THE DREADED D WORDS.

Deflation. I have heard numerous comments about the current "loose money" policies of the Federal Reserve. Most say, we are going to have to face the consequences and the most likely result is hyper inflation. I know that money creation is always linked to inflation; however, it seems unlikely in view of some of the obvious deflationary pressures we are seeing. The most obvious to the casual observer is energy prices. Since July, crude oil has dropped 60%, unleaded gasoline has dropped 62%, and natural gas is down 52%. These are huge drops and it could be expected that these drops would filter down to other commodities. In just three weeks, steel, a basic building block of industry, is down 20 % with China and other countries exporting mega tons of the stuff into the US at cut rate prices. Aluminum is down by 29% and plants are closing in places like Booneville, Indiana where 770 jobs have been lost. Copper prices are no exception, having dropped by 31% in the past three months. Finally consider molybdenum, a hardening agent for steel. Prices are down by 60% since mid-October. That huge drop caused a the loss of several hundred jobs in the Colorado mountains as the long-anticipated re-opening of the Climax mine was put on hold indefinitely.

Since I have been following markets, I don't remember anything like this. Deflation is dangerous since it can cause massive job loses and lowering of wages as the newly unemployed workers tend to work for less than those currently employed. From what I have read about the great depression, this is what happened then. Hopefully, the central bank can manage monetary policy in such a way as to prevent it from happening again. To the extent that we can change our over- consumption habits to eliminate the excess consumption of the past, an adjustment could be healthy.

De-Leveraging. Acquiring leverage is fun. You can buy stuff without using your own money. Using leverage to buy income producing assets is often highly profitable while using it to buy consumption assets is almost always unprofitable. People who loan you money are very unreasonable. They want it back. They also want interest. When they are in trouble, they want it back faster. In the past, they were willing to roll it over when it became due. Now they are much less willing to do so. Most everyone (except the federal government) is in the process of de-leveraging. Real estate investment trusts, mortgage lenders, mutual funds, and hedge funds, are selling assets into a market where there is little demand, in order to repay loans that are being called due. Even prior to the due date, some loan documents give the lender the right to call the loan due if certain conditions are not met. There are also government regulations that keep some types of businesses, such as business development companies, from having too much leverage. When the value of assets fall, these rules can come into play. As much fun as acquiring leverage can be, the pain of de-leveraging is even greater. Companies previously considered as healthy can be forced into bankruptcy in extreme circumstances. Unfortunately, the market is concerned about some of the companies in our portfolio. An example is Prologis, a company I talked about in my last post. Even though the value of real estate in the portfolio is worth $30 per share, the share price is close to $6.00. When I bought shares of this for my own portfolio, I made a bet that they would be able to manage these assets during this period of deflation and de-leveraging, and emerge in a much healthier position. Hopefully, they can. As with anything you buy in today's market the risk that they can't is almost always there.

Back To Colorado In December. I will be available from December 5 to 14. Be glad to talk to any of you then. Please call Susan at 720-449-0200 and let her know you want me to call to schedule a meeting.

OIL PRICES THROUGH THE FLOOR

Gas Prices Soon Below $2.00 a Gallon. Happy days are here again. With gas prices down, consumers will soon be driving to the mall again and spending their money. The stock market will soon go back to 14,000 and we can stop worrying. NOT!! The reason oil has dropped more than 50% is a massive world-wide recession, the depth of which we still don't know. While the rise in oil prices didn't cause this recession by itself, it was a major contributor. It scared the dickens out of a lot of us who figured we would have to cut back in other areas in order to afford to continue to afford sufficient fuel to take us to places we need to go. Even with gas prices below $2.00 a gallon, the memory of $65.00 fill ups are fresh in every one's mind. Even the most optimistic among us believe prices will rise when, and if, the economy starts to grow again. Every one told me that prices wouldn't drop this time like they did in the late 80's because it was different this time. I agreed that it was different this time but guess what? It's different every time. Petroleum exporting countries need to sell a lot of oil and anything that causes a reduction in sales will result in a drop in prices so they can keep the revenue coming in but prices will rebound as soon as they believe the market will allow it.

Renewable Energy Will Save us. If you believe that, we should talk about this condo I have to sell. We have 250 million cars in this country that run on gasoline. There is no way we can cut our dependence on fossil fuels overnight. Tuning up our cars and putting more air in our tires won't save us either. I believe T. Boone Pickens statement that "we can't drill our way out of this". President-elect Obama grabbed onto that one in a hurry but he didn't give us the full benefit of Mr. Pickens statement that we still need to "drill, drill, drill" while we are developing renewable energy technology. I don't believe that "The Answer is Blowing In The Wind" either.
Mr. Pickens wants to put up a whole host of windmills to power our utility plants. Then he wants to use natural gas to power our cars. I believe we should work on this; however, the problems of establishing a nationwide system of outlets to fill our tanks with natural gas is immense. The cost of modifying our cars to use this fuel is also expensive, if not economically prohibitive. High pressure natural gas lines will be difficult for consumers to handle and their are safety issues with putting our cars on the highway with pressurized gas tanks.

I Sound Like A Pessimist, But I'm Not. I believe answers to our energy crisis are available. I just don't know what they are and I have no confidence that anyone else does either. One thing I do know is that we can't sit around and do nothing. We have to try several things at once. I still don't know whether or not climate change is a legitimate issue but I believe it will eventually take a back seat to the more serious issue of how we can maintain a reasonable standard of living in the wake of a shortage of affordable energy.

There are Opportunities Out There. Look at Colorado residential real estate. Prices are down but sales are up and inventories are shrinking. A recent piece in the Denver Business Journal states that October single-family sales are up over 14% from a year or so ago. The rental market is still strong and you can get a break-even before tax cash flow. While it takes considerable skill to enter the "fix and flip" market, you should be able to get excellent returns on a long-term basis. It is possible to buy lower-end properties for less than $150K that would have sold in the $190's two years ago. If you sold out of the stock market, this might be a good place to deploy some capital. With inventories shrinking and builder activity at a minimum, the seeds of a recovery are well in place.

Stocks Are On Sale Also. Because our asset management clients are so risk averse right now, we are not aggressively pursuing stock market investments in those accounts. I am however, being somewhat more aggressive in my own accounts. My last investment was in an industrial REIT called Prologis. I bought in at $9.85 a share. That is about half of the value of the underlying real estate they own. The dividend is in excess of 21%. While I suspect that this will eventually need to be cut, I think that is already priced into the shares. Just to hedge my bet, I sold the option to buy it from me at $10 a share in December. I got $1.75 for this which makes my acquisition price $8.1 a share. I like this so well that I also bought the preferred stock that yields 11+%. I plan to hold the preferred as a long-term investment. If the price of the common rises above $10 a share, I will have to sell it but a profit of 23% for a little less than 2 months is good enough for me. Win or lose I will let you know how this investment performs.

Back In Texas. I made it back here about a week or so and have been busy cleaning up after hurricane Ike. I'm pretty sure a tornado came with it and blew down some 100 year old Magnolia trees. Oh well, I still have 16 left and the reduced shade will make my hibiscus bloom better.

BUY LOW, SELL HIGH.

Have You Been Doing the Opposite? Warren Buffet says, "Now is the time to buy American." He is referring to the stock market and I suspect that quote has something to do with the market rally we're having today. Am I going to rush out and do just that? Not me. On the other hand, I didn't sell everything and I have raised a few dollars in cash by selling anticipated losers and accumulating, rather than reinvesting, dividends. As I mentioned in my last post, I did buy some more Anthracite Capital at around three bucks a share. It wasn't because I thought the company was going to turn around next week but because I thought the upside was infinitely higher than the downside.

We Should Listen To Mr. Buffet. When an investor as successful as Mr. Buffet speaks, you have to listen. Do you have to do what he says? No, its just another data point that you can use in conjunction with other data points to make sound financial decisions. When we have a crisis as serious as the one we're currently in, the key word is caution. I have been cautious in managing my portfolios and recommending that you do the same. If you have read my posts carefully during the past few weeks, you may have noted that I am becoming a bit more bullish in my approach. While I am not ready to "bet the farm" I find it difficult to resist some of the opportunities in this market.

What's Wrong With Marathon Oil? I've been watching this company for quite a while. Over the past few months, it has dropped from the mid $40's to to $28.5 per share. Why the drop? There are several possible reasons and anticipation of falling energy prices may be one of them. If you look at the share price trends vs the price of oil, it doesn't quite add up. While the price of oil has dropped to the 70's, it has simply returned to the levels of October, 2007. At that time, Marathon was $58.04. Obviously, Marathon share prices have dropped 50% from this level. So what were oil prices, the last time Marathon was in the current price range. In June of 2005, Marathon sold for $25.08 and the price of oil was $49.8 a barrel. Using that data point, you might conclude that investors predict a drop in oil prices to that level. If the current recession deepens, that is not impossible.

There Are Other Factors Influencing Share Prices. We certainly don't know them all but here are some reasons why Marathon appears to be a very good buy. 1. The dividend is 3.6%. This may not seem like a screaming return; however, you do get something close to a CD return while you wait for prices to get back to "normal." 2. It doesn't appear likely that the dividend will be cut in the future since they are only paying out 21% of their earnings. 3. The share price is slightly below book value. Although book value isn't an entirely accurate measure of intrinsic value, it is another data point. Historically, Marathon has sold for almost twice book value. Other oil companies are also priced at a higher multiple to book value. 3. Marathon is actively exploiting new energy sources. They have a stake in the Bakken field, one of the most promising new areas of domestic production and they are also participating in a new discovery of the coast of Angola. Given these factors, I have decided to invest some of my cash in Marathon oil at $28.7 per share. With a sufficient time frame, I think this investment will prove to be a good one, there is one more factor that allows me to hedge my bet.

Option Prices Are At Record Levels. When I made this investment on Tuesday, investors were willing to pay a dollar per share for the option to buy my stock at $30 three days later. This means that I would make $2.30 or 8% over a three day period. If the stock didn't rise to $30 per share, I could keep the dollar. That option expires today and Marathon is selling for around $27 per share and the dollar is mine to keep. What's my next move. Since I still think Marathon is a good company to own, Ill keep the stock and sell another call $30 call option, This option expires in November and can be sold for around two dollars a share. I'll continue to own this stock until I change my mind about the prospect for Marathon, or until I sell an option that is called. There is still plenty of risk involved in this investment but I am committed to keeping most of my funds in the market. If you are afraid to invest when the market is down, you will be stuck in a "buy high, sell low" strategy.

Don't Try This At Home. While this is an actual example of an investment I made, it is not a recommendation for you. In many cases, an investment like this one is totally inappropriate for a given financial situation. Never make an investment unless you have studied the risks involved and determined that you are willing to tolerate them.

OPTIMIST OR PESSIMIST?

Which Are You? A pessimist might argue that our current economic situation is permanent because we have lost our position as the number one nation in the world. An optimist might argue that American work ethic and ingenuity will keep us at the forefront and an eventual rebound is inevitable. Both optimists and pessimists can be stupid at times but the optimist will be happier and more successful most of the time. I have been reading a book by Martin Seligman called Learned Optimism. Dr. Seligman is a prominent psychologist who discovered that individuals learn to be helpless when they reach the conclusion that, whatever their behavior patterns, they cannot improve their situation. If they persist in this state, they are prone to long bouts of depression, poor health, and a reduced life expectancy. Much of the book goes on to describe how we can reverse our helplessness and restore our optimism. I have argued that, since no one can predict, with any degree of accuracy, the future investment environment, the next best quality you can have is resilience, the ability to keep going after a setback. The more optimistic we are, the more likely we are to persist.

We Have Undoubtedly Had A Setback. We no longer have money we thought we had. Now what we have to decide is what to do with the assets we still have. Here are a few strategies that come to mind. 1. Get out of the financial markets and stay out. This strategy works for a number of my friends and family. The key here is to have an adequate income to meet your needs without having to rely on investment income. 2. Get out of the financial markets and get back in when the environment improves. If this is your strategy, I'm afraid I can't help you. Knowing when to get back in is critical. Past recoveries show that a third of what has been lost is recovered within 40 days of the turnaround. Like I've said before, I've known several market timing specialists over the years. None are still practicing. 3. Change to a less aggressive strategy emphasizing safety. This is what I've attempted to do in most cases; however, it has been only moderately successful. An investment with perceived safety can drop in price right along with those considered more aggressive. The best you can hope for is that it won't drop as much. I will continue to utilize this strategy while looking for opportunities that may arise. One area of interest is some of the beaten down financial stocks. As an example, I recently added shares of a stock that is selling for only $2.75. It currently pays a dividend of $1.24 per year or a yield of 45.09%. The book value of the company is more than $10 per share. What are the odds of that dividend continuing? I don't have a clue but if I can buy $10 in book value and get back 11.27% of my investment in three months, there has to be more upside than downside. The most I can lose is $2.75 per share. Bank of America can drop that much in a flash. If the market decides the company is worth its book value, I stand to make 7.25 a share. Worth taking a flyer? It is to me.

Notice How Few People Are Talking Energy Prices These Days. The price of a barrel of oil has dropped 51.02% since June of this year when I told you prices had to come down for the right reasons or the wrong ones. Remember, the wrong reason was a worldwide recession? Here it is folks. It is likely the price will drop further unless some miracle occurs to erase the pending recession. Hopefully, we won't ignore our long term need to find new energy both from renewable and non-renewable resources. We also need to conserve, which I suppose we will do automatically because we have less money to spend.

It's Getting Chilly Here In Colorado. I suppose that means this old snowbird needs to get ready to fly. Don't hesitate to call if you need to get in touch before I leave. I anticipate spending more time here in 2009. Hope to continue working with you whether I am here or in Texas.

HOW DO YOU MEASURE FEAR.

When Others are Greedy I am Fearful; When Others are Fearful I am Greedy: That is a quote from Warren Buffet. Mr. Buffet has recently been in the news as a result of placing billions of dollars in Goldman Sachs and General Electric. He obviously saw great opportunity there. Wouldn't it be nice if there were a quantitative measure of the amount of greed and fear in the marketplace? According to market technicians, there is. I looked for a reference to what I am about to tell you but have been unable to find one; however, I have a strong memory of attending a seminar where this was discussed. The quote I remember is that "the VIX is never wrong." What is the VIX? It's a measure of market volatility published daily by the Chicago Board of Options Exchange (CBOE). This is said to be directly proportional to the amount of fear in the marketplace. According to the speaker at the seminar I attended, when the market is dominated by very high levels of fear, a turnaround will occur within six months. The next question is what constitutes a high level of fear? Most technicians believe the VIX is only highly predictive at levels of 40 and above. The current level is 45. According to this we should be racing to put money in the market. I don't know about you but I'm not racing to do anything.

What Does History Tell Us? I attended the seminar I'm telling you about somewhere around 2003 and have watched the VIX ever since. During that five year period, the VIX has often been around 10 and has never been above 40 until now. Since I still don't trust the validity of some here say info I got from a seminar, I decided to do a quick scan of VIX values from now until they began to be published in 1990. To my disappointment, I found only three periods when values were above 40. The first occurred in August of 1998 when the value was 43. At that time the S&P 500 was 1027. Six months later the VIX was 27 and the S&P was up 20.5% at 1238. The next occurrence was in September 2001 when the value was 42 and the S&P was 1085. Six months later, the VIX was 17 and the S&P was up 5.8% at 1148. The last occurrence before now was in Sept of 2002 when the value was 40 and the S&P was 845. Six months later the VIX had dropped to 31 and the S&P was up 5.9% at 895. If we feel comfortable depending on three data points, we can say that the theory holds. Let's see what happens in another 6 months. I must say that I am more optimistic at this point than I was a month ago; however, I wouldn't recommend that anyone make an investment decision on such a small sampling of data. I also don't recommend ignoring the VIX. One more factor to take into consideration when planning your investments can't hurt.

Gasoline Prices Below $3.40. Right down the street there is a service station offering gasoline at $3.31 per gallon. This is good news and bad news. With oil prices at $150 a barrel, the motivation to bring on additional energy sources was extremely high. At $94 a barrel it is less exciting. Although there are a number of patriotic reasons to conserve the energy we have and search for more, I'm afraid these will always take a back seat to economic incentives. As an example, I recently saw an article about conversion of cars to natural gas at the University of Denver. This allows them to run their vehicles at the equivalent of $2.25 per gallon, a savings of approximately $1.25 a gallon. This has to be a bargain right? I'm not so sure. The cost of modifying each vehicle was $12,000. Do the math. If a vehicle gets 14 miles per gallon and drives 15,000 miles per year, it uses 1,071 gallons per year. At a savings of $1.25 a gallon, it saves 1,339 a year. This means you break even at the end of 9 years. How long do we expect these vehicles to last? At 15,000 miles per year, the accumulated mileage after 9 years would be 135,000. While this is not an outlandish figure, I think most would agree that at 135,000 miles the vehicle is pretty well spent. The bottom line is that I wouldn't invest my money with zero return on investment over a 9 year period. Why would DU do this? Because they got a grant of $180,000 from a non-profit organization. Nice for DU but I don't think we can depend on non-profit organizations to solve our energy problem.

Still Here. I am finally catching up on my backlog of problems. Still, I doubt I will leave before late October. I always want to hear from old friends and clients.

TURMOIL IN THE MARKETS

Need Someone To Explain the Turmoil To You? Don't look at me. It's horribly complex. I have talked to several who claimed to understand it and found out that they really only thought they understood it. One thing I do know is that the problem is a great deal more complex than some bad loans. My strategy is to conservatively manage my assets and do the same with client funds. One thing is apparent to me: Both "good assets" and 'bad assets are under selling pressure. Why the good assets? Because investors are selling things they might not normally sell in order to raise capital to make up for the bad assets. Whatever congress decides to do, there is little prospect for a quick turnaround.


Let's Talk About Something More Simple. Several companies have announced that they intend to repurchase their shares in the open market. Some clients have told me that they don't understand how share buybacks can benefit shareholders. Here is a simple explanation. Suppose you own 1000 shares of XYZ company. Suppose there are 9 other shareholders with 1000 shares each. If the company has a million dollars in assets, half of which is in cash, the asset value of each share is $100. Looking at income produced by the company, let's assume it is $250,000 per year or $25 per share outstanding. That means your 1000 shares earns entitles you to $25,000 of those earnings. If the stock is selling on the open market for 15 times earnings, the market value of each share is $375. Since the company has a half million in cash, it can buy 1000 shares on the market for $375,000 and still have $125,000 left. After the purchase, there will be only 9,000 shares outstanding and each share is entitled to $27.78 of earnings per year. At 15 times earnings, your stock would now be worth $416 per share. Hopefully, this tells you why a company might embark on a share repurchase program.

The Real Question Is The Best Use of The Excess Cash. Share buybacks are but one use of the excess cash a company has beyond that needed for reserves. In the previous example, the company could have distributed the $375,000 in excess cash to shareholders with each share receiving a $37.5 dividend. Your 1000 shares would entitle you to a dividend of $37,500, a 10% yield on your investment. The share repurchase increased the value of your stock by $41,600, only slightly more but you also have to consider the tax implications. There is no current tax on the increase in value but the dividend would leave you with a tax bill of $5625 at 15%. One of the main benefits of both dividends and share buybacks is that it keeps the cash from burning a hole in management's pocket. It seems that the better company executives are at managing the business, the worse they are at managing cash. Years ago Mobil bought, now bankrupt, Montgomery Ward. Arco bought Anaconda Copper just before metal prices crashed. Paying out dividends or buying back shares keeps management from doing something stupid with the money. (Part of the Data for this paragraph came from an article in the Wall Street Journal by Jason Zweig)

The Downside To Buying Back Shares. While it would seem that putting capital into the hands of shareholders is a good thing, we can't overlook the fact that companies often buy back shares when the company is producing cash and prices are high, only to need the money later when the business is weak and share prices are down. In 2006 and 2007, Washington Mutual bought back 6.5 billion worth of stock at $43+ per share. This spring, they had to issue new stock at a price of $8.75. Citicorp and Wachovia made similar moves. That will dispel the rumor that these executives are smarter than the rest of us.

Who's Buying Back Shares Now? Microsoft just announced that it is going to buy back $40 billion worth of stock. While they are only sitting on $21 billion in cash now, they have good cash flow and borrowing power for the rest. Hewlett Packard is going to buy back $8 billion with part of the 14 billion in cash they now have. The biggest share buybacks came from Exxon-Mobil with a total of $102 billion worth of shares bought back.

Denver Real Estate Market Better than Most. A leading indicator in the Denver real estate market is the number of homes for sale. In this regard, things have improved immensely. Last August, a buyer had 30,800 homes to choose from. This August, there were only 24,648 homes, a drop of 20%. This is highly significant. Part of the reduction is due to major decreases in the number of new homes being produced. My belief is that inventories will continue to shrink until demand catches up with supply. Buying a residential rental unit right now may not produce a quick increase in price but it appears highly probable that prices will begin to increase in the near future.

Trying To Finish Up In Colorado. It has been a busy couple of months here in Colorado. I still have some real estate business to clear up and I have been making considerable effort to understand this crazy market. I am anxious to see what unfolds in the energy business as we argue over how to break free of foreign oil. Hopefully, we can make some of the right moves in stabilizing our economy.

BULLETS FLYING EVERYWHERE

Looking For A Place To Hide? If you find one, call me. I have long warned my readers that it is impossible to correctly predict market directions with a high degree of accuracy. I also warned that, if you can't anticipate the future, the next best thing was to be resilient and ready to persevere when negative events happen. In my thirty years as an entrepreneur, I went through a number of negative events and watched clients and colleagues do the same. Those that fell by the wayside were the ones who blamed others for their misfortune and expected someone else to bail them out. Successful people realized that they created their own existence and were responsible for correcting the situation. By resiliency, I don't mean that you should sit where you are and do nothing. That also is a recipe for disaster. What you have to do is assess the situation and develop a coping strategy. Of course you could be like Bill O'Reilly and blame everyone from the oil companies to the "speculators" to the government. His most stupid comment was that the President had the responsibility to monitor the financial markets and warn "the folks" when a disaster like the present one was coming. Can you imagine what would happen if the President called a news conference and warned that certain companies were doing things that put the system at risk. If there wasn't a panic before, that would certainly start one.




The Two Best Things You Can Do. One of my clients suggested that he might purchase a mountain condo which he could use for business purposes. He has $70,000 in cash for a down payment. My advice is one that I would give most everyone: Keep a Cash Reserve and Guard it With Your life. Now is not the time to speculate on anything, much less a mountain condo. I don't mean that you should have all your money in cash, only that you should have enough to see you through a crisis or take advantage of opportunities that may arise. The next point is Take A look At your spending habits and eliminate expenditures for which you don't receive adequate value. I am a good example of someone who needs to do that. I bet I could cut $500 a month from my expenditures and barely notice it. While that doesn't sound like much, in this market it would take $100,000 in capital to produce that kind of income at a reasonably safe rate. I am going to work on that while I am in Denver.



Hospices, Hurricanes, and Other Unfortunate Events. It's been a difficult summer. I just spent two weeks taking shifts in a hospice watching Betty's brother go through the trauma of dying. He was only a year or so older than me. It was hard on everyone. My son-in-law lost his mother to pancreatic cancer. She was a beautiful person who will be strongly missed by all of us. A hurricane blew into the Southeast Texas area and left a lot of my family members without power. My brother-in-law's barn was virtually ruined in the wind and one of my neighbors on the lake lost virtually his whole house when the roof blew off and the inside soaked with 12 inches of rain. I lost a few trees, none of which hit the house, gazebo, or boat house. I am lucky but I guess I hurt for all these people. The trauma of the current financial markets is certainly secondary to what happened to lots of other folks. I can little afford to quit fighting at this point. It's what I've done for most of my life. I am reminded of a joke one of my buddies used to tell because it reminded him of me. It is about a man who fell from the top of a 60-story building. When he passed the 30th floor he looked at the people watching and said, "So far, so good." I guess my friend, who died 12 years ago, was right about me. Next week, I'll have some comments about the markets with an emphasis on energy.

BETWEEN IRAQ AND A HARD PLACE.

Why Our Oil Companies Won't Drill. Those who oppose new drilling in so-called environmentally sensitive areas often call our attention to the fact that oil companies already have 60+ million acres of leases that they could be exploiting to increase our supply of domestic oil reserves. Why are they spending their capital on buying back their stock instead of exploration and production? Why aren't companies willing to invest more money in order to find more oil to sell at $120+ per barrel? We all know that the cost of locating and producing crude oil has increased dramatically; but surely at these prices it's worth it. Or is it? I recently read an article in The Economist about the potential for oil production in Iraq. Currently they are producing 2.4 million barrels per day with the potential for producing up to 6 million. Their proven reserves are 115 barrels, third largest in the world behind Saudi Arabia and Iran and these are only the proven reserves. They have hundreds of promising geological structures where no wells have been sunk. Only 2300 wells have been drilled in the entire country compared to over a million in Texas alone. The most important feature is the cost of additional production from existing fields. The state owned Iraq National Oil Company estimates that the new production will cost from $1-3 per barrel. Some time ago I called your attention to what happened in the early 80's when the oil producing countries flooded the market with oil and dropped the price by 80% leaving oil companies with a huge inventory of producing wells that could not compete at existing prices. No one worried about their sub-standard profits at that time. I was bombarded with comments calling my attention to the fact that it is different this time. Of course, its different this time because its different every time. Would you be enthusiastic about exploring for oil that costs $15-20 a barrel to produce when you know your competitor can put you out of business with their $1-3 per barrel oil? But our government can solve the problem. How about a windfall profits tax? That should get us a lot more new oil. Right?????????????

I Bet You Wonder Why I Defend These Greedy Oil Companies? Surely I can't defend the fact that Rex Tillerson, CEO of Exxon Mobil makes $11.3 million a year in salary, bonus, and "other" compensation. That's almost 1/4 of what they pay Judge Judy ($45 mil). Maybe some of these observations can explain why Exxon Mobil earned $40+ billion last year only to lose twice that much when the value of their stock dropped from $485 billion to $400 billion.

Economy Better Than We Thought? Our Gross domestic product grew by 3.3% this past quarter. This is much better than anyone anticipated. Perhaps the main reason was an increase in exports by 13% and a decrease in exports of 7.6%. The stock market rebounded some 200+ points. I guess I can't get too excited; however, I have stopped raising cash and am ready to start buying selected conservative issues a little bit at a time.

Fourteen Days At The Hospice. Nothing like 14 days at the hospice to let you know how precious life is. The medical personnel all say they wouldn't work anywhere else. They feel honored to be chosen to help patients and their families at such an important time. They are truly special people.

THE TIME VALUE OF MONEY

How To Make Any Financial Decision. The key is a thorough knowledge of the time value of money. In six plus years of post high school education no one ever taught me that concept. I was in my late 30's when I was introduced to the concept and I immediately felt that I had the "key to the vault." With a $75 calculator and a thorough knowledge of this concept, you can make any financial decision from the right mortgage to finance a property, to whether to lease or buy a car, or which investment is appropriate for your circumstance. Further, there are assumptions you make which are different for everyone, allowing you to customize an answer for any client's situation. I won't go into detail but suffice it to say that 30 years after I learned about this concept, I decided it was not nearly as empowering as I thought. In order to modify the statement to make it more important, you simply have to turn the words around. It's not the time value of money that counts, it's the money value of time. That insight occurred to me this year when I turned 70. It became even more important this week end as I visited the hospice where my brother-in-law is ready to call his earthly journey to an end. It's sad to realize the time we've wasted worrying about things that don't matter in the least. Time isn't money, time is your life. Don't waste a minute of it.

A Word About Those Evil Oil Companies. Most of us have trouble holding down our anger every time we fill our gas tank lately. Even Bill O'Reilly accuses the oil companies of gouging consumers by holding prices at unfair levels. Surely a company like Exxon with a value of some 400 billion can force prices to levels that won't cripple our economy. Guess what. America doesn't have any big oil companies. Exxon with all it's billions is dwarfed by the really big oil companies, all of which are owned by foreign governments or government sponsored monopolies. In reality, Exxon is only the 14th largest in the world. Exxon buys 90% of its oil from the really big oil companies who, by the way, control 94% of the world's oil. Surprised? I was.

What About Those Windfall Profits? Oil companies are earning a lot of money, and the owners are getting rich. Sure, Exxon earned 43 billion this past 12 months bet those owners are rolling in dough. Don't believe it. The market value of a company is easily determined by multiplying the number of shares outstanding by the current share price. Since the first of the year, Exxon's value has decreased from $485 billion to $400 billion. That's 17.58%. They aren't the only one. Marathon Oil, a smaller $62 billion company has dropped to less than 45 billion, a 28% drop. Conoco-Phillips and Chevron-Texaco show similar trends. Of the four companies I researched, the total loss in market value since the first of the year, was $128.13billion, runs into real money sooner or later. Despite their huge earnings, they must have problems of which the public is unaware.

I Am Not A Huge Fan Of These Companies. Their executives obscene amounts of money but so do Rush Limbaugh, Al Gore, Bill Clinton, Shawn Hannity, and Carmelo Anthony. It is impossible for most of us to comprehend how anyone can be worth that much money. Some oil company executives are guilty of fraudulently taking money from their constituents but so are some politicians, communication company executives, and investment bankers. When our economy has problems, there is a rush to find out who is at fault. After all, it can't be us. It has to be someone else. In this case, there blame for enough people to go around, not the least of which is the "man in the mirror."

LOOKING FOR A PORT IN THE STORM.

Protecting Portfolios From Volatility. Dividend paying stocks are historically less volatile than those that don't pay dividends. My strategy is to emphasize these stocks for a number of reasons. Unfortunately, the recent market has not worked that way. Mainly, this is due to the crisis in the financial and real estate markets. I have also said that the best strategy has been to "stay the course, " collect dividends and wait for these stocks to recover. For the most part, that strategy works; however, I know how difficult it is to tolerate large reductions in the market price of our portfolios. I have occasionally raised cash in portfolios via carefully selected sales of stocks and retention, rather than reinvestment, of dividends. That reduces volatility; however, the yield on cash is less than two per cent, a guaranteed way to lose in the current inflation environment. I continue to search for ways to get better returns with less volatility. While there is no sure-fire strategy, there are a few that I think have merit in getting somewhat higher yields without at less risk. Here are some of them.

Health Care Stocks. I recently bought Pfizer at 17.78 per share. This is a major drug company which has dropped from the 50's over the past 5 years. They have some problems in that patent protection on many of their major drugs is expiring during the next few years; however, the aging population should provide a growing market for many of their products. The dividend of 7.19% is not a barn burner but it should more than justify the risk. I will continue to seek out similar health care investments.

Preferred Stocks. These are becoming more popular as investors seek stable yields. You can find yields in the 8-10% range. While there is limited upside, you have much less worry about dividend cuts since the preferred dividend has to be paid before any dividend can be paid to common share holders. Preferred shares on real estate investment trusts appear to be particularly attractive since they are bought primarily for dividends and companies strive to maintain high dividends to keep from losing investors. An example is First Industrial Reality, a REIT that has industrial properties world wide. At present they pay a dividend of 11.68%. I wouldn't buy the common stock because of the potential for a dividend cut; however, the preferred has a yield of 9.54% and the potential for a dividend cut is greatly reduced.

Combination of Preferred and Health Care. Someone recently called to my attention is a REIT called Biomed Realty Trust. It is a company that buys properties for lease to companies in the life science industry. They currently pay a 5% dividend on their common stock. While that isn't bad, you can buy the preferred stock at a yield of 9.54% and there is little danger of a dividend cut. There are a number of similar opportunities out there which offer higher dividends combined with lower volatility. You won't double your money but you can sleep better with some of these in your portfolio.

I Have To Brag A Little. On July 13, I told you that oil prices had to come down. At that time, oil was selling for more than $140 per barrel and many were saying the next stop was $200. Today, the price is $115. There are a number of reasons this has happened to include a world-wide reduction in demand, a renewed pressure in congress to open up more areas for exploration and production, and an a heightened awareness among Americans of the magnitude of the problem and the consequences of continuing like we are. The debate rages as to how to deal with this problem. Suggested solutions run from putting more air into our tires, to batteries, to wind energy. These solutions fall into three main categories: Conservation, finding more fossil fuels, and finding alternative (mostly renewable) sources. My recommendation: All of the above. One last comment: Before you finally decide whether the fault lies with OPEC, China, India, President Bush, futures market speculators, or those evil oil companies, go down and look in the mirror. We build bigger houses than we can possibly use, buy huge cars with little regard for the energy they consume, and we borrow on our houses to buy consumer goods we really don't need (forcing the value of our dollar lower).

I will Be In Colorado For Longer Than I Had Planned. Should be here for the next two months. I am looking forward to meeting with many clients and friends during that time.

PTL, para XYLENE AND THE PRICE OF OIL.

Almost 50 Years Ago. I had the honor of working at one of the premier chemical research laboratories in the country, the DuPont Experimental Station just outside Wilmington, Delaware. My first assignment was as part of a team working on a substitute for para xylene, a starting material for Dacron, polyester fiber. The main reason a substitute was needed was the high price of para xylene. Virtually every oil company was swimming in the stuff, yet the price was deemed way too high for the existing demand. Our project was focused on para tolualdehyde (hereinafter called PTL). Our initial lab work in obtaining high yields of this compound was very promising and economic projections indicated that we could produce this material for substantially less than we were paying for para xylene. As I worked on this project, I was puzzled that DuPont allowed publication of some of our work, directly opposite to the air of secrecy that surrounded most of our research. Because of the success of the laboratory work, a pilot plant was constructed to demonstrate the feasibility of producing this material on a commercial scale. Again, press releases told the world of the success of this pilot plant operation. I was doing lab work in support of this project when one day our department manager walked into my laboratory and told me to cease all work on the project, it was being abandoned. Why? Because the price of para xylene had steadily dropped to the point that we could no longer make PTL at a price to compete with para xylene. Several years later, I worked in research for a major oil company and was told that para xylene was no longer the high profit compound that it had been before DuPont forced the price down by their PTL project. Finally, a light bulb went off and I discovered that DuPont never really wanted to make PTL, although I'm sure they would have if their hand had been forced. The main objective was to be able to buy para xylene at a much lower price. This objective was accomplished without ever making a single drop of PTL on a commercial scale.



Why Did I Tell That Story? Because I get so weary of the political arguments, one of which says that even if we did exploit all the energy resources at our disposal it would make a difference of only 2 cents per gallon of gasoline. If DuPont can force a huge drop in the price of a commodity by initiating a project to manufacture a substitute, what could the world's largest consumer of petroleum do if they convinced their suppliers that they were no longer going to be held hostage by suppliers who would do whatever they can to disrupt our way of life?



Lawmakers are Split Along Party Lines. I have always said that this is a scientific issue and shouldn't be a political one. I am doing some research on both sides of the argument and trying to be objective. One conclusion is definite. Al Gore's statement that the debate over global warming is over makes no sense. I have read arguments by very credible scientists that call into question the statement that man made carbon dioxide is responsible for global warming. I have recently read an argument that says we have experienced no global warming during the past 10 years. It's hard to get enough of the raw data to determine who is right but it is obvious that the debate is not over. Each side seems so entrenched in their opinion that it is unlikely that even the most objective of scientists, much less politicians, can ever be open minded enough to look at the data objectively.



Look At My Post of July 13. I told you that oil prices would come down, or at least stabilize. Before I brag too much, I have to tell you that I didn't have a clue when or how much. We all know that world-wide demand is falling in response to high prices. While it may rebound some, I believe the overall trend is down. I am still going to maintain some exposure to energy stocks. I don't think we need $140 per barrel oil to make some, if not most, of these companies favorably priced. I am still in high dividend stocks. I recently added Pfizer to some portfolios, including my own. At less than 10 times earnings and increasing demand from aging baby boomers, firmly entrenched health care stocks appear to be a "port in the storm."

WHISTLING THROUGH THE GRAVEYARD.

I'm Not Afraid. Like hell I'm not. Its been a tough market and there are several sticky problems that just won't go away. This situation could be with us for awhile. On the other hand, there are some who are in a state of panic to the point that they believe that our country is rapidly declining and in danger of becoming a second rate power. John McCain's economic advisor Phil Graham said last week that we aren't in a real recession, just a psychological one. Shades of President Carter and his "crisis of confidence" speech. While I don't necessary agree with Dr. Graham, he has a point. This recession, like many others before this, is accompanied by a feeling of gloom and pessimism. While I don't want to understate the problem we're having, it may not be all that bad compared to others. I did a bit of research to compare our financial markets with several other large countries. You can draw your own conclusions as to how we are doing.

We Aren't The Only Ones With Falling Markets. Several of our clients have urged us to move money from the US markets to overseas markets, especially China and India. Here are some statistics to consider.
Using the S&P index as a guideline, our stock market has dropped 15.9% year-to-date.
The Chinese market has dropped 45.7%
India's market is down 34.9%
Great Britain is down 18.5%
France is down 27%
Germany is down by 23.7
So much for transferring our investments overseas. Our gross domestic product, while not growing as rapidly is more than the next three countries combined.

Even Gasoline Hasn't Increased That Much. We're all nervous about the high price of fuel and how badly it is going to affect our economy. In 1974 we were paying 40 cents per gallon. Now we're paying four dollars. Sounds horrible doesn't it. In fact, an increase of that magnitude amounts to only a 7% compounded rate of return. The real difficulty is that the increase has not been gradual but has occurred in the past 2-3 years. I sound like Phil Graham when I say that much of the impact has been psychological. We've stuck our heads on the sand and took advantage of unrealistically low prices. We squandered our money on great big cars and bought houses that were way too large and luxurious for our needs. Many, like myself decided they could have two homes. Its been fun but now we have to pay for it. Reminds me of a song written in the 70's when gas prices rose rapidly. It was written by Jerry Jeff Walker and entitled, "Goodbye Easy Street." We thought our way of life was ruined back then but it turned out not to be not such a big deal after all.

I Believe Oil Prices Will Come Down or Level Off. This will happen either for the wrong reasons or the right ones. The wrong reason will be a huge drop in demand due to a worldwide recession. The right reason will be similar to what occurred in the 1980's when the car companies increased the mileage of the cars they produced. Many small measures were taken by consumers to reduce their energy consumption and exploration and production activity increased dramatically. We can do this again. In addition, we can get serious about renewable energy sources.

All Is Not Sweetness and Light. I am aware of the seizure of Indy Mac Bank. I also know the Federal Reserve has announced strong measures to prevent the failure of Fannie Mae and Freddie Mac. This is unfortunate but not a total disaster. Remember the RTC (Resolution Trust Company) formed to deal with the Savings and Loan crisis of the late 80's. Strong measures are often called for and these don't mean that we are "going to hell in a handbasket".

My Investment Policy Remains Intact. 1. Emphasize investments that provide cash flow. 2. Increase cash allocation. 3. Re-invest prudently. I am currently diversifying into areas expected to be more recession resilient ( I bought Pfizer at 17.5 and a 7+% yield). We are buying REIT preferred stocks. (These have higher yields than most stocks and a preferred claim on earnings to be distributed as dividends). Like many others, I will spend more time at home. (I have virtually everything I want right here.) I will be back in Colorado at the end of August for an extended stay. Contact me by e-mail or call our office if you want to arrange a meeting.

WHEN YOU WISH YOU WERE WRONG.

The Markets are Still Volatile. In my last post I talked about the markets and the investing environment. I questioned the rally that had occurred and predicted that the new levels wouldn't hold. I was right but I wish I had been wrong. It's been difficult to make a buck in any markets lately as consumers are overwhelmingly pessimistic and investors are following suit. The vast majority believe they were better off five years ago and 70+% are pessimistic about the future. When it takes 60-70 bucks to fill your gas tank, you aren't real anxious to go to the mall and spend money. Still, economists are not predicting a recession in the classic sense, which is two straight quarters of negative growth. The consensus seems to be that growth will slow to about 2% growth per year and unemployment will gradually increase to 5.9%. We used to believe that 5.9% was right at full employment. Based on those numbers, things might not be as bad as they seem. Still, the adjustment from the frenetic levels of the past few years can be painful.

Is It Real Estate Or Energy. It appears that energy prices have replaced real estate as the main concern for consumers. No doubt, residential real estate has dropped drastically in many areas; however, real estate recessions generally create their own recovery as builders quit producing new product and the excess inventory is absorbed. Of course, you can say its different this time and you would be right but it's different every time. The real question is how is it different? I have been watching builder production and the amount of new homes produced has slowed to a crawl as builders are more concerned about disposing of spec inventory than they are about opening new projects. As of March, year-to-date single family building permits were down 43% from last year. Condo and townhouse permits were down almost 70% from last year. Considering the fact that 2007 was also a down year, this could be highly significant. Land values are also dropping as a result of these changes. It may take awhile to start, but I believe residential prices will be recovering over the next two years.

What About Energy? While I doubt the dire predictions about the effects of "global climate change," I can't say I'm not concerned. My position is that there is little we can do about it. Even the most pessimistic of scientists, admit that we are in a position to control less than a third of these changes. What I am more concerned about is the fact that we are sending billions of dollars to the middle east where most people hate Americans and their way of life. Sending our president to beg OPEC leaders to increase oil production is futile when we do nothing to exploit our own energy reserves. Those opposed to exploiting these reserves have little input as to how we can control our own destiny without huge effects on our way of life. Those of you who believe in government regulation to reduce fuel consumption have only to look at some of the things they have tried in the past to get an idea of how effect these regulations are. Consider the 55 mile per hour speed limit that we imposed during the 70's crisis: On a 1000 mile trip, driving 55 instead of 70 increases travel time by 3.9 hours. If we assume that gas mileage increases from 20 miles per gallon to 25, we save 10 gallons of gas, $40 dollars at $4.00 per gallon. This amounts to slightly over $10 per hour. If there are two people in the vehicle, that is $5 per hour each. Very few of us work that cheap. Other maneuvers include going to daylight saving time year round. I fail to see how that saved any energy at all. Then we have ethanol, which has received the benefit of thousands of dollars of government subsidies. When we consider the energy it takes to produce ethanol and it's reduced fuel efficiency, we realize that the overall effect is negative. All we have done is driven corn prices out the roof and decreased the world's food supply.

Potential Solutions. 1. Consume less energy. Higher fuel prices will cause this to occur naturally, not only in the energy markets but in numerous other markets as well. While some reduction in consumption is a good idea, the real question is what will it do to our economy? It could be devastating if reduced consumption is the only answer. 2. Drill for more oil and natural gas. The majority of Americans are in favor of this but face stiff opposition from those who believe it will harm the environment. The most effective argument I have heard against opening up new areas for exploration (Anwar and offshore) is that oil companies aren't utilizing many of the areas available to them now. Instead of exploiting these fields, the oil companies are repurchasing their own stock. Those who wonder why this is happening need only to think back to the late 80's when OPEC flooded the market with oil in order to eliminate marginal producers. Oil prices dropped by 80% and oil companies, who had invested billions in new fields, could not utilize that production because it cost them more to get the oil out of the ground than it was worth in the marketplace. That could happen again since middle eastern oil costs $6-10 per barrel to produce. This is a fraction of what it costs for our domestic reserves. 3. Utilize nuclear energy. That could be a tremendous benefit but many environmentalists are opposed to this idea. 4. Use more coal. Again, we have a tremendous opposition from environmentalists but we have a lot of coal and wider usage could reduce our dependence on foreign oil by a large amount. Which of these paths should we take. My opinion is that the only correct answer is all of them. Our current dependence imported oil is too dangerous to be allowed to continue. We have to do every thing we can to reverse these trends or our way of life will disappear.

How Do These Trends Affect Our Investments. I am wary of the stock and bond markets and am sitting on more cash than ever. Of those investments I hold, most are high dividend stocks which have been hammered in the current downturn; however, dividends remain solid at this point. I am investing in the energy markets. Companies such as Marathon Oil are heavily involved in exploration in the Bakken Field which is touted by some as having huge potential. I still want some exposure to the oil service industry. Companies in this area aren't cheap but they can profit heavily from increased drilling activity when, and if, it occurs.

June Has Been A Busy Month. I have been heavily involved in things like my daughter's wedding, selling a long-held real estate investment, and concern over serious illness of a family member. I have not posted on this site as much as I would have liked. I am still available to visit with any of our clients who need extra help.

THE GORILLA IN THE MARKETPLACE.

A Full Blown Energy Crisis? It seems like oil prices have only one way to go. Up! This spring has been brutal on oil prices. We worried about $100 a barrel oil and $3.00 gasoline but we passed those barriers like they weren't even there. All this time, we've had a totally unexpected rally in the stock market. I can only say that I didn't expect it and I doubt that these levels can hold. My position is that the market hasn't figured out the difficulties that our economy will face because of these price levels. Although I am leaving day-after-tomorrow to drive to Colorado, I doubt there are very many families who plan to travel this spring or summer with fuel prices at these levels. Hotels, restaurants, and tourist related business haven't even begun to feel these effects yet. Truck drivers can strike all they want to but the only way they can cope is to raise their own prices. Some airlines will have to raise their prices to compensate and have already begun to do so via imposing a fee for all checked baggage. Retail stores and restaurants have been closing stores due to reduced traffic. This is bound to have an effect on the stock market. Don't expect the current prices to hold. Stay invested in dividend stocks but sell others, perhaps even energy stocks, into rallies. Raise cash for opportunities which will arise later.

Has The Housing Market Turned Around? Recent data show that it hasn't with nationwide prices dropping more than 3% during the past 12 months. These data also show how strongly regional factors affect the marketplace. In Tibodaux, Louisiana home prices increased 11%, the highest in the nation. You will probably be shocked to find out that number two was Grand Junction, Colorado with an increase in excess of 9%. No major city in Colorado reported a decrease. Is it time to venture into residential real estate investments? Some think it is; however, don't expect price increases to accelerate rapidly. It could be years before we see strong appreciation again. Still, those who want to diversify will probably find the returns from residential real estate investments will exceed those available from the stock and bond markets, particularly with the potential for renewed inflation.

Why Is Colorado Housing Doing Better Than The Rest of The Country? Part of the answer is the energy business. Colorado has always been sort of a hub for oil and natural gas exploration and production. I get numerous e-mails about the potential of "The Bakken Fields which are located in the Williston Basin of Montana and the Dakotas. The area is reported to contain 500 billion barrels of light sweet crude which has only become available due to improved drilling technology. Of course, much of this is probably hype but drilling activity has picked up considerably. Certainly, there are other areas in the Rocky Mountains and Denver will probably regain some of its reputation as an energy hub. These are high paying jobs and will probably insulate us from some of the ill effects of the slow down in other sectors.

Headed To Colorado For a Month. As I said before, I am driving towards Denver day after tomorrow. I will be available for client meetings so any of you who need to schedule a meeting can call our office and leave your contact information. Of course, you can also send an e-mail; however, I am not as tied to the computer while on the road as I am at other times. You can also leave some contact information in the event that I run out of money and can't afford the gas to get all the way home. Your help would be appreciated.

IN TROUBLE WITH YOUR MORTGAGE?

A Lot of People Over-Extended Themselves. I could lecture those who got themselves in trouble by taking out mortgages they really couldn't afford. Certainly there is plenty of blame to go around. If you are one of those in a position to lose your home because of a bad mortgage decision, what you really need is a strategy to deal with the problem today not a critique of what you did in the past. Here are some strategies that may help some of you.

1. Take Responsibility. There is a lot of talk about predatory lenders but, in most cases the bulk of the responsibility lies with the borrower. Borrowers who blame others for their problem tend to expect others to solve them. In some cases this may work but, in most cases, you will have to take charge of your own situation.

2. Look For Someone To Negotiate With. Your lender will not benefit by taking your home but there is no benefit in letting you live there free either. Your problem is one of finding someone within the lender's organization who is empowered to negotiate on the lenders' behalf. Often the lender that you make your payments to has sold your loan and is only a servicing agent with little motivation to negotiate a solution. Patience and persistence will be necessary in order to find someone to discuss the matter with.

3. Find an Advocate. There are real estate agents who specialize in liquidating properties for lenders. These often have contacts within the lenders' organization. If you have decided to sell your property to get out from under a bad situation keep interviewing agents until you find one who knows his or her way around the system. One potential strategy is to negotiate a short sale, that is one where the lender accepts less than the full mortgage balance in order to facilitate the sale of the property.

4. Beware of Simple Solutions. Once news of a potential foreclosure gets out, you are likely to be inundated by those who claim to have a solution to your problem. Many of these are attempting to buy your property at a below-market price. While it may be in your best interest to leave a considerable amount of money on the table in order to break free of a bad situation, you need to do all you can to preserve as much of your equity as possible.

5. Know Your Property Value. You can use the internet to get a handle on the value of your property. Public records are now readily available in most areas and sites like Zillow.com can help you find out what similar properties in your area are going for. If your home is worth considerably more than the mortgage amount, you should be able to find a solution to your situation.

6. Start Early. Many of those I try to help come to me after it is to late to solve the problem. If you have two or three weeks to work something out, your options will limited to those strategies that can be executed in a relatively short period of time. Start early, be persistent and patient and your odds of success will be greatly improved.

Its been a Busy Two Weeks Since My Last Post. I have been to Denver and back to Texas since my last post. Much of my effort has been directed towards closing out a long-term real estate investment and putting the finishing touches in settling a family estate. I'm sorry that my communication with many of you has been limited. I hope to get back to Denver at the end of the month, at which time I will be able to devote more interest to my clients. In the meantime, I would like to assure all of you that I remain in tune with the real estate and financial markets. The recent rebound in the stock market has been a surprise. We aren't totally convinced that these improvements will last. High food and energy prices and the credit crunch are still a problem and may mean further trouble for the markets down the road.

WATCHING REAL ESTATE CYCLES.

Why is Real Estate Cyclical? Just about everyone knows that real estate prices cycle from high to lows depending on market conditions. As markets improve more and more investors, builders, and flippers want to get into the market. Rising prices and higher profits result in higher demand until prices strain affordability to the breaking point. When that happens prices level out or drop until speculators decide that opportunities are limited. Prices then level out or even drop. We watch several statistics to get an idea of the risk level in a given market. One very important factor is the number of building permits being issued. In one of our previous posts we showed that the number of single-family building permits decreased by 34% from 2006 to 2007. Condo/townhome permits decreased by 8.3% over this same period.

Is This Trend Continuing? Looking at January 2008 compared to January 2007 certainly leads to that conclusion. Last January there were 344 single-family permits issued compared to 548 the previous year. Looking at condo/townhomes, we saw only 88 new permits this year compared to 614 last year. This represents a decrease of 85.7%. Of the 88 permits issued 58 or 66% came from Denver and Jefferson County. Arvada, Aurora, and Arapahoe County reported no new permits.

Its Not Yet a "No Brainer." Markets may drop even further and there is no guarantee of success; however, each month has brought us some new encouragement. Stay tuned for the next chapter.

Cash flow Is Improving. Vacancy rates in rental units is dropping slowly and rental rates are starting to rise. One investor I know who has 40 years experience in the business is beginning to acquire units to rent out and hold for up to three years, at which time he believes the market will rebound and he can sell those units at a profit. Not a bad strategy for patient investors. Generally, the best buyer for these investments will be nearing peak earning years with ample income from other sources.

LOOKING FOR NEW ENERGY SOURCES

Why Don't We Just............. You fill in the blank. This statement is usually followed up by suggesting some alternative energy source like bio diesel, ethanol, hydrogen, solar, oil shale, etc. I don't want to burst any one's bubble when I tell you that it ain't gonna happen folks. At least, not in a hurry. So-called experts used to tell us that alternative energy sources would be practical when oil was 60 dollars a barrel or higher. With oil at almost $110 a barrel, you would think companies would be scrambling to bring new sources to the market. You can always bring the old paranoia back and say that the oil companies are protecting their vast wealth by destroying any attempts by entrepreneurs to develop alternative energy sources. Let me assure you that these companies are just as eager as you are to develop alternative energy. If they don't, their future is limited by a finite pool of fossil fuels waiting to be found. Many of these companies are using their profits to buy back their shares rather than search for new reserves because of the high cost of finding and developing those reserves. Here is the most important point you need to remember about alternative energy sources: It Takes Energy To Make Energy. What does that statement mean? Using ethanol from corn as an example, you have to use fossil fuels to cultivate the soil, fertilize, water, and harvest the crop. Then you have to convert the corn to ethanol and distill the ethanol to the desired purity. At the end of this process you have a fuel that you can use for energy; however, you get very little more energy out than you used to manufacture the ethanol. This example holds true for a number of alternative sources. Using current technology, by the time you consume the fossil fuel it takes to produce these alternative sources, you might as well have burned the fossil fuel for energy in the first place.

Are We Doomed? I don't want to imply that we can never have alternative energy sources, only that we have to use fossil fuels until we develop the technology to make these sources economically feasible. Of course we can conserve by limiting our consumption which means driving less, lowering thermostats in the winter, buying more fuel efficient cars, etc. This can help a lot in the short run but it only buys time. We need to obtain more domestic fossil fuels to use in the transition period between now and the availability of alternative sources. We need to utilize more of one alternative source that is currently available and that is nuclear energy.

I Am An Environmentalist. I love this planet and I believe we need to limit those things that do harm to it. I differ from the majority of those who call themselves environmentalists in that I realize we have to be practical. It is insufficient to just call our attention to the problems, we have to find solutions. Don't just tell me that the planet is growing warmer, tell me a practical, economically feasible way to prevent it. Don't tell me that we can't develop known fossil fuel reserves in the US, tell me how to find the energy we need without enriching the treasuries of those countries dedicated to bringing us down.

On a More Positive Note. I don't know how many of my fellow Colorado residents have heard about the purchase of the Louisville Storage Tech site by Conoco-Phillips. They propose to develop a huge research facility dedicated to energy research. They will be looking for alternative energy sources and more efficient ways to utilize fossil fuels in the interim. This could be very positive for the Colorado as well as the national economy. These are the kinds of steps we need to take.

How Important is All This? A recent poll shows that more people want to solve these energy problems than want a cure for cancer. While this may sound appalling to those of us who have lost loved ones to cancer, it shows how important this issue is to Americans. I will strive to discuss this issue more in the future and relate it the management of our current finances.

SOME INVESTMENT PRINCIPLES

What Principles Govern My Investment Policies? I've never claimed to be a guru when it comes to investments and I have often said that there is no one approach that works all the time for everyone. Still, I have several principles which strongly influence the decisions I make. Here are some of them.

1. Cash Is Not King. Never has been. The real king can be seen in the title to this blog: Cash flow. I'm sure none of my regular readers will be surprised to hear this. You can generate cash flow from a stock portfolio in several ways but the main two are dividends and capital gains. Of the two, dividends are the most reliable; however, it depends on your station in life. If you need the cash flow to sustain your lifestyle, dividends are definitely preferred; however, if you are younger, with ample income to support your needs and a long time frame before you need the cash flow, you can depend more on capital gains. A friend of mine once said, "You can't eat growth."

2. You Can't Time the Market. Over the years, I've met advisors who use several different methods to get you in the market or out at appropriate times. Few, if any, are still around today. While there may be some who are successful at this, I have never met anyone who can deliver consistent results. Anyone who left the market last September and stayed out until the present is sitting on a bunch of cash they can use to re-invest. If you will look at my posts from last summer, you can see that I had some fears about the stability of the market. Still, I didn't have enough confidence to go totally out of the market.

3. You Cannot Not Forecast. I am reminded of Thomas Dewey who once forecast that he would be voted president of the United States. Before he went to bed on the night of the election he told his wife, "Tomorrow night you'll be sleeping with the president of the United States". The next morning, he and his wife heard the news and his wife asked, "Tom, will I be going to Washington or will Mr. Truman be coming here." (I must give credit to my friend Steve Goodier of lifesupport.com for that story). Even if you have no intrinsic forecast in mind, every financial decision you make involves a forecast. For example, if you choose a lower interest rate adjustable mortgage over a 30 year fixed rate, you have forecast that interest rates are unlikely to go though the roof and the current lower payment will be less than with a fixed rate for some time. I would encourage everyone who doesn't have a set of assumptions about what you think will happen in the future, to write some down. These should have an influence over your current decisions and you should always ask yourself if a decision you are making is consistent with your assumptions. You might be surprised at how often they are not.

4, Price is What You Pay, Value is What You Get. The Motley Fool website gets credit for that little slogan. What it really means is that the market may "misunderestimate" the value of a stock. A stock may drop for a number of reasons, not all of which are indicative of the fundamental value of the underlying business. An example in recent times is the large drop in the price of all oil service sector stocks right after Slumberger reported disappointing earnings. Stocks in a given sector often advance or decline based on some event that influences the price of an industry leader. While this isn't always irrelevant, it often is.

5. Watch The Business Not The Stock. I have mentioned before that you are buying into a business any time you buy a stock. Instead of becoming enthralled with the fluctuations in the market price of the stock, watch the business fundamentals and management action. Base your buy/sell decisions on these rather than price changes.

6. Patience Is Genius. It's OK to bail out of a stock if you change your mind about the prospects of an investment but if the company you buy is still fundamentally sound, have patience even if the price drops. I have been advised by a close friend to use "stop losses." which are automatic sell orders if a stock drops to a certain price. Granted, these can be invaluable when a stock drops before the news about the fundamentals come out but I have found it preferable to base my decisions on fundamentals not price. In the late 90's I bought real estate investment trusts, even though the rest of the market thought they were less valuable than the high tech stocks that were all the rage. I chose to stay with them and buy more, a strategy which allows me to work on my own schedule now rather than being chained to my office every day.

These Are Trying Times. High home foreclosures, volatile stock prices, falling home values, and inflation worries are rampant. I know astute investors who have made the decision to get out of the market entirely. My approach is as it has always been. Stay informed and act accordingly.

EXCESS CONSUMPTION

I Try To Stay Away From Sugar. That's because I have diabetes. Fortunately, they make everything from Hershey's chocolate to Jello Pudding without sugar. Sometimes they use a substance called "sugar alcohols" which are chemically altered sugars that have a sweetening effect without causing an increase in blood sugar. If you read the label carefully, you will see a warning that says: "Excess Consumption may have a laxative effect. As one who has experienced excess consumption of sugar alcohols, I am here to tell you not to ignore that warning.

We Can Extend That Warning To The Economy. A natural consequence of excess consumption causes considerable discomfort in our economy. That's why the Fed and JP Morgan had to bail out Bear Stearns. The Bear got in trouble because they were stuck in the sub-prime mire. The sub-prime fiasco was started to allow borrowers with no down payment and marginal income to buy houses they couldn't really afford (excess consumption). During the past five years, virtually anyone who could fog a mirror could buy a house. Lenders who originally made sub-prime mortgages cashed in big time. Because few lenders offered these loans, they had little competition and could charge high enough interest rates to offset the projected higher delinquency rates. Because of property appreciation and a high demand for housing, the projected high delinquency rate didn't happen. Because of the high profit margins, more and more lenders got into the business and competition forced lenders to lower their rates and relax their qualification standards. The Fed didn't help when they lowered the fed funds rate to 1%. The yield on savings accounts went through the floor and investors had to utilize a more speculative approach to get higher investment returns. We are now experiencing the "laxative effect" that the labels on sugar free foods warn us of.

So Now What Do We Do? The Fed is trying. They even took time yesterday (Sunday) to lower the fed funds rate by a quarter per cent. Another cut is expected on Tuesday. This is the same practice that caused the present fiasco, only now some other unintended consequences are taking place. The dollar has lost much of its value. In Europe, oil prices are up over 100% as opposed to 200% in the US. This is because of the weak dollar. I may sound like the people I complain about, those who love to point out problems but have few solutions to offer. Here are some of the more obvious measures you can take.

1. Raise cash. I don't mean to imply that you should sell everything and go to cash; however, instead of re-investing your interest and dividend payments, leave them in cash. This will allow you to withdraw money for emergencies without having to sell assets into the current soft market.

2. Avoid excess consumption. Don't use credit cards if you can't pay the balance monthly. Don't borrow on your home to buy depreciating assets (cars, furniture, etc). Before making a major purchase ask yourself if you really need it and make sure you can afford it. If you aren't willing to pay cash or write a check, you probably are better off foregoing the purchase.

3. Diversify. Don't put all your money into any asset class. While I recommend emphasizing certain market sectors to fit what you want to accomplish, don't overdo it, especially in this volatile market.

4. Don't quit your day job. Unless you are absolutely certain you will have adequate cash flow to replace your employment income, don't quit working just yet. If you've already retired, look for new employment, at least part time. This income can help you weather some tough times and may even be better for your mental health than a life of leisure.

Reflections on Turning 70. I guess I am now one of the "elderly" but I am not retired. I still have clients and I still manage money and consult for my former company, "Westmont." Frankly, I am as retired as I want to be. I am reminded of the 103 year old skycap at the Beaumont airport who considered himself extremely fortunate to have such a fine job at his age. He called in sick on a Friday and passed away the following Monday. A much better fate than being "warehoused" in a nursing home waiting for death to set you free.

POLITICS AND YOUR PORTFOLIO

Your Check Will Soon Be In the Mail. Hey! Let's send everyone six hundred dollars. That will solve our economic problems. It's doubtful that many investors believe that. If the stimulus package is an example of how the government is going to solve our problems, I prefer the problems. In my last post, I was critical of those who believe the declining value of our homes and our 401k plans is more important than international conflicts. One of my readers reminded me that a lot of folks are in "survival mode" and are so worried about their financial situation, they have little energy left to worry about anything else. I can understand that. I've been there. In reality, it is difficult to separate what's going on in the political arena from what's taking place in the financial markets. The government has little power to control the markets and their attempts to try have consequences that are often different from those intended.

We've Been On A Binge. In an attempt to encourage home ownership and full employment, as well as mitigate the economic consequences of 9/11, the FED lowered interest rates to unrealistic levels. Investors seeking high yields bought sub-prime mortgages. This allowed borrowers, who could barely afford to pay rent, to buy homes they couldn't possibly afford long-term. Buyers who needed a 1500 square foot home bought 3000 square feet with adjustable mortgages and low initial interest rates. The party is over but no one wants to go home. How can we prolong the party? Sending everyone 600 dollars that we borrow from China will only add a few hours and we will still have to go home and sober up. Allowing congress to change the terms of existing mortgages might save a few homeowners from the horror of foreclosure but it will also discourage lenders from making new loans without higher profits. The bottom line is that we will have to solve our own problems and not depend on the government for solutions. Betty and I will donate our $1,200 to Wounded Warriors and pledge to make sure we live within our means. We will continue to practice prudent investment strategies that emphasize cash flow over capital appreciation. We will keep an eye on the markets and government policies in an effort to preserve capital and obtain a reasonable rate of return.

It's A Cold, Clear Day In East Texas. Looking out my window I see Azaleas blooming, green grass, and Magnolia trees with glossy green leaves. I am indeed fortunate to have survived 70 years on this beautiful planet. I know I can't predict what tomorrow will bring but I am extremely thankful for this day.

MAKE LOVE NOT WAR.

Hell No...We Won't Go. War is not healthy for children and other living things. What would happen if they gave a war and nobody came? Remember those statements? I sure do. They were part of a fierce anti-war campaign brought forth during the Viet Nam era, almost 40 years ago. These protests were certainly a major factor in our decision to abandon the war effort. Almost 10 years of effort, 50,000 American lives wasted, and hundreds of thousands of Asians were down the drain after we left. We didn't lose the war because of our military, we lost it because the folks at home lost the will to fight. Should we have been in that war? Two democratic and one republican president thought it was worth trying to win. They had huge brain trusts of military and diplomatic advisors who thought so. Looking back, I can't imagine why so many thought they knew more than the commanders in chief and their legions of advisors.

How Does This Relate To The Current Conflict? One similarity stands out. We have more than a hundred thousand of our young people with their lives on the line while the rest of us go about our daily business. In the Viet Nam era, the "sex, drugs, and rock and roll" crowd marched the streets, attended events like Woodstock, and smoked dope on the streets of San Francisco while our troops were sleeping in the mud and rain if they were lucky enough to survive the day. What are we doing while our soldiers are being killed and maimed? The vast majority of us are more more worried about the value of our homes and our 401k accounts than we are about our kids. Don't take my word for this. Look at all the polls taken during this primary season. They show that the economy is by far the main concern of the voters.

Should We Have Gone To War In The First Place? My position is that I don't consider myself qualified to out-guess those who began this venture. They had access to far more information than I. Most everyone blames President Bush. How can we possibly believe he made this decision by himself? Prior to the invasion, I heard politicians from both parties proclaiming the danger from weapons of mass destruction that were proven to be present in Iraq at one time. Most of those politicians conveniently forgot these statements and place all the blame on Bush.

What Should We Do Now? It's too late to dwell on the question of whether or not we should be in Iraq. The real question is whether or not we should beat a hasty retreat. I tend to think that would be the worst strategy. We can ill afford to leave that area to those who who want destroy us. I'm tired of those who complain about what is going on without offering a solution. Want to close down Gitmo? What do we do with those who are detained? Don't tell me we shouldn't have established the facility in the first place. It's too late to change what has occurred. I could support any solution that made sense.

One Serious Question Is Whether Or Not You Will Read This. I have tried to stay away from politics on this blog and I am tempted to erase this entire post before anyone gets a chance to see it. I know much of what I have said sounds partisan but the main point is that we need to make this conflict our main concern and we need to work together to find an honorable solution.

MANAGING YOUR RISK

What Can We Do To Lower Our Risk? Just when you think your portfolio is coming back, we have a day like yesterday when the Dow Jones average lost more than 300 points. Retail stocks, financial stocks, and even energy stocks were hit hard. The sub-prime mortgage debacle and lousy housing markets are spilling over into a number of other sectors. Oil at $100 a barrel has resulted in consumers spending much of their discretionary money on gasoline to get to work and the grocery store. None of this adds up to a favorable economic environment. As I have said before, much of this correction is a healthy payback for the excesses of the previous 5 years when people bought bigger houses than they need and borrowed on their home equity to finance purchases they didn't really have to make. Stocks and real estate have dropped because they were driven to unrealistic levels by easy money. Everything became over-priced and now a correction is necessary. All this is an attempt to explain that which really can't be explained. The real question is in the first sentence of this paragraph. What is an investor to do? Here are some suggestions.



Get Out of The Markets. This is what happened in the late 70's and early 80's. (See my last month's post entitled, Turn Around and Run Like Hell). To a certain extent this worked in the 70's and 80's because people were able to get 8-12% on insured bank CD's. The trouble was that they saw these rates drop to 2-3% over the years that followed as inflationary excesses were wrung out of the economy. With rates already down to 3-4%, it is difficult to settle for returns that low. Despite my encouragement to stay with the markets, I have reduced my and many of my clients exposure to the markets by increasing cash reserves. A radical change to 100% cash is nothing I would recommend, so here is another approach.



Stop Worrying. Suppose you bought 1000 shares of 3M in August of 2007 at the high for that month of $91,000. Six months later the "value" of your investment is $78,000. That's a loss of $13,000. Or is it? What you bought was a share of an operating business. The market thought that business was worth $91 per share. A scant six months later, the market thought that business was worth $78 per share. Has the business really changed that much? Not to my way of thinking. Worrying about daily market fluctuations is like planting carrots and pulling them up every day to see if there are carrots forming yet. My philosophy is to buy great businesses like 3M and stay with them unless the fundamentals of the business change. The market is a manic-depressive. Don't let it make you one. There is another criteria I use .


Look For Cash Flow. I bet you knew this was coming. Using 3M as an example, in August of 2007 3M was paying a $480 quarterly dividend. Not a huge yield, but its close to what you would get in a bank. In addition, your tax rate is only 15%, less than half of what a high income investor would pay on a CD. Recently, 3M raised this payout to $500 per quarter. They have raised this dividend each year for several years (in 2003, the payout was $330 per quarter). Statistically, dividend paying stocks have been proven to be less risky than those who don't pay dividends. Using Dow Jones statistics, their are three times as many dividend paying stocks in the below average risk category than non-dividend paying stocks. Even if you earn more than enough money to fund your living expenses, the lower risk category of dividend stocks make them a must for virtually any portfolio.

I Spend Several Hours Each Day Studying The Markets. If you are one of my clients, remember I do it so you don't have to. That doesn't mean I encourage you to stick your head in the sand. If it is as much fun for you as it is for me, by all means do it. If not, spend your time doing things you enjoy. The main thing is not to spend it worrying.