When Bad Things Happen to Good Investments, Part II

Before you do anything precipitous — like sell your last stocks and stuff the cash into your mattress — let’s ask a few more questions.

If you sell out now, what price will you get? A low price, right? So if you sell now, you will leave a lot of value on the table. That is, most things in the world of energy and resources are underpriced compared with their intrinsic value. I don’t care how bad the market looks just now (and it looks awful). Go out and try to find an oil field somewhere, or build an oil refinery, or find an ore deposit and build a mine. Can’t do it, can you?

So if you sell out now, just be aware that you will be getting a relatively low value. You will be leaving long-term value behind. If that’s what you want, then that’s what you ought to do. Just understand the point.

Which brings up the next set of issues. How badly do you need the money? How soon do you need it? How scared are you of further declines? How much risk can you handle, especially going forward? What kinds of reassurance do you need?

The markets are down. A lot of Elvises have left the building. And who is left to do the selling? Just you? Nope. Whatever you think, you are not alone. There are still a lot of people holding their shares. What do they know? And what is their reasoning to hang on?

Have You Lost Control?

From what I have seen, the biggest sellers — the market drivers who are taking the express elevator down to the subbasement — are people who have lost control of their money, if not their investment destiny.

People are selling to meet margin calls. The wildest sellers are traders who are just plain behind the eight ball. It’s more than being scared by what is happening. Heck, we’re all scared in some way or another. I wasn’t around in the 1930s, so I have no firsthand experience with the Great Depression. I know only what my parents and other relatives and friends told me. It was pretty bad for a lot of people.

But right now the serious sellers are people who cannot afford to be patient. A lot of the sellers in the energy and resource field are hedge funds. These firms are meeting redemption calls from investors who want out. The hedge funds just plain need cash. They have to sell. And a lot of those funds are throwing everything over the side, even the life rafts and the emergency rations.

Where Do You Fit In?

When you look in the mirror, is that you? Are you like a hedge fund in panic mode, selling everything just to raise cash? Do you fit into this “sell-sell-sell” model? Don’t feel bad if this is what you have to do. Just be honest with yourself.

Meanwhile, the U.S. — and the world, really — has been dealing with a credit crisis for over a year. Which makes me wonder if there is a turnaround coming sooner, rather than later. I don’t know that. I don’t have a copy of the Financial Times from next March. So I just cannot say if we are closer to the bottom than to the top.

How soon do you need your funds? If you need cash within the next 12-24 months to pay bills like those for college tuition or a nursing home for a relative, then maybe you ought to just take the hit and get out of the market now. There’s no shame in being safe. Look after your needs.

But do you have a longer horizon? Are your “down” stocks in your IRA or 401(k)? You can’t take it out without penalty until you are 59½ years old. Then consider riding it out. And maybe with these low valuations on most stocks, it’s even time to go shopping — but certainly not blindfolded. Nibble away.

For example, for less than three thin dimes, you can buy a share of a Canadian miner that is the only significant tungsten producer outside of China. For under six bits, you can own shares in another Canadian miner that controls one of the richest deposits of indium ever discovered — and according to the U.S. Geological Survey, the world will “run out” of indium in less than eight years.

The World Is on Sale

In a lot of respects, the world is on sale right now. Heck, a lot of stocks in the OI portfolio have turned into dividend plays. Can they maintain their dividends? That’s a good question. Can they sustain earnings? At the same time, if you were management at these companies, would you risk further tanking the stock by cutting the dividend?

And let’s look ahead a year or two. Commodities in general have been plunging in price since early July. The dollar has been strengthening. Will that continue? Can it continue? Why should the dollar stay strong? Does the number $700 billion mean anything to you? So sure, the strong dollar can continue and commodity prices will stay weak. But at some point, the dollar will start to decline in value. And commodity producers will have to cut back on operations by closing mines and mills and smelters. Then they regain pricing power.

And if the world has the vast recession that many people are forecasting? Then global demand should decline in the near and further future.

But there are 6.5 billion mouths to feed on this planet. The world will still have to produce a lot of materials to satisfy basic demand. That is just built into the equation of human survival. And what will happen to pricing power as some layers of high-cost output go away?

For example, the world petroleum industry will lift over 31 billion barrels of oil this year. Even if world demand dropped by, say, 5% — as if the world airline industry simply vanished — the world would still lift nearly 30 billion barrels. And as the current economic woes cause new projects to slow, annual depletion will overwhelm annual new output from new fields. There will be less oil.

That is, looking ahead, the world may never again exceed the oil output levels that we will have in 2008. Indeed, it will require heroic efforts just to keep global oil output flat in the future.

So this brings us back to that OI investment thesis. Energy and resources are getting scarcer and ought to become more valuable going forward. Hey, too bad the world financial system is busted. But that just means that there’s an opportunity to buy good stuff really cheap.

No, I’m not saying that you ought to go out and buy stock with both arms or back up the pickup truck and start shoveling. You need to be very cautious right now. But don’t panic, either.

Sell if you need to sell. Buy if you want to take on the risk. We’re in for some rough economic times. But unless world population starts to die off fast or people develop a taste for living low and being cold a lot, the energy and resource plays are still going to work over the long haul.

Until we meet again…
Byron W. King
October 20, 2008