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Surviving Keynes' Hair-of-the-Dog

"Buy precious metals and energy" to escape the Keynesian consensus...

and talk show guest John Pugsley has been writing and publishing highly popular financial advice since the late 1960s.

His first book, Common Sense Economics, sold 150,000 copies. John Pugsley's second book – The Alpha Strategy: The Ultimate Plan of Financial Self-Defense for the Small Investor – spent nine weeks on the New York Times' bestseller list, and is a standard reference on stocking up on food and household goods as a hedge against inflation.

Now pouring his experience and energy into Stealth Investor, a weekly stock advisory that alerts subscribers to potential investments beneath the radar of the big funds and brokerage houses, John Pugsley here speaks to The Gold Report about why precious metals and energy offer investors unique opportunities.

The Gold Report: John, your Stealth Investor portfolio has outperformed the DOW, S&P and Nasdaq. To what do you attribute your success?

John Pugsley: There are several reasons we've consistently outperformed the market.

First, we're concentrating on micro-cap and nano-cap natural resource exploration and development companies with market caps usually under $50 million and sometimes under $10 million. Within this relatively large group we've been successful in identifying a small number of outstanding firms that are deeply undervalued simply because they are off the radar of brokers, institutions and investment newsletters. Without brokers and investment letters getting the word out to individual investors, these stocks' share prices languish.

TGR: So why aren't they promoted by brokers?

John Pugsley: Two or three reasons. First, the smaller companies can't afford the registration costs to register their shares in the United States with the SEC and all of the state securities agencies. In fact, many of the companies discovered by Stealth Investor are required by law to put a notice in their press releases stating that the information should not be disseminated or the securities offered or sold in the US Since it's illegal for US brokers to introduce or promote companies that aren't fully registered, these companies don't get exposed to the big market of US investors. Of course, if an investor knows of a company, and asks a broker to buy it, the broker can place the order. The broker just can't recommend non-US-registered companies to clients. This severely limits a small company's ability to raise capital.

Secondly, even when it's legal for brokers to recommend a company, tiny companies are usually of little interest to brokerage firms and underwriters. There just isn't enough "juice" to get a broker's attention.

Third, companies with small market caps are usually of no interest to funds. There just isn't enough float to allow a fund to take a substantial position. The big money managers are looking for opportunities to place large chunks of capital, and since it takes about the same amount of due diligence to study a small company as a big one, the funds tend to ignore the small firms.

TGR: There are a lot of stock advisory letters. Why aren't the companies you recommend being recommended by other advisory services?

John Pugsley: Most financial newsletters have larger subscriber bases. When a letter has 2,500 or 5,000 subscribers or more, every recommendation results in a rush of buy orders. The share float of a company with a market cap of $10 million may have a float of only one or two million shares. If the price is a dollar or two, it takes very little in the way of buy orders to drive the price out of sight. When a rush of orders hits, the price immediately soars, and subscribers get disgruntled because they're unable to get shares. The point is, letters with a larger number of readers just don't bother to recommend nano-cap companies.

I knew from past experience that I couldn't really exploit this niche of undervalued stocks unless my subscriber base was so small that the price of a stock wouldn't be affected by the buying pressure from my subscribers. Consequently, I have limited the number of subscribers. I probably have the smallest number of subscribers for any letter in the industry. Small, but very successful.

TGR: How do you identify the companies that finally make it into Stealth Investor?

John Pugsley: Good question. I still have to ferret out the truly undervalued small companies out of the thousands of little natural resource companies struggling to make it. I have an advantage over some of my younger brethren. I've been writing about natural resources for nearly 40 years, and as a consequence have become friends with a wide range of people in the industry – geologists, engineers, successful entrepreneurs, CEOs, brokers, etc. By tapping this resource I get tips on deeply undervalued companies, as well as solid opinions on those that seem to fit our model.

The idea has worked extremely well. From our start four years ago, our portfolio is up 147%, while during the same period the S&P500 is down 5.7%. So while the subprime credit collapse drove everything down, we've managed to pull through, survive and make great profits. It's all because we're in a unique niche.

I might add that there is another element in our success: we concentrate in natural resources. When government printing presses are gushing IOUs, solid value lies in tangible goods, not in paper promises. While one can buy physical commodities like copper and Gold Bullion and store them away, owning those same tangibles still in the ground is an even better hedge against inflation. Before they're going to be tapped and brought to the surface, the price of those commodities must be high enough to yield a profit to the companies producing them. It's automatic. By discovering and acquiring resources in the ground, we're storing value.

TGR: In your Stealth Investor newsletter at the end of March, you talked about a paradigm shift coming in the way people look at the economy, but you also said that we shouldn't hold our breaths. When do you see that paradigm shift happening?

John Pugsley: The ruling economic paradigm embraced by almost all of the economics profession and certainly by the politicians and bankers, is "Keynesianism." It holds that the cure for a recession or depression is to drown it in government spending and central bank monetary expansion.

This is a recipe for stagnation and inflation, but a shift away from a belief in deficits and fiat money creation won't happen until there's true catastrophic decline in the world economy. In fact, the Keynesian paradigm may not be abandoned even then. The collapse and depression of 1930s, which was caused by the credit explosion that ensued after the creation of the Federal Reserve in 1913, could have turned us back to a true gold standard. Instead, Keynes came in and gave the politicians new justification for more government spending and money printing. There was such a collapse between 1929 and 1932 that one would've assumed that they would have gone back to 19th century classical economics and a stable monetary system. It didn't happen.

Based on the current worldwide belief in Keynesian economics, and considering the measures that are now being pursued to deal with the credit collapse, this current depression will probably continue for another 10, or 15 years or longer. It isn't going to end in the next few months, or few years, as the economists are suggesting, because they are trying to cure the problem with a dose of the "hair-of-the-dog," the same drug that caused the problem in the first place.

TGR: John, as we've discussed, your investment strategy has been pretty successful for the past four years. How important is the particular sector, such as the precious metal sector or the alternative energy sector, when you're making your investment decisions?

John Pugsley: Not very important. I'm looking for raw resources in the ground. I'm not looking at any one sector like Gold Mining, industrial metals, oil and gas or water. I'm trying to find companies that are searching for or developing all types of natural resources. Whether it's gold, water, or phosphate doesn't really make much difference in my eyes. It's a question of how necessary is the commodity, how good is the management, what properties do they own, and how cheap the stock is.

TGR: What about the difference between companies in discovery mode versus companies in production mode? Does that have an impact?

John Pugsley: Yes, it does. Generally, companies that are producing minerals, oil, gas, etc. tend to be much bigger. It takes a lot more capital to develop and mine minerals or produce oil than it does to explore and find deposits. Our unique, under-the-radar niche consists of tiny companies in the exploration or prospect generation sector that will make discoveries and then joint venture them or sell them to larger companies. We are looking at the early stage prospect generators as the best prospects for our particular strategy.

TGR: As that alternative energy sector continues to get attention, what do you feel are going to be the key factors driving that sector forward?

John Pugsley: The driving force behind green energy is environmental activism. These "greenies" put pressure on the politicians, and the politicians subsidize the sector, both with cash subsidies, as well as regulations that force utilities to get certain percentages of their power from renewable energy sources. Thanks to government subsidy, green energy is going to be the wave of the immediate future. A lot of the green energy section is puffery. Wind and solar, for example, in most cases would be unprofitable to produced if it weren't for government subsidies.

The green-energy industries I find attractive as an investment are low-head hydro and, of course, the biggie, geothermal. These two sources are continuous, and in unending supply, at least in those areas of the world where the resources are available. With the addition of state and federal government subsidies geothermal is a no-brainer.

TGR: Are there any pearls of wisdom you'd like to share with our readers?

John Pugsley: I think that the individual who hopes to survive financially in the near future, and in the next 10 or 20 years, should invest significant time and money in gaining a deep understanding of economics. We're very unlikely to experience the long bull markets of the past three decades where it was possible to ride the bull and get rich. The sub-prime real estate collapse and the concomitant plunge in stock prices is not just a normal up and down cycle.

The few who understood what Greenspan and the politicians were doing to blow up the real estate and stock market balloon through credit expansion, subsidy and regulation exited real estate and the broad markets three or four years ago. To those of us who understand the fallacies of Keynesian economics, it was apparent that these markets were dangerously overvalued. Going forward, it's not possible simply to take recommendations from brokers or investment gurus (even this one) and expect to survive. The answer is to back away from the experts, and become knowledgeable. Economics is just common sense. If somebody's offering you something for nothing, like interest rates at 1%, and free money to buy a house you can't afford, there's something wrong. Self-education is the secret that will help people survive in the days ahead.

TGR: Great advice, John. We appreciate your insights.

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