recurring revenue streams. And that steady ramp up in customers looks set to coincide with an impressive rebound in its core navigation business.

KVH doesn't run a network of satellites. Instead, its expertise lies in its antenna technology that can help pull in weak signals and deliver voice and data at prices lower than other satellite-intensive firms. The company's high-bandwidth, low-cost approach could be facing a potentially large target market: Marisec.org estimates that there are more than 50,000 ships at sea in any given month. The International Maritime Organization's estimate is closer to 100,000.

KVH's 2010 results can be summarized quite easily: strong defense-related business for its FOG (fiber optic gyroscope) navigation equipment and more modest results for that nascent TracPhone business. Total sales are likely to finish the year about +25% above 2009 levels. Looking into next year, the stars appear aligned for both cylinders to be firing, leading to a further +20% to +30% gain in sales.

The TracPhone business should finally build a head of steam now that KVH has a truly global footprint in place. The Coast Guard just signed up for a 10-year, $42 million contract, and KVH is expected to secure other key wins over the next few quarters.

Yet this remains as a “show-me” stock, as shares have largely moved sideways in the past year. As both cylinders start to fire, shares could finally move up toward the $20 mark, reflecting the long-term view of strong growth and rising recurring revenue streams.

Action to Take –> These three stocks remain below the radar, even as they are steadily building out their product lines to capture more customers and bag higher profits. Next year could shape up to be a breakout year for these names.


– David Sterman

David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More…

Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

This article originally appeared on StreetAuthority
Author: David Sterman
My 3 Favorite Small Cap Stocks for 2011

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My 3 Favorite Small Cap Stocks for 2011

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