Stephen Leeb's 'Game Over': Good Advice for Tough Times

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 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 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 also likes Canadian Oil Sands Trust (COSWF.PK) for its long lived reserves and uranium producer Cameco (CCJ). In a similar 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.

Comments

[jse17:]

"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?"

Avoiding functional fixation is a critical first step in creating solutions for any problem. The question that jumps to the fore is why must the wind generating system be iron ore based. Additionally, how many years are in play to complete the project?

May 28 08:50 AM

[biomedlives:]

"We don’t think the US can afford the kind of military it has over the long term,..." Amen!

May 28 09:58 AM

[SWUguru:]

Just from the few quotes lifted from the book, Leeb sounds a bit short on facts and long on BS:

He wonders where we will get the steel to build 700,000 windmills--how about recycling the steel from the 15,000,000 cars Americans buy each year.

His remarks on Australian nuclear power being stymied by a lack of cooling water are also nonsense--all power plants need cooling, and Australia is surrounded by oceans of water.

May 28 10:41 AM

[dondon:]

Australia has decided not to build new nuclear plants because they don't have the water seems like a ridiculous reason. The last time I looked Australia is surrounded by water. Probably the reason is that the new government is liberal and we know that liberals do not categorize nuclear power as a means to reduce green house gases.

As for energy efficiency, I agree that will be a huge reason for reduced power needs. I had a monthly electric bill between $300 and $500 per month. I turned off the AC and started hanging my clothes on a line to dry. (I fluff them in the dryer for 10 minutes.) For the past six months my bill has not exceeded $80.

We have to get off this mindset that we are doomed if we don't get off fossil fuels. Making our fossil fuels use more efficient will continue our high standard of living. The earth will warm and cool regardless of what we use for energy.

May 28 12:32 PM

[masf:]

I appreciate dondon's comments because articles like this tend to intimidate me and make me feel helpless. On the whole, I think this article makes important points, and I learned a lot. (I have a lot to learn, truthfully, which is why I participate in Alpha.) But thanks for the reminder that we as individuals can influence these events. Also, sometimes this financial world seems to get out of touch with us struggling regular people who worry about the monthly electric bill.

May 28 12:51 PM

[justbrowsing:]

"we" also don't like a single person referring to
himself in the "plural" - the adjective for such behavior os "pompous",
and at least for "we", it brought down the quality of the
article.

May 28 02:08 PM

[Jonathan Be...:]

Regarding Australian sites for nuclear plants, Leeb might have been more precise if he had said, "Australia decided not to build new plants on rivers," and I would have done well to look into that issue more. Seems like Australia is at least thinking about building plants on its coasts: www.abc.net.au/science.... On the other hand, as the article says, that country may be short of sites that are convenient to its existing power grid. Since energy is lost over long distance transmission that is not exactly a trivial problem.

Justbrowsing: "I" write the editorials for theinsightfultrader.com, and that is how my work got to Seeking Alpha. In editorial writing, "we" is customary usage, as you may know. But we understand your objection, lol.

May 28 05:09 PM

[Jonathan Be...:]

In my reply, I meant to say, Australia "short of coastal sites" suitable for nuclear plants that are convenient to Australia's existing power grid. Hopefully that was clear.

May 28 06:57 PM

[fourthrocker:]

The idea that if we only make a car that gets 40mpg instead of 20mpg that will solve our problems is as short sighted as most notions. What good does doubling the gas mileage do if the population doubles and there are twice as many cars? All our problems can be reduced to one cause, we are now overpopulated, have been overpopulated and are getting even more overpopulated. There are about 2 billion more people on this planet that can be sustained indefinitely and we have all these idiot economists (who should all be taken out of circulation along with politicians and lawyers) who say that not only will the population go up to 10 billion but that we can support that population. BS. We can't support the population we have now, we are killing this planet with our numbers. The only solution is to reduce our population to no more than 4 billion in ADDITION to everything else.

May 29 11:37 AM

[johncm:]

I agree tht the iron argument bespeaks of somone who has not looked at the problems very hard; same point re the water problem in Australia vis-a vis nuclear plants. But he has missed the whole point as far as electricity is concerned. MIT's Technology review hits it on the head - we don't have the electricity distribution system we need to make use of the new technologies properly. Edison would fondly recognize our present "dumb" system when we need a smart system. Also, the point regarding our military expenditures is WAAAAY off the mark.

May 29 07:29 PM

[Dana H.:]

Anyone who claims wind power is a solution to our energy needs is ignorant, deluded, or dishonest -- and it has nothing to do with any alleged shortage of iron. See here for a good article on the green energy fantasy (or talk to an engineer who knows something about the reliability requirements of an electrical grid power source, rather than a Caltech scientist who apparently does not): www.capmag.com/article...

The solution to our energy problems is to remove government restrictions on oil exploration and drilling, on oil shale exploitation, and on nuclear power plant construction -- and to drop the idea of carbon emission restrictions once and for all. If this doesn't happen, be prepared for your standard of living to collapse.

May 30 06:39 PM

[User 391027:]

Well said. Amen!


On May 30 06:39 PM Dana H. wrote:

> Anyone who claims wind power is a solution to our energy needs is
> ignorant, deluded, or dishonest -- and it has nothing to do with
> any alleged shortage of iron. See here for a good article on the
> green energy fantasy (or talk to an engineer who knows something
> about the reliability requirements of an electrical grid power source,
> rather than a Caltech scientist who apparently does not): www.capmag.com/article...
>
>
> The solution to our energy problems is to remove government restrictions
> on oil exploration and drilling, on oil shale exploitation, and on
> nuclear power plant construction -- and to drop the idea of carbon
> emission restrictions once and for all. If this doesn't happen, be
> prepared for your standard of living to collapse.

Jun 02 11:29 PM

[enviro111:]

You should take all stock picks with a grain of salt. No one knows the future. If leeb's future is true, it is likely that virtually all stocks will be bad investments. The economy and potential collapse is a dynamic process - not an incremental process. the process of building the economy of the last 150 years has been incremental with some burst due to technology and the growing use of ever cheaper and cleaner energy. If one of these factor ends (i.e., Peak Oil) then all bets are off. A collapse in one area will lead to problems in other areas. Most of the problems will be unforseen.

Take the windmill example - its not just the steel. Without cheap transportation

how will workers, equipment and supplies EFFICIENTLY get to the the sites where they are needed?

will transmission be available?

how about timely maintenance and repair? can it be done?

who will buy the power if they are unemployed?

who will finance the power if it not needed and the development costs keep rising?

how about social unrest and even war over scarce and more expensive basic resources?

Is the government going to just sit and be quiet or cause lots of new problems?

Jun 10 05:36 PM