January 19, 2013 You Say You Want a Revolution

Risk/Reward Vol. 153

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

"Old school, when I ride, forever sky high
Workin' wood wheel with the sun outside
I'm just rotating my tires, rotating my tires."---lyrics from "Rotation" by Big Krit

"You say you want a revolution/Well, you know
We all want to change the world
You tell me that it's evolution/Well you know"---lyrics from "Revolution" by the Beatles

"Drilling for oil/Mining for gold
Looking for a love/That never gets old"---lyrics from "Oil and Gold" by Sophie Madelaine

Even though the debt crisis still looms and there were no blockbuster earnings reports, the Dow Jones Industrial Average closed up 172 points for the week, is up 4% year to date and is at its highest point since December, 2007. How can that be? Some savants suggest that we are in the early stages of a Great "Rotation": out of fixed income (read, Treasury securities) and into equities. Indeed, during the first full trading week of 2013, more money was invested in stock mutual funds than at any time since 2008. Remember those "old school" days when the "sun" shone brightly on the stock market? Those days may be returning. With the cost of Treasury securites (and the instruments priced in relation thereto such as certificates of deposit and corporate bonds) "sky high" and everyone "tired" of their low returns, maybe "rotating" really has begun. If so, that is good news for the stock market. More money chasing the same amount of stock means higher prices. I, for one, am heavily weighted toward equities anyway, and I shorted Treasuries (TBT) just in case the market is actually "rotating its tires".

Do you ever stop to marvel at the energy "revolution" that we are currently enjoying? Fracking in the United States is literally "changing the world" at a "revolutionary" not "evolutionary" pace. Here are some statistics. BP estimates that the United States will be 99% energy independent by 2030. In 2008, The United States produced 6.9 million bbls/day of oil; in 2012, 8 million bbls/day; and by 2020 we will produce over 11 million bbls/day, making us the largest oil producing country in the world. Natural gas costs 1/3rd what it did in 2008. The cost of feedstock is so low, world wide petrochemical production is moving back to the United States. Why here, you ask? Clearly, the combination of bountiful resources, flexible capital markets and excellent infrastructure contributes. But the main reason is often overlooked. In the United States, surface land holders own the subsurface minerals--- including oil. Virtually everywhere else in the world, subsurface mineral rights are owned by the state. So, when an oil company approaches a rancher in North Dakota about siting an ugly oil rig on his property, the rancher does not hesitate to assent, knowing that a gusher will make him a multimillionaire a la Jed Clampett. What incentive does a farmer in Poland, France or Germany have to grant drilling rights when all of the proceeds from any oil or gas discovery will go to the state? Nothing drives progress like the prospect of personal profit---pure and simple.

So how have I invested in the domestic oil and gas revolution? The easiest and surest way to "mine for gold" is pipelines. Pipelines are like toll roads. The more the oil and gas flows, the more the revenue; and that formula "never gets old.". I like AMLP, an exchange traded fund that holds shares in all of the major pipeline master limited partnerships and that pays a 6% dividend.. For tax reasons, AMLP may not be suitable for retirement accounts so you may wish to investigate JMF, a closed end fund which likely is suitable for such accounts. (WARNING: check with your own tax advisor!) My favorite domestic oil exploration and production (E&P) company (the one "drilling for oil") is Linn Energy (symbol LINE as a partnership; symbol LINCO as a corporation suitable for retirement account investing). Linn's production is 50% natural gas and 50% oil. It hedges both to ensure a steady 7.5+% dividend at its current price. I gain exposure to other domestic E&P companies via NDP, a closed end fund which owns stock in every major player and which enhances its return through leverage and call option writing. On the refinery side, one "looking for love" need not look beyond Indianapolis favorite, Calumet Specialty Refining (CLMT), controlled by NCHS Class of '69 grad Fred Fehsenfeld and its nearly 8% dividend. I am not currently invested directly in fertilizer or chemical companies, but they too should prosper in a world of plentiful and cheap natural gas.

Next week, earnings reports from tech stocks dominate. Expectations are low so let's hope for a surprise to the upside. Nothing would "please, please me, whoa yeah" more than that.