Permanent Wealth Investor

September 2011 • Vol 3 Issue 9
105 West Monument Street • Baltimore, Maryland 21201
How to Lock In A 13% Yield Today
Why This Isn't A Repeat of 2008
Portfolio Review

Lock In This 13% Yield Before September 14th

Dear Reader,

Back in May, we finished a nice 18-month run on BlackRock Kelso Capital Corporation (Nasdaq:BKCC). We sold the shares when they hit our raised stop loss, locking in a 47% return.

Now it’s time to get back in…

The company has declared another dividend of 26 cents. The stock is 20% below where we sold it (and close to our buy price in November 2009). And it’s trading 19% below its net asset value.

The stock yields 13% now.

And the reasons we did well on it the last time are still true…

The company is controlled by the BlackRock investment management group, which manages funds of $3.346 billion. So there’s an additional assurance in being with a well-established company of such size.

BKCC buys both mezzanine debt and equity in middle-market companies. The BlackRock group’s size doubtless helps it in sourcing deals, which is an advantage.

I like this business because the banks are still not lending to small business, and private equity is finding it difficult to raise new money.

At a time when the banks have $1.8 trillion in free reserves doing nothing but sitting at the Fed, companies that are still prepared to invest in small business are not only performing a vital public service, they are also likely to achieve very nice returns. The business becomes particularly attractive for shareholders when management takes such a grown-up approach and pays out those nice returns in dividends, rather than keeping them within the company to engage in empire building. After all, there will come a time at which this becomes a less attractive business. And at that point, we’d rather have had the cash.

An additional attraction to buying BKCC is that we’re buying it for nearly 20% less than net asset value. I never like buying investment businesses – or even banks – for more than net asset value. That’s because you’re investing $100 to get the investment returns on $80. But here you’re paying $100 to get the investment returns on $124, which is nice.

We sold BKCC when it cut its quarterly dividend from 32 cents to 26 cents. But again, at today’s lower price, the 26-cent dividend still gives us a yield of 13%. And it’s sustainable…

In the second quarter, BKCC earned 35 cents per share and increased its net assets by 53 cents per share – both very encouraging figures after a number of poor quarters. So with its dividend currently well covered by earnings, BKCC is far from being a “Mangy Cur.” And it has a good chance of repeating its fine performance for us from 2009 to 2011… or beating it.

Action to Take: Buy BlackRock Kelso Capital Corporation (Nasdaq:BKCC) at market on or before September 14, and receive a $0.26 per share dividend. Use a 25% stop loss.

This Isn’t A Repeat of 2008

With the stock market falling sharply in the last couple of weeks, the U.S. debt rating being downgraded and banks in Europe getting a battering, commentators are making some extreme predictions. Focusing – as always – on the last crisis, they’re suggesting that the current malaise is a repeat of 2008, with a financial crisis, a 50% drop in the stock market and a lurch downwards into a major recession.

That does not look likely.

Focus first on the economy. Much has been made of the fact that Gross Domestic Product grew at only a 0.8% rate in the first half of the year, with weak June export figures suggesting that this feeble number may even be revised down. However, there is a guilty secret about GDP: It is a statistic invented by Keynesians to make “stimulus” spending look good. Government spending is included at cost, not its market value. So if the government spends an extra $1 billion on complete rubbish of no value, GDP still automatically increases by $1 billion. That’s why Keynesians will tell you that stimulus increases GDP; the statistic is fiddled to make it do so automatically.

If you want to examine the true state of the economy, it’s much better to examine Gross Private Product – GDP minus government spending (line 1 minus line 21 in the Bureau of Economic Analysis’ statistics, for those who want to try this at home). This gives a much better picture of the behavior of the private economy, where goods and services are sold in a willing-buyer/willing-seller exchange.

The good news is that in 2011, GPP is increasing by a much more robust 1.9% per annum than GDP’s measly 0.8% per annum. Government is shrinking in size (mostly because of state budget cutbacks). But the private sector is expanding to fill the gap at a decent rate, and is showing no signs of slowing. Thus the economic recovery seems likely to continue, with GDP remaining sluggish but GPP increasing steadily as government is cut back. It’s the reverse of the situation in 2008-09, when government was expanding and the private sector was being squeezed out.

As investors, it thus makes sense for us to retain an exposure to the U.S. economy and to believe that – over time – as government shrinks, the private sector will expand. That will bring higher profitability to our Alpha Bulldogs. While interest rates remain excessively low, the recovery will not be entirely healthy, since the unemployment rate will remain high. But at least growth is continuing and the economy is strengthening not weakening.

Ben Bernanke has now said that he will not change his very low interest rate policy until mid-2013 at the earliest. Events may force him to eat his words. But for the moment, interest rates will remain very low – far below the rate of inflation. That means inflation will accelerate and commodities and energy prices will continue to trend upward. We are well positioned for this trend, both in the portfolio and through the Play-Money Commodities Portfolio. And we will take advantage of it until it decisively reverses.

So let’s check in on our holdings…

Permanent Wealth Portfolio Review

B&G Foods (NYSE:BGS) is a branded food company with a broad portfolio of well-known brands that offer considerable recession resistance. CEO David Wenner expects the company’s margins to expand in 2011, on top of already nice earnings growth in 2010. BGS has paid us six 17-cent dividends and two 21-cent dividends on the common. Second-quarter earnings were again strong at 26 cents per share, up 36% from last year. To boost income – or get out at an excellent price, more than twice what we paid – we sold May $20 call options covering our BGS holding. It expired, giving us an extra 50 cents per share (which I have included in the Stage 3 investments return and not in the overall return on BGS). We have now repeated this procedure, selling August $20 calls, also for 50 cents per share, which are also likely to expire next Friday. HOLD

Aberdeen Chile Fund (NYSE:CH) is a closed-end investment fund investing in Chile, a well-run country with good property rights. The continued rise in commodities prices increases Chile’s growth potential and the potential for capital appreciation in the fund. In a world in which China and India have 2.5 billion people, an increasing number of whom are fully engaged in the world economy, natural resources look to me a better bet for development than cheap labor. So Chile is still my favorite emerging market. The last month has made global monetary policy even more expansionary, becoming still more so as inflation increases. That means the global commodities bubble should continue to inflate. (Chile itself has a modest inflation problem and a strong-minded central bank, so should do fine.) The Fund has paid us six dividends totaling $3.19 and has made a special cash election distribution of $1.6591.  BUY

Agree Realty Corporation (NYSE:ADC) is a real estate investment trust specializing in retail properties. It yields around 7.7% and has paid us four 51-cent dividends, and two of 40 cents.  Agree reported net income of 38 cents for the second quarter of 2011, but should continue to cover its reduced dividend fairly easily as the effect of the Borders bankruptcy wears off. In recent months, Agree announced the re-leasing of two of its five closed Borders stores, the acquisition of a store in Marietta, GA (leased to Advance Auto Parts), and another in Dallas (leased to National Tire and Battery). Thus the company continues to see new growth opportunities. What’s more, the retail environment is a lot better than 18 months ago, when we bought Agree. BUY

PennantPark Investment Corporation (Nasdaq: PNNT) invests in debt, preferred stock and equity of small to medium sized companies, with a somewhat greater focus than some competitors on equity rather than debt, which is attractive in an environment of gradually rising interest rates. Third-quarter earnings (our second quarter) showed net investment income of 29 cents per share plus an increase in net assets from operations of 5 cents per share. That means its quarterly dividend of 27 cents – giving it a yield of around 11% – is well covered. And its underlying net asset value is increasing. It has now paid us two dividends. BUY

The Mexico Fund (NYSE:MXF) has $354 million in net assets and has paid us two distributions totaling $1.584 per share. That gives it a yield of around 12% at the current share price (with two more dividends of $0.792 to follow in October and January). Mexico had a rough 2010 with the drug wars in various parts of its country, and has not prospered since the implementation of NAFTA in 1995. But its prospects are good. At an oil price of $100/ barrel, the inefficiencies in Mexico’s oil industry matter less than they did at lower prices, while the oil revenue gives the country some breathing room in its foreign exchange position. The Economist poll of forecasters has Mexico’s economy expanding by 4.2% in 2011 and 3.3% in 2012. While I regard CH as a good five-year holding (provided commodity prices don’t collapse), my time horizon on MXF is shorter, perhaps 18 months to two years. Still, I think it should do us fine over that period, as Mexico enjoys a bit of “catch-up” with the U.S. and with its other Latin neighbors with less responsible policies. BUY

MV Oil Trust (NYSE:MVO) has the rights to 80% on the net earnings of over 1,000 oil producing properties – 98% of them oil producing, the remaining 2% gas, primarily in Kansas and Colorado – until either 2026 or when the properties have pumped 14.4 million barrels of oil (giving MVO the receipts from 11.5 million barrels) whichever is later. So far, MVO has received royalties on about 3.5 million barrels, so there are 8 million to go; it is currently netting about 69% of the sale proceeds after 31% extraction and management expenses. MVO has paid us a dividend of $1.03 per share, up from 82 cents, and based on an average first-quarter oil price of $96.92 per barrel. If oil prices rise, as I expect, then both the dividends and the remaining value of MVO will rise in tandem. BUY

Solar Capital Ltd (Nasdaq:SLRC) is a mezzanine debt and equity company that has $989 million of investments in 35 companies with a mix of 28% senior debt, 64% subordinated debt and 8% equity. Based on trailing earnings, it is currently trading on a P/E ratio of 6.1. Its net investment income per share of 59 cents was just below its proposed dividend of 60 cents. But the 49-cent increase in net asset value in the first half of 2011 was a welcome plus. What’s more, with a quarterly dividend of 60 cents, it is currently yielding more than 10%, while its share price is 8% below its net asset value – an attractive rating in today’s market. It has paid us one 60-cent dividend. BUY

Seadrill Limited (NYSE:SDRL) is owned and managed from Oslo, Norway, but its legal headquarters are in the tax haven of Bermuda – meaning there are no withholding taxes on its dividends. It provides offshore drilling services in both shallow and deep water, and in both benign and harsh environments. It is one of the largest international operators, with 42 drilling rigs in operation and another 7 under construction. It reported first-quarter net income of $1.72 per share. It intends to pay dividends of at least 70 cents in the past quarter and the next three quarters, plus supplemental dividends of 5 cents per quarter. At current prices, the shares trade on a P/E ratio of about 7.2 times. And it has paid a dividend of 75 cents/share since we bought it. Seadrill has a policy of paying out most of its earnings in dividends; thus its dividends fluctuate sharply with the price of oil and more particularly with conditions in the drilling market. BUY

DHT Holdings Inc. (NYSE:DHT) operates a fleet of 12 double-hulled oil carriers, six of which are the largest VLCC type, two the Suezmax type (designed for the Suez Canal) and four the Aframax type (designed for smaller basins, such as the Black Sea and the Mediterranean). DHT pays a dividend of 10 cents per quarter, of which we have received one. Its earnings currently don’t cover the dividend, but its cash flow provides ample protection against a dividend cut. Moreover, all but one of its ships are on time charters expiring in 2012-2018, so it is well protected against the current weakness in the tanker market. Its current yield is more than 13% after the recent stock price drop, and it is selling for 24% below net asset value. BUY

Safe Bulkers (NYSE:SB) is in the business of bulk cargo shipping, which benefits especially from a global trade recovery concentrated in the area of commodities and other bulky goods that can be expected to have rapidly increasing demand from emerging markets. Its fleet consists of 15 Panamax-size bulk carriers (around 80,000 tons, capable of navigating the Panama Canal) and one 177,000-ton carrier newly delivered. It has eight additional bulk carriers on order with delivery dates through 2013. SB reported earnings per share of 27 cents for the second quarter and 68 cents for the half year, making its 15-cent quarterly dividend around twice times covered.  We bought SB on a day of sharply rising share prices. But even so, we got back in about 15% below the price at which we had sold it three months ago. With a yield of 9%, SB is a solid holding and may increase its dividend if market conditions improve. BUY

The “Stage 3” Investments

Our Stage 3 investments, designed to take advantage of market and economic moves, were stellar during the week the market dropped sharply – up 53% while the market was down 18%. They have dropped back a bit since, but remain as useful protection in case the market falls out of bed.

There are now five of these non-Alpha Bulldogs in the portfolio. Each one represents about 2.5% of our overall portfolio:

We own three tranches of S&P Put Options:

  • one dated December 2011 with a $600 strike price (CBOE:SPX 1117X600-E);
  • one dated December 2012 with a $600 strike price (CBOE:SPX1222X600-E); and
  • one dated December 2013 with a $700 strike price (CBOE: SPX1321X700-E). 

These are intended to hedge us against a big decline in the stock market below its March 2009 lows, which I regard as very possible. These did very well in the market downturn this month and offer further protection against a major market decline.

HOLD SPX 1117X600-E and SPL1222X600-E and BUY SPX1321X700-E at up to $25. At a cost of 2.5% of our portfolio per annum, this insurance is well worthwhile.

The fourth Stage 3 investment is a Chicago Mercantile Exchange $2,000 Gold call option due December 2011 (OG). You’ll find the prices of the December 2011 options at the CME website.

The call option allows us to buy at $2,000 a December 2011 gold future, representing 100 ounces of gold. We bought it at $27 for a total cost of $2,700. And its price declined almost to zero as December 2011 approached. But it has soared in the recent gold price surge. It now has very high leverage, because it’s short-dated and close to the money. At some point, we will have to take a bet on whether the gold price will get above $2,000 before December. HOLD

The last Stage 3 investment is a put option on the iShares Barclays 20-year+ Treasury Bond Index (NYSE:TLT) The purpose of this is to profit when interest rates rise from their very abnormally low levels. Our current investment is in the January 2013 options (the longest maturity available) with an $80 strike price (CBOE:TLT1319M80-E). Being based on the 20+ years index, this benefits from any yield rise at the long end. It has suffered badly with the recent decline in yields, but will benefit hugely from a crash in the Treasury bond market, which I expect at some point. BUY

The Play-Money Commodity Portfolio

In addition, we have four shares in our Play-Money Commodity Portfolio. For new members, this portfolio, which we bought in October 2009, is intended to allow us to take advantage of the current bubble in commodity prices. Since investing in a bubble is dangerous, we have invested only 2.5% of our portfolio in each stock, for a total of 10%. This has fallen back in the recent turbulence, but can be expected to rebound as global monetary policy remains very loose and emerging market economic growth remains strong.

Cliffs Resources (NYSE:CLF) produces iron ore pellets from six mines in the Mesabi range and a part-owned Australian project. It also produces coal in the United States and Australia. Through its Australian operations, CLF has exposure to Chinese growth, which it increased recently by a $4.9 billion purchase of the Canadian iron ore producer Consolidated Thompson (Toronto SE:CLM), which gave it a relationship with Wuhan Iron and Steel, an 18% shareholder in Thompson. CLF reported second-quarter net income of $2.92 per share, up 53% from the previous year. It has paid two dividends of 8.75 cents a share, five more sharply increased dividends of 14 cents a share and an eighth quarterly dividend, which has been doubled to 28 cents/share. Earnings are likely to continue to be strong. The stock has more than doubled for us, and it looks to have further to go, with Japanese rebuilding providing an additional potential boost. BUY

Eldorado Gold (NYSE:EGO) is a midsized gold mining company, owning producing gold properties in Turkey, China and Brazil, developing gold properties in Turkey and Greece, and a development iron ore property in Brazil. EGO announced second-quarter earnings of 14 cents/share, up 40% on the previous year. And the company recently received a permit to start production at the Efemcukuru mine in Turkey, from which it now expects to start production before the end of 2011. It has paid us two dividends of 5 Canadian cents a share and one of 6 cents, and plans to pay future dividends based on gold output and prices. BUY

Silvercorp Metals (NYSE:SVM) is a Chinese-managed company, mining silver, gold, lead and zinc properties in China. It operates four silver-lead-zinc mines in Ying Mining Camp, Henan Province, and is developing the GC&SMT property in Guangdong province. SVM’s first-quarter (our second quarter) earnings were up 82% at 15 cents/share on production for the quarter of 1.6 million ounces of silver. They were up 15% on the previous year, with production costs of MINUS $6.12 per ounce of silver, due to profitable sales of byproducts. It pays a quarterly dividend of 2 Canadian cents a share, of which we have received seven and will receive another with ex-dividend date September 28. Since I remain bullish on prospects for silver, BUY.

Teck Resources (NYSE:TCK) is a diversified mining, mineral processing and metallurgical company, producing copper, metallurgical coal, zinc, gold, molybdenum and specialty metals, with 15 operating mines in Canada, the U.S., Chile and Peru. TCK is a core holding of China’s Sovereign Wealth Fund. And its debt was recently upgraded to investment grade by Standard & Poor’s. TCK announced second-quarter earnings of $1.28/share, more than double the previous year. It has paid us three semi-annual dividends, one of 20 Canadian cents, and two of 30 Canadian cents. It’s an excellent broad-based resources play. BUY

Permanent Wealth Investor Portfolio

Stock Buy price STOP
Ex. date Current price Divs. Rec'd Return  % Remarks
Alpha Bulldogs            
BGS 9.50 12.00 N/A 9/28 18.02 1.44 104.8%  
CH 15.65 14.00 N/A 9/28 19.16 4.8491 53.4%  
ADC 23.99 17.99 N/A 9/28 21.71 2.84 2.3%  
PNNT 12.75 8.00 N/A 9/16 9.87 0.54 -18.4%  
MXF 27.41 20.56 N/A 10/1 24.97 1.584 -3.1%  
MVO 41.35 31.01 N/A 10/14 42.30 1.03 -13.6%  
SLRC 24.52 18.39 N/A 9/15 22.54 0.60 -5.6%  
SDRL 35.99 26.99 N/A 9/8 31.46 0.75 -10.54%  
DHT 3.90 2.92 N/A 10/26 3.17 0.10 -16.2%  
SB 6.90 5.17 0.15 8/22 7.30 N/A 6.8%  
BKCC         8.28     Buy at market
Stage 3 Investments          
SPX 1117X600-E 25.00 None N/A N/A 1.60 N/A -93.6% Hedges against market crash
SPX1222X600-E 25.00 None N/A N/A 12.90 N/A -48.4% Hedges against market crash
SPX1321X700-E 24.50   N/A N/A 33.10 N/A 35.1%  
OG call Dc11/ $2,000 27.00 None     26.20 N/A -3% Profits from gold price spike
TLT1319M80-E 7.50 None N/A N/A 2.75 N/A -63.3%  
BGS Aug $20 call 0.50 SOLD       0.10   +80%  
Play-Money Commodities Portfolio        
CLF 38.68 25.79 N/A 11/11 77.08 1.155 102.2%  
EGO 11.90 8.33 N/A 2/10 19.66 0.16 66.6%  
SVM 5.59 3.91 0.02 9/28 9.44 0.14 71.4%  
TCK 32.97 23.08 N/A 12/13 44.61 0.80 37.7%  


Return: Price change plus dividends received since purchase (un-compounded)
* Currently in the “Alpha Bulldog” position with a dividend declared but not yet paid
Alpha Bulldog performance since April 24, 2009: +53.7% (inc. reinvested dividends)
S&P 500 performance since April 24, 2009: +45.0% (including reinvested dividends)
Stage 3 portfolio since April 24, 2009: -14.5%
Play-Money Commodities Portfolio since October 21, 2009: +69.5% (inc. dividends)

Good Investing,

Martin Hutchinson

Martin Hutchinson
 is the Banking & Finance Specialist for Money Map Press. A British-born investment banker with more than 25 years of experience, Martin has worked on both Wall Street and Fleet Street. At Creditanstalt-Bankverein in Austria, he served as a senior vice president in charge of derivative operations. He has also been director of Gestion Integral de Negocios, a Spanish private-equity firm, and an advisor to Korean conglomerate Sunkyong Corp. But it was his work in Bulgaria, Macedonia, and Croatia (as U.S. Treasury Advisor to that country in the 1990s) that solidified Martin’s reputation as a true “hands-on” expert on developing economies. He is now the editor of the Permanent Wealth Investor, where he focuses on “Alpha Bulldog” stocks that pay high dividends covered by earnings. In his newest advisory, the Merchant Banker Alert, Martin uncovers the fastest-growing companies in the fastest-growing economies and brings those ideas back home to you. For more information, call our VIP Services group at 888.570.9830 or 410.454.0498.

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