Kelly Letter Article Excerpts

The Kelly Letter’s investment techniques work well, but what really sets this letter apart from other services is its curiously readable articles. There’s more to investing than numbers. Investing is an ideas business, and ideas are best when they’re interesting. There’s no reason we can’t have a little fun when we’re making money.

Many subscribers say the letter is the high point of their Sunday mornings. More than a newspaper, TV show, radio broadcast, or magazine, The Kelly Letter provides an erudite summary of all you need to know — which is far less than popular media would have you believe. If you’re tired of mass market information packaged for kiddie culture as insulting to your intelligence as it is useless to your portfolio, join me. You’re not alone. There are other thinkers on Earth, though they comprise a smaller percentage of the population every year.

Please enjoy the following excerpts.

From the January 18, 2009 Issue:

Vacations are now “staycations,” which explains tourism’s place on the Fed’s list of extreme slowdowns. The “stay” in staycation used to refer to staying in one’s hometown during time off work, but now it seems to mean staying in one’s own home, perhaps under one’s own covers. Retail sales dropped another 2.7 percent in December, following the 2.1 percent decline in November.

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Recent news about the recession notwithstanding, oil’s supply horizon is uglier than its demand destruction. Civil unrest in oil-producing regions is increasing. The oil industry’s infrastructure is aging. New technology has increased oilfield decline rates. Oil supply is tighter than ever.

Global demand, while temporarily off trend, still shows a steep ascent ahead.

That brings us to ask: Is the current price of oil fair? In this context, “fair” means at a level to keep the industry working at a profit without placing undue pressure on consumers.

No, the current price of oil is not fair. Producers in the Middle East are operating at a loss, important supply-boosting projects have been put on hold, drilling equipment is lying dormant, and other parts of the industry don’t work at prices below even $50 per barrel, while OPEC members say they need prices above $70.

Below the surface of brimming tanks of oil waiting to be sold at higher prices, a supply crisis is creeping in. Dirt-cheap oil has stopped industry revitalization just when the industry needs to be gearing up for unprecedented demand. A full 90 percent of the world population is just embarking down the path that the US and Europe paved after World War II.

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Let’s hope Team Obama does as good a job as Team Reagan did back in the early 1980s.

When Reagan took office, unemployment was passing 7 percent on its way to 11 percent in late 1982. As Obama takes office, unemployment just hit 7.2 percent and is probably on its way to double digits as well.

Reagan faced an inflation rate of 12.5 percent as oil came off a 600 percent price increase in the 1970s. Interest rates in the high teens didn’t help, and are part of why stocks had been in a 14-year funk. You read that right: 14 years.

Reagan cut taxes and built up the military, while the Federal Reserve under Reagan’s urging cranked credit down hard. The combined decrease in revenue and increase in spending produced a record deficit of 6 percent of GDP. After more pain and two quarterly GDP drops of 5 percent and 6 percent, unemployment hit the aforementioned 11 percent, and then at long last the economy began recovering. Reagan was given credit, and won re-election to his second term in 1984.

Obama’s stimulus plan is equally ambitious. He, too, is planning tax cuts and increased spending. His spending will go mostly toward infrastructure improvement instead of the military, but will also produce a record deficit when added to the enormous deficit Bush leaves behind. The projected FY 2009 deficit is 9.2 percent of GDP.

So, while the media is already putting Obama’s face on Mount Rushmore as the man who saved us from our worst moment in history, it’s just not true. Other presidents faced equally challenging times, indeed tougher times. We got through those and we’ll get through this, but nobody has any idea yet who the heroes will be.

From the January 25, 2009 post-Inaugural Issue:

The minions of hope re-took financial editorial offices and sounded the trumpets: the tone of the new administration had been set, it was all up from here, and anybody sitting on the sidelines needed a dunce cap.

Too bad Thursday arrived on schedule before it had a chance to catch up on financial editorials. FAS dive-bombed 15 percent to close at $8.38 and UCO dropped 5 percent to $11.08. The media re-ran Tuesday’s headlines along with fresh comments from Louise Yamada, the analyst who said at the November low that the S&P 500 was heading to 600. That was a perfect time to buy, as the S&P 500 rose promptly to 900 for a 20 percent gain.

Prior to that, Ms. Yamada made headlines in October 2004 by saying that US stocks were in a long-term decline, and then disappeared as the market gained 43 percent over the next three years. Now that it’s down 47 percent since October 2007, she’s back warning that it will fall.

This time around, Ms. Yamada said: “There is yet scant evidence of a significant bottom, no directional conviction and no definable leadership; and macro statistics continue to deteriorate. We must await the technical evidence that the market is coming to grips and developing a bottoming process beyond several weeks.”

Not to exceed a reasonable allotment of stone throws from my glass house, but that statement is self-evident and is the main problem with all technical analysis. TA tells us we’ll know the market has stopped falling when it stops falling, and we’ll know it has embarked on a new upward trend when we see it in a new upward trend. Helpful.

As for my market view, I still think we have another leg lower ahead.

NOTE: We did. In the six weeks following the above comment, the S&P 500 dropped 20 percent to its March 2009 low.

From the February 15, 2009 Issue:

The Iraq War and the various economic packages together add up to nearly $5 trillion. Had that money been distributed across the population, each US citizen would have been paid more than $16,000. That $64,000 for a family of four would have gone a long way toward mortgage payments and, I dare say, a fair amount of stimulative spending.

From the April 2009 Issue:

I think government is in too much of a hurry to take us right back to what got us into this mess in the first place. It wants consumers spending again — on credit cards, if necessary — and it wants giant banks to get busy lending to keep capital flowing. The mad scramble to borrow and spend is what dropped America into this swamp. How about a little true reform along the lines of teaching people to live within their means?

The nation’s debt/GDP ratio is gunning for 80 percent and we’re pushing the needle dangerously close to “Banana Republic.” The world is already clamoring for the end of the dollar standard because it can’t continue suffering the whims of our poorly run economy.

From the October 2009 Issue:

Durable goods orders were supposed to rise another 0.4 percent in August to show that factories are already busy churning out planes, trains, and automobiles in the post-recession good times around us. Too bad they fell 2.4 percent instead, making the words “strong” and “recovery” look as mismatched in a sentence as the words “audacity” and “hope,” to choose two others at random. The word “false” works better for both pairings to get false recovery and false hope, but those ideas haven’t quite sunk in yet.

From the May 23, 2010 Issue:

Transocean (RIG) was the most ridiculed addition to our watch list when it traded at more than $90 and our target buy price was a seemingly impossible $50. It closed Friday at $59.24 after getting as low as $57.84 in Thursday’s rout. When was it last over $90? You might think it was months ago. Nope, try April 22. In less than a month, it’s fallen 37 percent because of worries related to the BP Gulf tragedy.

Oil is not disappearing as a source of energy. It will remain the world’s primary fuel until the last barrel is sold because it is the best politically connected industry on the planet. No matter how awful the headlines get, no matter how much of the planet is spoiled by it, oil will flow because oil corporations pay to keep it flowing. We’re not judging that in this space, though judging it is a worthy pursuit. Here, we’re concerned with how we can profit from oil’s assured future as Earth’s energy.

From the June 6, 2010 Issue:

We’ve been watching Transocean (RIG) with an eye on buying somewhere below $50. Last week, it closed Wednesday at $48.35 after hitting an intraday low of $46.63. It closed Friday at $50.20. The BP Gulf leak has taken the price of RIG down to the zone where it bottomed in the financial crisis, with monthly lows of $42 in December 2008, $46 in January 2009, and $49 in March 2009.

While the current situation remains murky in terms of how much the deepwater drilling business will change from new safety regulations and politically induced liability, RIG has already priced in a lot of trouble after falling 47 percent since its January high and 46 percent since its April high. It’s unbelievable to almost everybody who saw our $50 price target on the stock back when it traded at more than $90, but we’re going to get $50 after all. Whenever you feel impatient in the market, remember this.

Siphoning of the leaking oil appears to be helping, and the relief wells continue apace. I want to start buying. In case the liabilities prove worse than we think, my first thought is to start with a half position so we’re ready to take advantage of further price weakness. However, I consider this position in RIG to be a key part of our long-term thesis that humanity will do nothing to reduce its dependence on oil, that demand will rise, that supply will fall, and that prices and profits will soar in the oil business. Therefore, we’ll begin with a full position at the $50 line we identified way back when we first began watching the stock in April 2009. We will:

<> Buy Transocean (RIG) at $50

Based on the analysis of revenue in different regulatory scenarios going forward, which you read about two weeks ago (The Case For Transocean), I see fair value of RIG waiting somewhere around $115. If its revenue stays flat but disposition toward oil stocks improves so that people pay somewhere near the multiples they’ve paid historically, the stock should get to $160. If its revenue improves and people pay those historical multiples, the stock should eclipse $200. From $50, then, I see upside potential of between 130 percent and 300 percent.

Beyond the current disaster and swirl of awful news, Transocean is a fairly safe company. That, combined with the excellent upside potential, makes it a superb candidate for doubling down on further price declines. In fact, I’d welcome the chance to add more money in the lower $40s or even $30s.

The reason we’re moving now is twofold: (1) RIG has already declined significantly and, (2) waiting for the all-clear signal will see a much more expensive price. The news is dark now because nothing has worked in the Gulf, the relief wells that will work are months away, and politicians are talking tough about oil companies and new regulations. There’s lots of mystery. Stocks hate mystery. The question, “How bad will it be?” is what’s making RIG cheap. We’re betting that the answer will be, “Not as bad as everybody thought,” and we’re beginning that bet with a buy at $50.

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