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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 AM EST, Friday, September 14, 2007:
Diversification or concentration? All the great fortunes have been made through concentration, including Warren Buffett's. There is a real argument for concentration on one, two or three investments. I made my money through concentration on one business, which -- and this is the key -- I controlled.

Now I invest in things I don't control. To me that's called gambling. There are degrees of gambling. Buying Treasurys is limited gambling -- but it's still gambling. The U.S. dollar has lost 33.5% of its value since early 2002. The interest paid on those Treasurys did not cover the loss on the dollar. Treasurys have been a lousy investment.

For investments you don't control, there is only one path -- it's called diversification.

Diversification has one benefit: It protects you from complete blowups -- an investment that completely disappears. Bankruptcy, Chapter 11. Fraud. Poof. etc. I've had my share.

Diversification has one downside: It limits your rewards.

Diversification is called investment's "free lunch." That's another of Wall Street's meaningless statements that are designed to sell you something. (My favorite is "putting your money to work," i.e. buying what they want to sell you.)

Diversification is increasingly important today because of four happenings:

1. it's impossible to predict. More things happen counter-intuitively. An example: Oil is skyrocketing in price. It's above $80. Yet the economy is contracting and the weather fine. Oil should be down in price. But it's up because of ... wait for this -- hoarding. (See story on oil below).

2. Things are changing faster. What was valuable a year ago is no longer. Blowups are happening without warning. A year ago, residential real estate was hot. Now it's ice cold. (See story on personal guarantees below.)

3. The effects are more widespread. Sub-prime lending problems are not only hurting hedge funds and institutions who have those bad loans in their portfolios. The sub-prime problems are hurting broadly and, in weird ways. One of my biotech stocks recently cratered. A hedge fund was dumping it because it had to meet redemptions by investors who wanted their money back. It had to sell the biotech stock because it couldn't sell its subprime holdings -- the investment that was causing all the problems. So it sold anything and everything at any price it could get -- irrespective of the stocks' prospects. And worse, Wall Street gets wind of the forced sales, pummels the stock -- so the seller gets less money. Then a day or two later, the stock rises. Hence volatility is magnified.

4. The insanity of institutions. In 1950, 90.2% of U.S. stocks were owned by you and I, individual investors. Today, we own only 25.9%. That means there's a lot of money managers competing to manage our money.

The easiest way to get rich is to manage a billion dollar hedge fund and charge 2% annual management fees and a 20% incentive fee. If you break even, you still make $20 million a year. Getting to a billion means you need high returns to attract the money from investors. High returns means taking risks -- extraordinary risks. Yesterday I talked about how Goldman Sachs' Global Alpha hedge fund fell 22.5% in August, its biggest monthly decline, on losses from currency and stock trades. Alpha's biggest loss in the month stemmed from its managers' decision to sell Japanese yen and to buy Australian dollars. This so-called "carry trade" unraveled (i.e. went kaput) when the Australian dollar fell 6 percent against the yen in August.

Now, ask yourself a question: Would you take your hard-earned money and gamble that Australian dollars were going to rise against the Japanese Yen in a very specific and very short timeframe. No way. You and I would buy a decent company in a sound industry with sound financials.... But gamble on currencies. No way. I'm not nuts, nor prescient. Nor am I under the pressures to perform that these money managers on Wall Street are. And, of course, they're not playing with their own money. It's your and my money. These guys must maintain a life style to which they have become accustomed. To wit:

A hedge-fund manager Daniel Loeb paid $45 million for a penthouse apartment at 15 Central Park West.

The New York Times refers to the limestone covered building as "uber-luxurious". Denzel Washington and Sting are also moving in. $45 million for an apartment?

Personal guarantees are valueless: When you default on a $1 million bank loan, you're in trouble. When you default on a $1 billion bank loan, the bank is in trouble. You can "personally guaranty" the loan -- and the bank will insist you do. But your secret weapon is to declare personal bankruptcy. Your personal net worth statement might have shown net worth of $2 billion -- but if they were in assets now significantly devalued -- like Arizona desert real estate -- you could easily now have a negative net worth. From being a billionaire to a pauper in a few painful months. With all your debts, it now makes sense for you to declare bankruptcy, or at least threaten it. Hence, your bank and all your investors are screwed. You get to start all over again with a clean slate, and maybe a few million dollars squirreled away into a fancy home. Hint: live in Florida or Texas.

$100 a barrel and more, coming soon. I've talked about my belief in $100 a barrel for oil. I've felt that the major driving factors were "peak oil" and insurrections/political problems in key oil-producing countries -- Iraq, Nigeria, Mexico, Venezuela, etc. My friend Jim Kingsdale is an oil expert. He writes Energy Investment Strategies. His latest posting is fascinating

$80 Oil: What’s Different This Time?

As the price of oil in dollars hit a record on September 12, breaking $80 for the first time, the question occurs: Is the breakout a harbinger of consistent and significantly higher prices or just the Pit Boys on testosterone? For perspective let’s note the environment surrounding this news.

A. The price of oil in Euro’s is far from a record. Clearly, $80 has something to do with the drop in the dollar. In fact, oil is becoming like gold, something of a hedge against a falling dollar and, perhaps, inflation. A friend recently asked me if I hold a portion of my funds in currencies outside the dollar and my reply was, “no but I have a lot of oil.”

B. The dominance of national oil companies (“NOCs”) and rise of oil hoarding is becoming a generally recognized reality. I suggest you take a minute to read the following account of a discussion of this topic by the CEOs of three oil majors. In fact, you might take another minute to look at my essay on hoarding oil and to the area called Hoarding in my Information area that collects news items on the subject. I won’t repeat the logic that underlies oil hoarding, which is discussed in detail in the referenced essay. But please note that the combination of hoarding by some NOCs and the supplanting of private corporations by NOCs in global oil production, it is clear that oil hoarding is a growing trend.

C. Oil broke $80 despite “bearish” news. Just preceding the breakout, OPEC announced it would increase production by 500,000 b/d — after various OPEC leaders had spent the preceding months saying they would not increase production. On the same day as the breakout, the International Energy Agency in Paris (“IEA”) reduced its estimate of oil demand based on a slowing U.S. economy. In fact, the preceding several weeks of financial news has focused on the increasing likelihood of a weaker economy, which implies lower oil demand. Finally, we are in a traditionally weak “shoulder” season. Last year at this time the price of oil had started a free-fall from a record of $77 in August to just under $50 in January. Add it all up and you get a classic indication of strength used by professional futures traders: if prices go higher in the face of “bad” news, it generally means that the trend upward is for real.

D. Longer term fundamental trends are disturbing. Recent months have seen the following developments:

— Kazakhstan has pulled its contract with ENI, the Italian oil major, and a consortium of other majors for developing the world’s most promising new oil field in the Caspian which was to have added 1 million b/d, first in 2008, then in 2010. It is no longer certain when this oil will be seen.

— Mexican oil production continues to stall out and, more importantly, its exports are falling even faster as domestic use continues to rise. The solution requires major new investment in Mexican production, but so far that’s not on the horizon. Moreover, violence is increasing against the Mexican government, threatening to make Mexico into the next Nigeria. I don’t think it will get that bad, but the trend is not good. As Mexican exports fall, the U.S. has little option for replacing Mexican oil other than to outbid other consumer nations for Middle Eastern oil.

— Chavez continues to strangle Venezuelan oil production and to divert more it to any customer other than the U.S. Recently, in addition to China, he plans more exports to Iran and to his “friends” in South and Central America.

— In the Middle East, where the world’s only spare oil capacity is said to exist, the UAE is planning to shut down production of perhaps 810,000 b/d for three weeks in November for field maintenance. The Saudi spare capacity is still a matter of conjecture among oil experts both in terms of how much is really there and what the quality of the oil is. Many believe that virtually all Saudi spare capacity is heavy, sour crude, which requires special refining capacity that may not exist. The Saudis are in the process of building their first refineries, to come on stream in 2010, and some experts believe they are doing it because there is insufficient global refining capacity to handle their less valuable heavy, sour crude which makes up the bulk of their spare capacity and which will increasingly become a more important part of their output in the next decade.

— Political chaos in Iraq and Nigeria is not indicated to decline much in the immediate future. Shia are fighting each other in southern Iraq for oil control, now that the British are leaving, which has the potential to lower current production. The Kurds have signed contracts for new exploration and production, but even if that goes forward it will not produce oil for several years at the earliest. In Nigeria the efficacy of the new government’s efforts to curb corruption and bring peace with the local tribes in the southern oil producing areas is unknown as of now.

There are some positives like the growth of Angolan oil production and the fact that oil inventories are not currently strained. In fact the latter is one reason that OPEC was leaning against raising its production quota.

On the whole, however, it looks to me like the wind is to the back of the oil price if the dollar continues to weaken and exporters continue to lean increasingly toward hoarding oil.

The kicker is the imminent test of whether global production can support a new, never-previously-experienced level of demand for oil that is forecast to occur based on winter heating requirements. As the world breaks the 87 mb/d threshold of oil demand for the first time in history during the fourth quarter this year, it is not at all certain that production of oil will be sufficient to meet that demand.

The fourth quarter will be the final exam of oil production capacity. If the world fails this test, we will find ourselves on a new price plateau. If that happens, I suspect that the current range expectations of $50 – $75 may be replaced by a range of $80 – $110.

We thought the last few years have marked the end of cheap oil. Everyone has sort of agreed to that. But as oil routinely sells for $70 now instead of $30 a few years ago, demand does nothing but expand. We may find that anything under $100 is still cheap for the price of oil and that the true end of cheap oil is still over the horizon.

Old Jewish stockmarket saying. Predictably, I got it wrong. From Mike, my learned reader:

Harry, It's sell Rosh Hashanah, buy Yom Kippur. You had it reversed.

Going back to 1915 if you bought the close before Rosh Hashanah begins (that was Wednesday afternoon) and sold the last day before Yom Kippur (which is is ten days from RH) the Dow fell 0.62%. If you bought the day after Yom Kippur (that will start at sundown on September 21) and held until the end of the year, you averaged 1.99%.

Proposed half time show for next year's Super Bowl. Featuring Michael Vick and Happy the Wonder Dog.

(I cannot stop laughing over this stupid, faked up photo. The expression on the dog is superb. And his name -- Happy, the Wonder Dog -- is priceless.)

Today is the second day of Rosh Hashanah. Time for more bad Jewish humor.

Yiddish proverbs
+ If the rich could hire other people to die for them, the poor could make a wonderful living.

+ The wise man, when he holds his tongue, says more than the fool when he speaks.

+ What you don't see with your eyes, don't invent with your mouth.

+ One of life's great mysteries is how the boy who wasn't good enough to marry your daughter can be the father of the smartest grandchild in the world.

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads. Thus I cannot endorse any, though some look mighty interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
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