Storm of Profits

The Daily Reckoning – Weekend Edition
July 1-2, 2006
Baltimore, Maryland
By Kevin Kerr

MARKET REVIEW: STORM OF PROFITS

Hurricane season is in full swing, and it could be a very long summer and fall, indeed. Gulf Coast residents have barely picked up the pieces from last year’s debacle, and now may be time to batten down the hatches again.

Earlier in the year, various predictions laid the groundwork for an above-normal tropical storm season. Experts predict that Mother Nature could produce between four to six major hurricanes in the Atlantic Ocean and Gulf of Mexico this year. Some forecasters, like the much respected National Hurricane Center, optimistically say that the conditions don’t appear ripe for a repeat of 2005’s record activity. Remember, though, they said something similar the year before.

The center predicts that there will be up to 16 named storms, which would be significantly less than last year’s record 28. Four Category 3 or higher storms, Dennis, Katrina, Rita and Wilma, decimated the United States last year. Hurricane Katrina’s strong winds and heavy waves devastated the Gulf Coast in late August. The storm and flooding caused more than 1,800 deaths and about $100 billion in damage, making it the costliest U.S. natural disaster, according to the National Climatic Data Center.

Nobody can say for sure what the season will hold, but if experts are correct, then we are in the beginning stages of a hurricane “supercycle,” which usually lasts 15-20 years.

Even though Max Mayfield, National Hurricane Center director, painted an optimistic picture, he still warned strongly that “People in coastal regions should prepare for the possibility of major storms.” He went on to say, “One hurricane hitting where you live is enough to make it a bad season.”

At Outstanding Investments, Justice Litle and I are always looking for ways to hedge our portfolios from what could be very rough going for investors in all sectors. Over at Resource Trader Alert, we have been stockpiling positions in some of the key commodities that may be adversely affected. Everything from natural gas and sugar to orange juice and crude oil. industries brace for another storm season, we can hedge ourselves by adding these commodities to our portfolios on a limited basis using options, or even futures to some extent.

The drain on energy supplies and refining capacity can be one of the biggest problems with an active hurricane season. The Gulf Coast, particularly the Houston Ship Channel, is the heart of oil and gas production and transport. Thirteen percent of natural gas production is still offline since last year’s storms, even before we begin this season. So supplies are already behind the eight ball even before we get out of the gate. No matter what, the energy industry’s capacity to repair and maintain equipment has been drastically reduced this year compared with last year.

The combination of higher oil prices and any additional damage to refineries will almost certainly result in gasoline prices surging to $4.50-6 in some states, which could mean economic growth coming to a grinding halt. Severe weather combined with the seemingly endless geopolitical risks could throw predictions out the window. All bets are off should anything disrupt supplies from OPEC at the same time as a major storm system impacts the United States; the results could be catastrophic. Oil supplies are ample right now, but have very little room for any disruption, and the slightest loss of supply could have a major impact.

Don’t feel guilty betting on a rough hurricane season; after all, like any type of hedging, it’s insurance. When we purchase fire insurance on our homes, we don’t hope they will burn down (at least not usually). No, we take it out to protect our investment, and that’s all we are doing now.

Adding some unleaded gasoline call options can be a good risk-reward scenario heading into an active hurricane season. As some RTA subscribers have done recently, adding some November orange juice calls can be more affordable on a margin basis and less daunting than something like natural gas.

Much like the energy markets, orange crops have been destroyed by hurricane-force winds, disease and other factors. Orange juice is in a fullblown bull run anyway, and a strong storm season could push it even higher.

Sugar is another market that has seen its crops hard hit in Florida and elsewhere from last year’shurricanes. Sugar has the added benefit of being a key ingredient in production of ethanol and is already in high demand. All of these commodities and many more are almost certain to see intense volatility during hurricane season.

A smart trading strategy, and one we are employing in RTA, is to add one or all of these commodity options, and then as we enter the season hopefully grab fairly quick profits, even before the first winds start to really hit.

The fear of what “may” happen can be more of a factor than the actual storms, so it’s best not to be greedy. Use a hedge for what it’s for: protecting your overall portfolio from losses storms may cause to your property and other holdings in your portfolio.

It’s important to understand the psychology of the markets as much as the mechanics. As we are at more or less the start of hurricane season, nobody knows for sure just how bad it will be.

One thing is certain: There is a lot of attention being paid to it. This can often have the reverse effect on a trading market, should the hurricane season be relatively light. The old saying, “Buy the rumor, sell the news” certainly applies here.

In other words, put your positions on early and take early profits simply on the back of fear of what might happen, not what actually does. Being married to a weather position is never fruitful for a portfolio. Simply get in and get out. Remember, it’s always important to be four to six months ahead of the regular calendar when trading futures.

Even if you have not yet wanted to dip your toe into commodities options, this is a perfect opportunity to do so. OJ options are relatively cheap and the market is fairly easy to follow.

Good luck.

Kevin Kerr
for The Daily Reckoning

— Daily Reckoning Book Of The Week —

Trading Risk: Enhanced Profitability through Risk Control
by Kenneth L. Grant

“My attitude towards trading books is this: if I come away with at least one good idea or useful insight, the cost of purchase is paid for a hundred times over,” says Agora’s own Justice Litle.

“Ken Grant’s book contains a handful of useful ideas for improving performance, and some interesting perspectives to boot. When someone has worked with the best of the best (Jones, Cohen, et. al) their views carry weight. Ideas aside, I found Grant’s overall philosophy of risk to be worth the price of admission.

“While the subject matter doesn’t delve especially deep, this isn’t a book for beginners. To fully appreciate the observations, a little seasoning is required. Grant speaks to those with a well developed respect for the markets, typically earned by grinding it out, experiencing the inevitable ups and downs over time, and taking a good hard knock or two. If you are a beginning trader still in the bright-eyed, bushy-tailed phase (having not yet received your first frying pan to the face), this book may bore you. If you are a crusader in search of the Holy Grail, or a techno-junkie hooked on chart patterns and oscillators, the lack of packaged advice may frustrate. But… if you have been around the block, seen the ups and downs, and love the game enough to make excellence and longevity your true ideals, then this book might be for you.”

THIS WEEK in THE DAILY RECKONING: The Fed is on a mission to “battle inflation”…or so they think. Can Bernanke et al fight inflation without letting another enemy rear its ugly head? Bill Bonner explores in Friday’s essay “Inflation, Deflation or Bust!”

Inflation, Deflation, or Bust!    06/30/06
by Bill Bonner

“At 7:15 p.m. London time came the news we already knew: the Fed raised rates an 18th time – to 5.25%. Inflation will be tamed! Deflation, be damned!”

Clean Water Crisis    06/29/06
by Chris Mayer

“Getting clean water to growing populations – that is the nut that has to be cracked. Whether you’re building a new suburb in the States or piping water through the Andes, there is a tremendous amount of build-out required.”

A Torrent of Darkness, Part II    06/27/06
by Byron King

“There is no question but that wind power, with its ability to reduce the need to emit carbon dioxide into the atmosphere, is an investment opportunity for the future.”

A Torrent of Darkness, Part I    06/27/06
by Byron King

“More than 50% of the nation’s population lives in counties adjacent to the seacoast. So, global warming and concomitant rising sea levels have the potential to devastate the United States both physically and as a society.”

The Economy of Gentlemen    06/26/06
by The Mogambo Guru

“If the dollar buys a lot of stuff, you feel good. It’s sort of like when I came home from my strenuous research at the Club Wanda Wanda Wanda, situated, as it is, way out on the dusty outskirts of town.”

Fed Follies    06/25/06
by Kate “Short Fuse” Incontrera

“The rate-hike campaign has its two-year birthday this month, and this next hike will bring the Fed’s key short-term target to 5.25 percent.”

FLOTSAM AND JETSAM: We’ve been talking a lot about the clean water crisis that’s unfolding before our eyes…and Chris Mayer has been researching the water industry to find out what companies will be part of the solution. Read on…

Special Situations
by Chris Mayer

It’s amazing when you start to dig into the facts of the emerging crisis in clean water. They just boggle the mind. Consider these, from Summit Global Management:

“World Health Organization says that 60,000 children die each day from lack of water and/or dirty water, by far the largest health problem in the world.

“The typical American lunch – hamburger, fries and a soft drink – takes 1,500 gallons of water to produce. Water is needed to grow the potatoes, irrigate the grain for the bun, feed the cattle and the production of the soda.

“It takes 1,000 tons of water to produce one ton of grain; agriculture consumes 75% of the world’s fresh water. World Water Council says we will be 17% short of necessary water to feel global population by 2020.”

I’ve been writing about this water crisis since I got back from China in November. Perhaps more importantly, I’ve been researching the water industry looking for the companies that will be part of the solution.

It’s taken me a long time to get through it all. The “water industry” is not really an industry in the usual sense. It’s extremely broad and diverse. It covers water utilities, treatment companies, pipe companies, pump companies, consultants and much more. I’ve gone through over a hundred companies.

Finally, though, all this is going to pay off.

I’ve put the rest of the research in a much-anticipated water report. It’s finally finished, and it’s available as part of your charter membership to my new Special Situations letter. It’s a meaty 16-page report and there are five stock recommendations.

These companies have huge opportunities in China and around the world. There is a Japanese company and a company from Singapore. There is a filtration company, a pump company and more. And these are not puffball companies. They are the real deal. They have good businesses and generate lots of cash. Many of them have roots going back decades.

I’ll follow all these stocks in my new service. And of course, I’ll have new ideas for the Special Situations letter, too. The investment style will be familiar to my Capital & Crisis readers – I’m just applying it to a different opportunity set. These stocks are smaller than what I could normally recommend here and/or they each have some unique aspect that makes them “special situations.”

Editor’s Note: Christopher Mayer is the editor of Capital and Crisis and Mayer’s Special Situation. Chris began his career in corporate banking after earning an MBA with a concentration in finance. He later started Capital & Crisis, a monthly newsletter that gave Chris’ unique brand of financial commentary a more regular and expanded format.