Is the ethanol frenzy similar to the .com bubble?

A recent Jim Cramer article has gotten me thinking about the current speculative ethanol frenzy in comparison to the .com bubble of the 90’s.

Here is a quote from a recent Jim Cramer article entitled “Ethanol: Live Fast, Die Young, Take Profits”

Ethanol is in the last stage of a speculative fad’s life cycle. I know this because we see it all the time in these hot sectors.

We saw it with the dot-coms in 1999, with the power merchants in 2000, with the oil service names last year and into this year and with solar power. Now ethanol is following the same pattern.

Ethanol is a commodity much like gold and is now a viable cost to energy efficient alternative to gasoline. I believe there are two key differences between ethanol’s speculative frenzy and that of the .com days that Jim Cramer draws a comparison with.

The first difference is that most of the attention to ethanol has been concentrated in the U.S. During the .com days you could go anywhere in the world and talk about websites and .com ideas that would cause people to get excited. Talk about ethanol with financial professionals in Hong Kong or Shanghai, both relatively sophisticated global economic hubs, and few people will know what you are talking about. In the U.S. ethanol is clearly a buzzword. Globally I don’t believe ethanol has the same type of speculative hype or education among financial professionals found in the U.S. A lack of publicly traded ethanol stocks in emerging markets is also to blame for the lack of interest outside the U.S.

The second difference is that a real business model exists for ethanol. Dot com revenue models were murky but ethanol revenue models are simple to understand. Ethanol has a cost and sale price. Emerging markets will fuel strong interest in ethanol for many years to come. I believe a crash in ethanol stock prices are inevitable, given the speed at which stock prices have been driven up. Long-term I believe a price correction will present the same type of opportunities that the .com crash presented with stocks like Yahoo! Inc. (YHOO), eBay, Inc. (EBAY) and Amazon.com, Inc. (AMZN). I don’t see a crash happening anytime soon. Ethanol interest will remain high as long as crude oil prices stay high. There is too much unrest in the Middle East and fears over a looming war on the scale of World War II for oil prices to dramatically drop.

Raw Greed ethanol watchlist

I believe trading ethanol stocks represents a strong speculative opportunity to trade against rising crude oil prices. Corn and bio-waste ethanol fuels are a hot alternative energy source to gasoline. As crude oil prices rise, I expect to see ethanol stocks continue to post gains. I believe the greatest future opportunity in ethanol stocks will be with companies that serve or produce ethanol in emerging markets. Consumers in emerging markets are having a difficult time absorbing the high cost of fuel. Brazil is currently the world’s largest producer of ethanol, followed by the U.S. in second and China in third place.

There is a lot of worry about ethanol being an alternative energy fad. Ethanol has been around since the 1970’s and only until recently has the cost of production to energy output ratio been in ethanol’s favor. In the past, the inverted cost to energy output ratio meant every dollar spent on ethanol production yielded less than a dollar’s worth of energy output. Due to manufacturing efficiencies and technology improvements, ethanol now gains more energy output than each dollar spent on production.

I believe ethanol is here to stay as an alternative fuel source to gasoline. In the long-term I expect to see global ethanol use grow. I do believe ethanol stocks have been driven up in a speculative frenzy, but I also believe there is room to grow so long as crude oil prices remain high.

Here is my current watchlist of ethanol related stocks:

Archer-Daniels-Midland Company (ADM)
VeraSun Energy Corporation (VSE)
Pacific Ethanol, Inc. (PEIX)
MGP Ingredients, Inc. (MGPI)
The Andersons, Inc. (ANDE)

Raw Greed portfolio changes

I am making a large number of changes to my Raw Greed portfolio that will involve me using either margin or additional funds to take a larger position in gold mining stocks. My changes involve selling a portion of my current positions to free up additional capital. If your portfolio is tech heavy similar to my own portfolio, I suggest going long on existing positions since the market has yet to stage a recovery to early May, 2006 levels. I’ve written in the past about my strategy for the remainder of 2006 in this article.

Gold update

It looks like my prediction about gold’s bottom may come true. I believe we might see gold rebound past $600 quickly. I expect to see gold trading in the $600-$650 range for much of the summer.

Here is a recap of my top gold mining stock picks:

Barrick Gold Corporation (ABX) Barrick Gold Corporation is the world’s largest miner of gold. I like ABX at $25-$27.
Newmont Mining Corporation (NEM) Newmont is the world’s second largest miner of gold. I like NEM at under $50.
Yamana Gold, Inc. (AUY) I like AUY at current prices under $10.
Tanzanian Royalty Exploration Corp. (TRE) I like TRE at current prices under $7.

Gold update, have we hit a bottom?

Yesterday I predicted that gold’s bottom in the current correction would be $540-$550. I never anticipated the drop to be so aggressive. Gold is currently trading at $550.80. I am planning to take a large position in gold mining shares by depositing additional funds into my Raw Greed trading account. I think getting into gold is both for investment and for safety reasons. Let’s see if gold can maintain $550 levels.

Gold update, now is the time

I believe now is the time to start accumulating a position in gold mining stocks if you haven’t done so. I’ve been watching the recent declines in the global stock market and waiting to see a reprieve from the slew of down market days. I believe we have seen uncertainty take certain shape in the market. There is almost no financial news source that either isn’t speculating on a summer long bear market or a possible large scale war in the Middle East creating a negative market environment. Gold is the only safe haven investment that I see in the uncertainty of the stock market. I believe it is only a matter of time before the slew of Hedge Funds (which now number over 12,000 and control over $1 trillion in funds) pile money into the metal. I remember reading a quote from Doug Casey that the majority of Hedge Funds are likely run by 20 and 30 something’s that have never really experienced a bear market. I believe these Hedge Fund managers won’t know what to do if the market collapses and gold will provide the only reasonably safe way to invest in a bear market.

I believe the relative inexperience of Hedge Fund managers is a repeat of the .com days where decisions at Venture Capital companies were being made by the same group of young Ivy League graduates controlling vast amounts of wealth. It’s no fault of theirs that old wealth tends to chase new wealth since new wealth is likely younger and more able to identify hot new ideas and investment vehicles. Old wealth should be able to smell an opportunity or concept that has been oversold by having the benefit of experience. A truly wealthy businessman knows that the ability to manage and keep wealth is equally as important as the skill to earn wealth. Gold is likely going to be a stronger investment to preserve wealth in the next 1-3 years than holding USD in a high-yield interest bearing savings account.

I am going out on a limb to say the bottom for gold’s current correction will be $540-$550. I agree with a comment made by Peter Grandich in this recent article:

Reward now equals or surpasses risk, going forward ($50 lower and up to $500 higher is worth risking being aggressively long again).

I trust many of the comments made by Doug Casey and Peter Grandich. Both authors are more frequently correct than incorrect about gold and both agree that there is less downside risk to potential upside for the metal. Both authors see gold possibly passing $1,000. For Doug Casey it’s not a matter of if, but when gold will pass $1,000. I made almost the exact same prediction in some of my earliest Raw Greed posts for gold passing $500.

I expect that gold’s potential downside is another $50-$60. I see the potential upside heading out of the summer into the end of 2006 at $200 with gold possibly reaching $800. We have the right mix of volatility in the stock market for gold to come into close proximity to the metals previous historical high of $850. Now is definitely the time to start building a cash position to invest in a mixture of gold and high quality stocks in any industry affected by an overly speculative bear market.

The Bear Market Anamoly

It’s funny how most people concentrate on stocks when the market goes up, but shy away from purchasing stocks when some real opportunities exist. When the market is going up, people will invest large sums of money to gain a small return. When the market is down, some of the most savvy business people will choose to sit on the sidelines until prices go back up. If your portfolio is down 20% or more in just the last month and your portfolio is comprised of a diversified group of mid and large cap investments, why would you wait until the market gains back that 20% to continue investing additional funds? It’s really difficult for investors to go against the curve, but the contrarian mentality can help separate your returns from those of the average investor.

When stocks like Taiwan Semiconductor Manufacturing Company Limited (TSM) or United Microelectronics Corporation (UMC) drop more than 20% in the past month, you know these will be the first stocks to recover if the market shows bullish signs again. TSM and UMC are among a few stocks of companies that have shown steady improvement in their businesses and show no signs of business slowing down in the short-term. It’s much easier to sit back and try and earn an over 20% gain in a comeback rebound than to speculate how high stocks like these might go when the market does rebound. I would invest in an improving business in a declining market.

I made the mistake of not leaving enough free capital to take advantage of the recent drop in prices. I’m going to set a new rule for my stock portfolio. If something seems to be too good to be true then it probably is. If my portfolio ever posts a 15% or greater gain in one quarter I will sell at least half my portfolio (most likely spread evenly) to lock in gains and create a hedge against a declining market. Uncertainty is the most correct thing I’ve predicted about the stock market this year.

Update Intel Corporation

Yesterday Intel Corporation (INTC) dropped to a new 52-week low of $17.05. INTC is part of my Raw Greed portfolio. Readers know that I believe the market has overreacted to worries over the company’s declining market share to rival Advanced Micro Devices, Inc. (AMD) and a slowing PC market. The release of Windows Vista should prompt users to upgrade en masse as the new Microsoft operating system poses the most stringent hardware requirements since the upgrade from Windows 3.11 to Windows 95. The release of the new Microsoft OS should signal the beginning of a new PC cycle that should prompt strong demand for PC hardware and software till the end of the decade. I believe Intel has the marketing muscle and deep R&D budget to take best advantage of the Microsoft Windows Vista release. If INTC drops below $17, I consider the stock an incredible long-term buy.

Update, my top gold mining stock picks

I would add any of these four gold mining stocks to your portfolio while the metal is still trading under $650.

Will the global stock market crash?

I’ve been reading some of the opinions of financial commentators that are predicting a global stock market crash. The opinion of one author, Chris Laird of the Prudent Squirrel, caught my attention last week.

Here is a quote from the article:

…Japan allowed financiers world wide to borrow Yen for a literally zero interest rate and then invest that money in world stock markets and to buy other nations bonds for about a 3% interest rate premium. The amount of borrowed Yen invested in the world’s financial markets is astounding. We are talking trillions of dollars value in Yen that has found its way into every major financial market in the world.

The US is considering a pause in its interest rate hikes of late. The interest rate differential the US holds over Japan and Europe is as much as 3%. If that differential is not maintained, trillions of dollars of US denominated financial investments are going to be unloaded on the world markets. A combination of unwinding the Yen carry trade and a serious drop in the value of the USD will just simply pull the rug out from under every major financial market that has benefited from the cheap USD and Yen.

I agree with Chris that there are early signals of a global stock market crash with declines in emerging markets such as Indonesia, China and India. I’ve written for sometime that the stock market faces extreme uncertainty due to global fears over terrorism, natural disasters such as hurricane Katrina, or sicknesses such as a Bird Flu pandemic.

I am going to continue to recommend gold mining stocks as the best hedge against a major drop of the USD or a global stock market crash. I do not believe we are in store for a major crash in the next 6-12 months unless a new war erupts in the Middle East or we face some type of global Bird Flu pandemic. I will update my current top gold mining stock picks with current buy price targets with gold trading under $650.