Liquid Gold

Cutting Edge’s Brian Hicks keeping an eye on a meteorological crisis slamming its way into the East Coast…and exploring the key to turning crisis into profits.

I’m not one to walk away from a crisis opportunity. Even though I make my living as a financial analyst and writer, two years ago I started a nursing temp agency in Baltimore and another in Orlando to take advantage of the growing shortage in registered nurses.

With thousands of baby boomers hitting senior citizen status every day, there’s going to be a shortage of about 1 million RNs in the U.S. by 2010. Demand for nurses is so high that we were able to quadruple revenues last year without breaking a sweat.

We even turned a modest profit. Not bad, considering we’re a small start-up. But the best is yet to come.

I love it. And I love crisis investing.

Last December, I re-issued an urgent buy on shares of Crown Cork & Seal. The stock was trading at $0.90 – a level it hadn’t seen in nearly 20 years.

In the post 9/11 disaster, rumors were flying around that the company was about to file for bankruptcy. But I knew better. Insiders of CCS had been buying the hell out of the stock.

So I bought alongside them. Today, Crown Cork & Seal is trading above $9.00. But that’s nothing compared to the crisis that’s looming this summer. And the profit potential could be even bigger.

In fact, I’m going to give you the name of 5 companies that prove the rule, below…but first let’s take a look at the crisis.

I don’t know if you’ve been keeping an eye on the meteorological reports coming out of the East Coast, but Governors from Maine to Florida could be facing a revolt reminiscent of Shay’s Rebellion.

Sounds overly dramatic, but it isn’t. In fact, there was a revolt of sorts just last summer in the West. A group of farmers rebelled in Klamath Falls, Oregon for exactly the same reason – a severe water shortage caused by drought.

Tired of watching their crops die of thirst, farmers broke into the Klamath Falls Canal, releasing about a million gallons of water into the valley to water their farms.

It didn’t help much. The Feds were called in to restore order and to protect the water. And many farms turned into dust bowls.

The same pattern is about to repeat itself here on the East Coast…and most residents are not prepared. It’s not even 2 weeks into the Spring season, and Governor Glendenning of Maryland has already implemented water restrictions and declared a state of emergency in 7 Maryland counties.

Some think he’s jumping the gun. But I see a crisis developing on par with the natural gas squeeze of Winter 2001 and the California electricity crisis of last summer.

To Glendenning, who isn’t exactly popular to begin with (after having dumped his second wife, confirming that one of his staff aides was pregnant with his baby, and blessing a budget that would leave the State nearly $800 million in the hole), the drought may be welcome news.

But for New Yorkers, the situation is nothing if not scary. Water reservoirs in New York City are so low that dangerous levels of diarrhea-causing bacterium have been detected. And doctors are now advising city residents with weak immune systems to boil the water before drinking it. It’s bad. Residents of the West Coast have already felt the pain. States like California, New Mexico, Nevada and Colorado have endured a drought for years, which is why some major rivers in the West are completely dry in parts.

The Colorado River, one of the primary water sources for California and Nevada, has been sucked so dry it doesn’t even reach the ocean anymore. I’m far from being a geologist, but even I know that when a river doesn’t make it to the sea – it’s a problem.

How bad it will get is anybody’s guess. The La Nina weather pattern of 1998 changed the course of the jet stream in the U.S. Instead of getting a steady flow of precipitation coming from the Pacific Ocean, some states in the West are now receiving only about 50% of their normal rainfall.

Los Angeles, for instance, only received a third of its annual rainfall last year. If the La Nina effect continues for another year or two, the West and Midwest could see year-long forest fires. With no rain and an already severe shortage of water, firefighters would be helpless.

As dismal as this sounds, this is exactly the time to invest.

Why?

Simple. Inherent in the crisis is the blueprint for its own solution. Let me give you an example.

The water shortage has gotten so bad that many oil and precious metals mining companies have switched gears and started drilling for water. Last week, a small exploration company…with an even smaller stock price…announced it has discovered groundwater reserves in Colorado.

They discovered about 50,000 to 100,000 acre-feet of water. Not exactly a sea, but big enough that investors bought the company’s stock in such large blocks, the price rose 50% immediately after the discovery was made public.

I don’t own the stock personally, but I can almost guarantee that it won’t be the end to the stock rally. The stock is up 275% since January. And that’s just the point. You don’t have to fly out to a water drilling operation – or have a PhD in meteorology – to take full "advantage" of the water crisis.

All you have to do is follow the buying activity of corporate insiders.

Check this out. In the 8 water stocks I’m currently following, there have been 167 insider buys in the past year-and-a-half. You think they know something? You better believe it.

But before I tell you, I want to show why following insider buying is so important.

One of the biggest companies in the water market is Philadelphia Suburban. There have been 30 insider buys in the past 2 years. And the stock has risen more than 100% since March 2000.

But that gain is a trickle compared to what’s it done since 1990. It’s up more than 1,000%, and has outperformed both the Dow and NASDAQ in that period.

Middlesex Water, another stock that has outperformed the Dow dramatically, has seen 36 insider buys since June 2000.

Two others – Connecticut Water and California Water – have experienced massive insider buying that has continued into 2002. And there have been 21 insider buys in Southwest Water, up more than 420% since 1995. Even more bullish is the fact that Southwest Water’s stock has split 5 times since 1998.

So what do the insiders know? During a March 28 meeting, Christine Todd-Whitman, director of the EPA, got everybody’s attention (especially investors) when she announced that water was "the biggest environmental issue that faces the U.S. for the 21st century…"

If you don’t know Christine Todd-Whitman, she’s the ex-governor of New Jersey, where clean and fresh water is as scarce as virgins. According to the U.S. Geological Survey, 57 rivers on the East Coast – 8 in New Jersey alone – are at their lowest levels in history.

That’s pretty dramatic. But not as dramatic as this: the government plans to spend anywhere from $480 billion to $1 trillion over the next 10 years to "fix" the water problem.

During the next ten years…specific companies will reap the government’s trillions. It could be oil and energy companies who’ve switched gears to drill for water, like the firm in Colorado. It could be those ensuring drinking water is cleansed before delivery.

Whatever, the case, the coffers are there…waiting to be pried open. That’s what insiders in the water business know…and why they’re buying up their own stocks with abandon.

Cheers,

Brian Hicks,
for The Daily Reckoning
April 10, 2002

P.S. You should be aware, I’m not advising you to buy the stocks I’ve mentioned in this essay. I don’t own them personally, nor have I recommended them to my members. But I have been following this sector for several years…a crisis of this proportion must be addressed, and you might as well as benefit from the market solution.

The little company that just discovered water in Colorado will be one of the solutions.

Brian Hicks has been the editor of The Cutting Edge since 1996. Out of the top 10 best performing stocks this year, readers of Cutting Edge have been in 2 of them – Crown Cork & Seal (+230%) and Providian Financial (+106%).

These days Brian is "dumpster diving", as he calls it. He buys stocks so beaten down or unknown that the only people who own them are the "corporate insiders." The strategy is paying off. Brian has had a stellar first quarter – one reader turned a profit of $100,000 – just one of the reasons we invited him to the Daily Reckoning.

Leicht denken…light, wishful thinking…is all around us. Pick up any newspaper. Turn on the TV. Talk to a congressman.

Yesterday brought news that consumers had continued their big spending ways in March. Bless their hearts.

And why shouldn’t they?

Just as Norman Angell figured that modern business and financial arrangements – in 1910 – made war a thing of the past…Alan Greenspan thinks that serious economic problems are behind us. We enjoy, he told Congress last month, "a far more flexible and efficient financial system – both domestically and internationally – than we had just twenty or thirty years ago.

"As a consequence of increased access to real-time information and, more arguably, extensive deregulation in financial and product markets and the unbundling of risk (through derivatives), imbalances are more likely to be readily contained, and cyclical episodes overall should be less severe than would be the case otherwise.

"The forces that have been restraining the economy over the past year are starting to diminish," Greenspan opined, "and…activity is beginning to firm…"

Gosh, we hope so.

Greenspan cuts rates 11 times last year…from 6.5% to 1.75%. The lower rates – and unshaken faith in America’s miracle economy – induced consumers and businesses to do something they had never done before: go deeper into debt during a recession.

"Debt by private households and nonfinancial corporations," explains our guru, Dr. Kurt Richebacher, "increased by a record $1,109 billion. The financial sector added another $916 billion to its debts, also an all-time high."

"For every single dollar of additional GDP," Richebacher continues, "the U.S. economy incurred $65 of additional debt…hardly a promising start for a recovery."

Yet the leicht denkers are convinced that a major recovery is underway…as long as consumers keep borrowing and spending!

But what are investors up to, Eric?

******

Monsieur Eric J. Fry…

– Whoopsy-daisy! Maybe Mr. Market isn’t as rugged and durable as he appeared to be two days ago, when he doggedly battled back against a "tag-team" assault from IBM’s earnings-shortfall announcement and crude oil’s continuing price spike.

– Yesterday, however, Mr. Market acted a little punch- drunk – perhaps from having his head slammed one too many times into the turnbuckle of disappointing corporate earnings.

– Making matters worse, a fresh 8% drop in Cisco shares staggered Mr. Market, as if someone had smacked him with a metal folding chair. As the closing bell rang, he staggered into his corner with large losses.

– The Nasdaq tumbled more than 2% to 1,743, while the Dow slid 40 points to 10,209. Cisco shares led the way down, thanks to a negative report from RBC Capital. (No investment banking business for them!) RBC – citing sluggish capital spending for the kinds of technological marvels that Cisco sells – trimmed its revenue and earnings estimates for 2002 and 2003…but hey, there’s always 2004.

– "There is an appointed time for everything, and there is a time for every event under heaven," observed the writer of Ecclesiastes (reiterated a couple millennia later by the Byrds). "A time to sow, a time to reap…A time to keep, and a time to throw away…"

– In other words, life cycles along. It does not unfold as a straight-line extension of the present. Nowhere is life’s cyclical tendency more evident than in the financial markets (Wall Street’s ill-founded arguments to the contrary notwithstanding). Stocks go up. Stocks go down.

– Sometimes they are lowly valued and sometimes they are richly valued. In short, there is "a time to keep" stocks, and a time to throw them away. But investors tend to confuse these two financial "seasons." They hate stocks when they should be loving them, and love them when they should be hating them.

– Observing this cyclical tendency in financial markets, the school of contrarian investing emerged. Popularized by the legendary value investor Benjamin Graham, contrarian investors try to buy stocks when they are cheap and to sell them when they become dear – i.e., to buy low and sell high. Few are the investors who have amassed (and retained) a fortune through any other means. And yet, the majority of investors think nothing of feverishly buying stocks when they are expensive, nor of scorning them when they are cheap.

– Like original sin, the tendency to buy high and sell low seems to be an innate human trait that besets all investors. Perhaps there is some partial salvation from this portfolio-damning practice, if only we remember not to invert the phrase: "Buy low, sell high."

– It is a well-known phenomenon on Wall Street that last year’s winners are this year’s losers. A related axiom states that last year’s losers are often this year’s winners. And yet, most investors behave as though financial cycles – like polio – has been vanquished by modern scientific advances.

– A case in point: The Silicon Valley-based Firsthand Funds – a shining star of the New Economy.

– "Investors in [the] Firsthand Funds have gone from the equivalent of winning the stock-market lottery to the mutual-fund version of holding a ticket for the Hindenburg," the Wall Street Journal jokes. However, the Firsthand Funds’ woeful performance over the last several months is no laughing matter.

– "Two-and-a-half years ago, Firsthand’s flagship Technology Value portfolio sported the best five-year track record of any mutual fund of any kind, posting eye-popping average annual returns of more than 50%."

– Any fool could see that the Firsthand Technology Value fund had performed brilliantly over the prior five years, and many foolish investors assumed that the outsized gains would continue.

– The Best Man at my wedding worked for the Firsthand funds during its peak go-go years in 1999 and 2000. Throughout that time he would tell me how investors were "throwing money" at them. So fast and furiously did the hordes of performance-chasing investors throw money at Firsthand that its assets under management skyrocketed by several billion dollars. Woefully, yet predictably, the money-throwing era at Firsthand marked the top of the market, and thousands of investors incurred very large losses. The Firsthand Technology fund has collapsed nearly 80% from its peak in March of 2000.

– Remember, past performance is no guarantee of future results. Or, to state it differently, chasing past performance is a near-guarantee of abysmal future results.

******

Back in Paris…

*** A report in the Figaro tells us that U.S. troops are expected in Tblisi, the capital of Georgia, to help out against Chechnyan terrorists. The Chechnyans have been fighting for independence off and on since 1864! Russian poet, Lermontov, said of them: "Their god is freedom, their law is war."

*** In 1944, the entire Chechnyan nation was exiled to Siberia by Stalin.

*** Who would have thought it possible? American soldiers in Josef Stalin’s home town…helping the police suppress freedom fighters (whoops…I mean, the terrorists!) But that’s what’s nice about the WAT. Like any kind of leicht denken…the thought process behind it is so abstract and airy, it floats wherever the hot air of popular opinion or convenience blows it.

*** Nietzsche had his good days and his bad days, like everyone else. Some of his insights were brilliant… others were sophomoric rubbish. But he thought hard…so hard he went mad – a perfectly respectable thing for a philosopher to do, in our opinion.

*** But his sister, Elizabeth, was a disgrace to the profession. Instead of taking his "Beyond Good and Evil" and "Man and Superman" with a wry smile and a sense of humor, she took them seriously. She decided to create a colony of pure Germans in the jungles of South America to protect the purity of the race. A logical thing to do…but, of course, preposterous, and a good illustration of how imbecilic the master race could be. The colony was a total failure and was abandoned shortly after it was begun.

*** But Elizabeth lived for many years after the philosopher had died. Late in life, she gave Adolf Hitler her brother’s favorite walking stick. Friedrich would have been appalled.