The Rude Awakening
Laguna Beach, California
Wednesday, March 21, 2007 ------------------------------ - How to ensure your money is doing the smart thing,
- Gold…and other non-combustible investments,
- Back to Phoenix for more Fry slides and plenty more…
------------------------------ Joel Bowman, reporting from Laguna Beach, California… "Money is like mercury," a good friend of ours reminded us over dinner last night, "you push on it, and it flows somewhere else." "From bubble to bubble," they continued, "smart money will generally find the path of least resistance." Curiously, when it came time to push some money forward for the bill, there was little resistance to the party that offered to pick up the whole check. Just last week, another friend of ours, Eric Fry, examined the path of the "smart money" at an Investment U conference in Phoenix, Arizona. So, how does one know if they are holding the smart money or the dumb money…or the entire check? Following is part two of the speech Eric delivered in Phoenix… ----------------------------- What Makes the "Smart Money" Smart, Part II
By Eric J. Fry We can't be certain that the "smart money" would be selling the shares of mortgage lenders, but we wouldn't rule out the possibility. The sub-prime sector is already a huge disaster. The rest of the mortgage-lending industry might follow. It has become popular to suggest that the worst is over - that the recent implosion in the sub-prime sector is great for the surviving lenders. They'll be able to buy baskets of distressed loans on the cheap, the optimists say, and that's really going to power their earnings going forward. Maybe they're right. I'm not omniscient. But I would want to have more evidence of a recovery before investing in mortgage lenders…with my money. In fact, I think you'd have a much better shot at these stocks from the short side - much, much better. Many stocks in the mortgage-lending industry are still trading up around the levels where they were trading two years ago, before all this deterioration began. Another Smart Money "sell" might be ethanol stocks. Ethanol could be a good industry for certain individuals, or for certain producers. But I don't think it's a great industry for a public shareholder. The reasons why are numerous. But I would point first to the laws of physics. There's a researcher at Cornell University, David Pimental, who has described corn-based ethanol production as "subsidized, unsustainable food-burning. Ethanol does not provide energy security for the future. It is not a renewable energy source." What he means by this statement is that, according to his research, the energy required to produce one gallon of ethanol is actually 30% greater than the yield. Pimental may not be right. His assumptions may be erroneous. But if you are going to invest in ethanol, you would want to be certain that he is wrong. Good luck with that. I liken U.S. ethanol production to using caviar to make cat food. You are taking imported foreign oil and dumping it into a production process that yields a "renewable resource" where the energy return on energy invested is probably no better than one-to-one. Where is the "renewable" facet of that process? Where's your energy independence? In addition, the economics of ethanol production itself are questionable. Without the 51-cent a gallon government subsidy, most ethanol producers are not making money. These economics could change with market conditions. But the more ethanol we produce, the higher the price of corn rises, the less profitable ethanol production becomes. Am I picking on the ethanol industry? No I'm not. I'm just saying that if you sit here today and look at things that might not benefit the minority shareholders of a public company over a 5-year or a 10-year period of time, ethanol is one industry that fits the bill. Now that we've mentioned a few Smart Money "sells," what might be a few Smart Money "buys?" 1) Gold…and other things that do not combust near an open flame. We are in an environment where the U.S. dollar is under pressure. I think it will continue to be under pressure as far out as we can imagine. And any asset that provides a reasonable hedge against dollar weakness seems like an okay place to be. 2) Alternative Energies. Obviously, I am referring to alternative energies, ex-ethanol. We are in a world where solar, wind and every other form of alternative energy provides less than one percent of total electricity production worldwide. So even knowing the drawbacks and the high-cost of some alternative energy technologies, it seems very likely that they will capture a growing share of global electricity production, even if this share remains a very small minority. Alternative energies, in aggregate, will capture more than 1% of the global market at some point. 2% would double the current market share. 3% would triple it. Whatever the number, the market share trend is definitely higher. And this is a long-term trend. So you might want to poke around in this area. 3) Water At the Rude Awakening, we've written probably twenty-five columns about water investments during the last year. Chris Mayer, who's sitting in the back of the room, wrote most of them. Also, he and I produced a report on water stocks a while back. Even if you forget everything else that I have said today, do not forget what I'm about to say about water stocks. I think this is an area you really want to keep an eye on. The ramifications of the current global water crisis - and it is a crisis - are far-reaching. So the investment opportunities are also far-reaching. They are not always intuitive, but they are far-reaching. Let's look at a sampling of the traditional big-picture issues of the global water crisis: ? Half of all hospital beds in the world are occupied by someone who's suffering from a water-related issued.
? 80% of the world population lacks access to running water.
? Half of China's population drinks contaminated water.
? China has the world's highest liver and stomach cancer rates Why did I end this slide with a couple of data points about China? Because in China, water has finally become a major economic issue, rather than "just" a major health issue. Filthy water has always been a developing world "thing" that most of the world's major economies have ignored. So it hasn't ever been a front-burner investment idea. But finally, the water-related health issues in places like China and India have become so enormous that they've become economic issues. Polluted water, and the related health-care costs, is trimming GDP in China by half a percent per year, or maybe even 1% per year. And it's getting worse and worse. Jim Rogers, among others, believes that water is the Achilles heel of the Chinese economy. If the Chinese can't figure out a way to purify their water for the population, Rogers says, the economy will cease growing, and maybe even contract. That's why China has become one of the world's largest investors in water purification and infrastructure. This is a new phenomenon. Only within the last two or three years has water become a top economic agenda item in many parts of the world. And because of that, we are seeing, really for the first time, urgent investment in water purification, water infrastructure, etc. Not just in the developing world, but also in the developed world. There are several companies in Singapore that focus on purification in Asia - the one that Chris Mayer has written about is called Hyflux ltd. "It may sound strange to talk about a global water crisis," Chris wrote recently, "especially from the perspective of a comfy Westerner who pays pennies per gallon for clean water. Then again, it probably sounded strange to talk about $60 oil when it cost little more than $13 per barrel in 1999." A couple of very successful investors share Chris's point of view. A guy named T. Boone Pickens just made a huge investment in water in the Southwestern United States. Jimmy Rogers has also been talking about making water investments. But this story is not yet on the front page of the newspapers, or of the Wall Street Journal. But it is a terrific long-term story. Therein lies the opportunity. Here in the Developed World, the main water opportunities have to do with repairing aging infrastructure. We're not drinking filthy water here in the U.S., but our usage is extremely inefficient. And that's true throughout the Developed World. Much of that inefficiency derives from the fact that the infrastructure is quite old. America's water pipes are just one example, 
In 1980 only about 10% of America's water pipes needed to be replaced. Today, that figure is closer to 25%, and it is on track to go to 45% by 2020. In other words, we've got to get busy replacing pipes. The dollar value of these various investment needs is in the "who knows?" category. The numbers keep getting larger and larger. But in general, we're looking at $1 trillion over the next decade in global infrastructure, and water treatment projects. And $1 trillion domestically over the next decade. Those are both big numbers that could make a lot of profit for a lot of companies. Water supply is also an issue, especially in places like here in the Southwest. Most of Southern California and most of the American Southwest developed and prospered based on cheap and abundant water. But it's not cheap and abundant anymore. Throughout California, and here in Phoenix, and in many places throughout the Southwest, access to water is becoming an enormous issue. Therefore, the one thing about which everyone agrees is that the price of water is going up. 
Right next door in New Mexico, the value of water rights has been soaring. An acre foot of water in the Middle Rio Grande used to cost about $1,000 in 1993. But now it costs about $5,000. The trend is pretty clear. And this is still a young trend. Over the last year or so, Chris Mayer has identified a number of water-related investments. All of these ideas have appeared in Chris Mayer's work, primarily in Mayer's Special Situations: 1) Gorman-Rupp (AMEX: GRC)
2) Nalco Holdings (NYSE: NLC)
3) Lindsay Corp. (NYSE: LNN)
4) Northwest Pipe (Nasdaq: NWPX)
5) San Jose Water (NYSE: SJW)
6) Hyflux ltd. (OTC: HYFXF)
7) Pico (Nasdaq: PICO) Eric's note: All seven of these stocks have advanced since Chris' initial recommendations - delivering an average gain of 38%. Despite these gains, Chris is still very excited about most of the stocks on this list.] According to Fortune Magazine, "Water promises to be to the 21st century what oil was to the 20th century: the precious commodity that determines the wealth of nations." If that's the case, water might also be the precious commodity that determines the wealth of portfolios. Joel's Note: If you would like an update on exactly how these water companies are performing, and, more importantly, how Chris expects them to trend in the near future, you might like to take a peak at his revised water report. His newsletter, Mayer's Special Situations specializes in commentary and analysis on precisely this kind of investment opportunity. If you are interested in either, you will find all you need by simply following this link: The Blue Gold Report: Investing in Water
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