The Insightful Trader

Stephen Leeb’s Book “Game Over” Could Help You Survive Tough Times

by on May.24, 2009, under Editorials

  The world economy is in longterm trouble because we are running out of oil as well as other key commodities, says longtime investment newsletter writer Stephen Leeb. Moreover, there is no easy fix, he says, because most of the proposed approaches to renewable energy, also depend on scarce minerals — and on water, the most vital commodity of all. Therefore it may be harder than some people think, to build enough windmills, solar panels, or nuclear plants to replace the fossil energy we now use while maintaining our standard of living, he says. America’s best response would be a careful study to map out the most feasible combination of solutions, probably in consultation with other countries. Otherwise if we try one solution, other countries may do something that makes our approach impossible.

   Meanwhile, Leeb says, the individual investor would be wise to concentrate on precious metals and commodity based stocks (he does name names). Essentially Leeb seems to believe: now that billions of Asians have joined the world’s capitalist economy, manufacturers compete fiercely. Therefore manufacturers’ profit margins get squeezed, and scarce natural resources are the thing to own. On this we could not agree more.

    The book is strongest where it explains just how hard it will be to adapt to the end of the Oil Age. For instance, he quotes Caltech scientist Mark Jacobson’s estimate that the US could take care of the bulk of its energy needs with 700,000 windmills. However, Leeb asks, where on earth would we get the steel to build them? Interested readers will remember that iron ore prices skyrocketed along with oil during last year’s commodity price boom.

    Similarly, because it is expensive to refine silicon so that it can be used in solar panels, First Solar (FSLR) has captured the imagination of many investors. FSLR uses thin film instead of silicon, and thin film’s active ingredient is cadmium telluride. This compound is cheaper than to make than refined pure silicon, at least in small amounts. Again the problem comes when trying to scale up production. Chemists classify tellurium as a “rare earth” element and while the earth might contain enough of it for our current uses, Mr. Leeb thinks that tellurium supplies could become run short if we began relying heavily on FSLR’s technology.

    One more example should drive the author’s point home. Leeb notes that Australia has decided against building any new nuclear power plants. Have the Crocodile Dundees gone soft? Far from it. Drought prone Australia simply doesn’t have the water needed for the big cooling towers that nuclear plants employ to diffuse their huge outputs of waste heat. Normally nuclear plants are built near a large water supply, but Australia needs every drop of water it can get for drinking and agriculture. 

     Leeb also thinks defense stocks will continue to do well,  because America will need to police unstable regions of the world that produce commodities. We are less sure of his argument here. We don’t think the US can afford the kind of military it has over the long term, and are reminded of how Russia had to retrench defense spending after its economic crisis in 1998. But if fiscal and trade deficits precipitate a dollar crisis as Leeb predicts, we think  the Pentagon will come in for budget cuts.

    The military uses about 40% of all stated federal expenditures as detailed in the annual budget, but in fact, the military spends about twice the budget’s stated dollar figure. To fully measure defense spending  we must also account for the “supplemental” appropriations that fund the wars in Iraq and Afghanistan, plus the “black” portions of defense expenditures that are not fully disclosed, as longtime defense analyst and China expert Chalmers Johnson points out here.

    We also disagree with the way Leeb dismisses energy efficiency as merely “buying time.”  We understand that if you drive a gasoline powered car that gets 40 mpg instead of 20 you will still be out of luck when the price of oil soars even higher than it did in 2008 –or if as Leeb predicts, the government eventually rations or even bans the sale of gasoline for use in private automobiles. Yet, if you agree with Leeb about the difficulty of developing renewable energy on a large enough scale, you want to use less energy for everything you do. In Leeb’s scenario, you would want an electric car that would need less solar electricity to stay charged, a car that would also need fewer batteries that contain exotic minerals. In other words, you want a car that weighs less than a thousand pounds and has a low drag coefficient, according to physicist and McArthur “genius award” recipient Amory Lovins. That way your car will get where it is going with less energy, no matter what kind of energy you use. When he began developing his prototype efficient “hypercar,” Lovins started by asking a question that ought to have been obvious to everyone else:  how can we change a situation where we burn up the gasoline needed to transport 4,000 pounds of car — and a 150 pound person?
   Energy efficiency provides even more dramatic gains in well insulated buildings. In a housing project in Darmstadt, Germany (not exactly a warm weather city) the buildings are so well insulated, they stay warm throughout the winter without any furnace whatsoever; the sun, body heat, and appliances do the trick. It’s true, these homes have less area per person than many Americans would prefer, but, we think we have proved our point: energy efficiency is going to count big time in the future no matter how we chose to produce energy.
   We think Leeb gets back on target when he talks about economic growth and inflation.  Leeb’s longterm scenario for the economy is that it veers from commodities driven inflation, to steep recession and back. In his view high commodity prices tax the economy and slow down growth. Commodity prices crash along with the economy. But then mineral exploration projects get put on hold, and so when the economy turns up, commodity prices soar even higher than they did during the previous recovery, because such projects have a long lead time to restart and so we are caught short of supply once more. That prediction seems to be dead on; many oil companies are cutting back exploration and production expenditures in response to oil price decreases, at least for now. It’s hard to know just how prescient Leeb was regarding the current economic meltdown: the book was due to come out in late 2008, and then he admits to updating it on a crash basis after Lehman Brothers (LEH) collapsed. On the other hand Leeb seems to have held fairly accurate views for some time, having penned books such as  The Oil Factor and The Coming Economic Collapse.

    Now for Leeb’s key stock picks (we didn’t quite include all of them), which are about what you would expect given the arguments he makes. He made these picks based on company quality and sector strategy given his economic scenario; he obviously did not know what the stock prices and valuations would be when the book actually reached stores.

    He notes that both in periods of extreme inflation, or in deflation, gold has tended to do well, and so he thinks that gold will be important for all investors. He recommends Street Tracks Gold Trust (GLD) as the easy way hold bullion. For gold miners, he notes that investors can choose GDX as an ETF to get general exposure to the sector, one could also use Fidelity’s Select Gold Fund (FSGAX) or the Tocqueville Gold Fund (TGLDX) if you want exposure to the smaller speculative picks that can also do well if gold soars as high as he expects . Among individual gold miners he picks American Barrick (ABX) as the conservative choice, along with Agnico-Eagle (AEM) and Kinross Gold (KGC). The latter two are mid size producers with properties that can expand their output in the future, but as Leeb notes, Kinross does have political risk since many of its projects are in Russia. For silver he suggests SLV, the silver bullion ETF, and industry leader Pan American Silver (PAAS).   On the energy side he eschews the oil majors, because they are no longer able to increase production. Instead he goes for oil drillers such as industry leader Schlumberger (SLB) as well as Baker Hughes (BHI),  Halliburton (HAL), National Oilwell Varco (NOV) and Transocean (RIG). Their technology will be in demand, he thinks, as the majors and some of OPEC’s national oil companies scramble to replace or work over existing  oil fields.  He aslo likes Canadian Oil Sands Trust (COSWF) for its long lived reserves and uranium producer Cameco (CCJ)In a like vein, he likes Fluor (FLR), the engineering and construction firm, because they help build energy installations.  His all round defensive stock is Berkshire Hathaway (BRK/B) not only because of Warren Buffett’s record but also because of its strong re-insurance franchise. He notes that consumer staples stocks, which are normally thought of as “defensive” did badly during the inflationary 1970s and advises investors to stay away from them. Water stocks he likes include French water infrastructure builder Veoila (VE) and ITT, which has a water engineering division along with its defense business. Finally, if you agree with Leeb about defense stocks, he likes Lockheed (LMT) and Raytheon (RTN).

  On the whole we think that in turbulent times like these investors should consider most of Leeb’s ideas carefully. As he points out, the conventional wisdom of putting something like  60% of your money in diversified stock funds and the balance in fixed income did not work out during the inflationary 1970s. We also think that (with the possible exception of defense) he is pointing out sectors that actually have a chance to preserve investors’ purchasing power in the years ahead, if bought at sensible valuations.

Disclosure: we own GLD in our personal accounts and look to buy AEM on pullbacks. We have no connection with Leeb or his newsletter and this article should not be construed as a recommendation for his products.

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2 comments for this entry:
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