Surging Energy and the Big Squeeze

While crude oil is rising, the energy stocks weve been recommending are surging.

There are several reasons for the moderate discrepancy:

First, many energy stocks dont rely exclusively on the price of crude oil for their profits. They also have a stake in natural gas, which is literally going ballistic.

Second, many of the companies weve recommended provide repair and maintenance services for the oil industry. And these services are in such intense demand right now that even a pretty sharp correction in oil prices would do little to slow down their meteoric profit growth.

Third, we cannot ignore the rising demand for the shares themselves.

For months, Wall Street gurus were naysaying this sector. They knew surging energy costs would be bad news for their favorite transportation stocks, retailers, and even tech companies. So the perma-bulls among them naturally rejected rising-oil forecasts and welcomed any falling-oil theories with open arms.

Now, in the wake of two hurricanes and the highest energy costs in history, Wall Street is finally waking up and starting to shift some big money into the energy sector.

The results are pretty dramatic:

The exchange-traded fund that Ive been tracking for you regularly in Money and Markets Oil Service HOLDRs (OIH) has just surged to new, all-time highs, but still has much more upside potential.

Last night, it reached 125.99, up nearly 1.5% on the day. For the week so far, its risen 3.70, or more than 3%. And looking ahead, even if it goes to 135, it will still be within the normal range for this move.

Recommendation: If you own the OIH or its component stocks, great. If not, buy on dips.

Ditto for Enerplus (ERF), which weve also been recommending for quite some time. Yesterday it was up a full point, ending its after-hours session at 46.45, up another 2% for the day. And just since May 16, its now up by over 40% not bad for a stock we told you to buy primarily for its high-dividend yield.

Remarkably, despite the dramatic rise in the stock, that yield is still holding firmly above 8%, or nearly triple what you could get in a money market. If youre living on income, that can be a wonderful improvement for you.

Dont get me wrong, though. Enerplus is not a place for all your savings. It is, after all, still a stock. And like any stock, it can go down in value. But since its a royalty trust, distributing nearly all of its revenues from energy royalties to unit holders, and since it has diversified interests, it tends to be significantly less volatile than most other energy stocks.

Stock options arent for your savings either. But for money you want to play with, they can fit in nicely. Reasons:

1. Even if youre wrong in your timing, in your picks or in both when you buy stock options, the most you can lose is the price you pay for them, plus any commissions your broker charges. So they can never have an adverse affect on your keep-safe funds.

2. Provided you keep most of your money in conservative investments, you can sleep nights with the knowledge that the absolute worst-case scenario is that youll lose all your play money.

3. Meanwhile, double- and triple-your-money returns in very short bursts of time are relatively common. Ten-for-one results are also not so rare. And right now, the stock options on companies like those in the OIH I just told you about have precisely that kind of potential.

4. If you own assets in your portfolio or your business that can be adversely impacted by rising energy costs, then investments like options, designed to go up sharply with each uptick in energy, can be used as a hedge or a kind of insurance policy. The goal: The more youre adversely impacted by the energy crisis, the more money you make in your hedge, helping to offset the damage.

Thats one reason Larry launched his Energy Options Alert. But I dont think its the main reason most people have subscribed. Their primary goal is to make big profits, and they understand that its a speculation. (If youre interested, call 877-719-3477. He has only 208 slots left.)

Fannie Mae
Going Down

The other way to use options is to pick the sickest, ugliest, and most poorly-managed giants in America and play them on the downside.

Instead of call options, you use put options. And, instead of aiming to buy the stock at a below-market price, you aim to sell the stock at an above-market price.Lets say that on Tuesday, a stock is selling for $46.70. And lets say you buy a put option that gives you the right to sell it for $46. It makes no sense to exercise the option on Tuesday because you can get more for it just by selling it at the current market price.

But now lets assume that on Wednesday, the stock falls out of bed and plunges to $41.71. Now, if you exercise your option to sell it for $46, you can get a lot more than the market price $4.29 more. If you paid just a buck or two for the option, you could be sitting on three- or four-to-one profits after just one day.

Thats precisely what happened this week with a stock weve been warning our Safe Money Report readers about: Fannie Mae.

This is a company thats so big, with accounting thats so complex, no one has had a clue as to how much money theyre making or losing.

And now, this week, it got a lot more serious: We learned on Wednesday that, in addition to a foggy profit-and-loss statement, Fannie Mae also has a murky balance sheet. They seem to have no clue how much their assets are worth.

With Fannie Maes world mortgages and mortgage guarantees now in turmoil, this latest accounting mess couldnt have come at a worse time. As Mike Larson and I told you earlier this week, the housing boom is ending and the bust is beginning. That means Fannie Mae has lost its compass precisely when its facing its worst storm.

Our advice: If you own Fannie Mae stocks or bonds, get out now. Dump it all, at the market.

Yesterday, some Wall Street Polyannas tried to persuade investors that Fannie Maes situation isnt all that bad after all. And they managed to set off a sharp rally in the stock back to $44.80 by last nights close. The rally wasnt enough to recoup all of Wednesdays losses in the stock. But it is enough to give you a convenient exit window.

To stay up to date with our recommendations on Fannie Mae and a host of related companies, consider my Safe Money Report. Or, for extra profits and extra protection that only put options can provide, consider the service Mike and I write thats designed especially to profit from these kinds of disasters.

Also, pay close attention to how all of this is beginning to impact American consumers, Tonys topic today …

The Big Squeeze on
American Consumers
by Tony Sagami

The world may look pretty rosy behind the tinted glass of a limousine in Manhattan or a black sedan in the Beltway.

But elsewhere in America, average people are facing The Big Squeeze: The cost of putting food on the table, clothes on their backs, and a roof over their heads rising faster than their paychecks.

I live in Big Fork, Montana where we rarely see a limousine. And like Tim The Toolman Taylor, I love roaming the aisles of Home Depot, my favorite store. But now, every trip is getting so much more expensive, I dread the experience at the cash register.

The crux of the problem: Building materials going through the roof. A 4×8 sheet of oriented strand board engineered wood used to enclose a house was going for roughly $8 a sheet at the beginning of 2005. Those same sheets are now selling for around $15, nearly double in just nine months. Ditto for 2x4s, PVC pipe, and sheetrock.

Some of those price increases may be related to the two hurricanes. But most of it is just old-fashioned sticker shock and near-rampant inflation.

Sticker Shock #2:
Surging Gas Prices
Starting to Bite Hard

In addition to my investment business, my wife and I recently bought a convenience store, which sells gasoline. Its a pastime, but its also supposed to be good income.

I like it because it gives me the opportunity to witness, first hand, the drama thats unfolding in the far-from-Manhattan-and-Beltway America.

The first thing we noticed is how many people including those with spiffy-new, expensive cars are pressed for cash these days. Otherwise, why would they pull up to our store, fill up their tanks, and then drive away without paying us one red cent for the gas?

And were not the only ones suffering from the drive-away epidemic. Its happening all over the country.

Meanwhile, just like during the 1970s oil shock, thieves are siphoning gasoline from peoples cars. In response, many people here in Montana and across the country are buying gas caps you can lock. No wonder Pep Boys and AutoZone are reporting a sales boom in locking gas caps!

Gas has been so expensive that Americans are looking for cheaper forms of transportation, such as European-style scooters. Here in Montana, the owners at Scooterville said their sales are up by 50% over last year. But customers from as far away as Florida are calling. Why? Because scooter dealerships in bigger cities are already sold out.

All this was already happening before Hurricanes Katrina and Rita. Now its about to get a heck of a lot worse.

At our own store, Ive been keeping a log of my raw cost for a gallon of unleaded gas, the taxes and delivery fees I have to pay, plus my final cost.

Just ten days ago, on September 20, my raw cost was $2.39, my taxes and fees were 54 cents, and my final cost was $2.93.

Then, the day before yesterday, on 9/28, my raw cost jumped to $2.62; and my final cost, to $3.16.

My mark-up is only about 10 cents. So even if I cut my profit down to zero, wed still be over $3 per gallon. And even the if taxes were cut in half, the price of gas would still be roughly the same as it was just a couple of weeks ago.

It seems the only folks who think this is harmless to the economy are the limousine crowd. The rest of America knows better.

Coming Very Soon:
Sticker Shock #3

While the price of gas has been roaring loudly, the price of natural gas is quietly exploding. It has doubled in price just this year and, as Larry told you yesterday, it hit a new, all-time high this week.

Thats bad news for the 75% of U.S. homes that use natural gas as their primary heating fuel.

The National Energy Assistance Directors Association estimates that the cost of heating a home with natural gas is going to cost $1,568 this winter a whopping 64% increase from the $957 average it cost last year. And thats assuming no further price increases between now and spring.

In just a matter of weeks, millions of Americans are going to feel the double-whip of higher transportation and higher home heating costs. For many households, it could be the straw that breaks the camels back.

More Americans
Already Falling
Behind on Their Bills

Martin, Larry and I have been among the earliest of early birds in warning our readers about this. But now, the chickens are finally coming home to roost: The mountain of debt Americans have piled up like no tomorrow are now starting to become unmanageable.

According to the American Bankers Association, the number of Americans falling behind on their credit card bills is jumping. The percentage of credit card accounts that are overdue rose from 4.76% in Q1 to 4.81% in Q2. To put that in perspective, the average delinquency rate over the last two years was 4.38%.

Credit cards are usually the first piece of debt that people default on when times get tougher. But right now, the ABA is showing that defaults are going up across the board:

The default rate on home equity loans rose from 2.57% to 2.66%.
On auto loans, its up from 1.87% to 2.08%.
The default rate on the ABAs composite ratio, which tracks eight different types of installment loans, also jumped to 2.22%.

You can point your fingers at a lot of different reasons why more Americans are struggling with their loan payments: higher gas prices, rising interest rates, rising property taxes, higher food prices, and/or stagnant income growth. But regardless of the reason, the end result is the same:

Banks and other lenders are going to get slammed with bad-debt losses.
A lot of Americans are going to cut back. Theyll spend less on movies, eating out, shopping, and driving.

My response: You certainly wont find banks, retailers and restaurant stocks in my portfolio.

Best wishes,

Martin Weiss and
Tony Sagami

About MONEY AND MARKETS

MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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