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MARKET NOTE #1: Secrets and silicon

The first story we want to touch on briefly – and "brief" is all we can do, because not much is known – is the biggest computer security story of the year so far: the recent cyberattack against Lockheed Martin (NYSE:LMT), the largest defense contractor in the US (and the world)…and probably the keeper of more American defense secrets than any other company.

We don't know how successful the attack was. We'll probably never know, because revealing that information would empower future hackers, and because no company likes to reveal weakness.

But we do know that it took over a week for Lockheed to even admit that the attack had occurred. We know that even though Lockheed claims the attack was defeated, it admits to needing US government help (i.e. defense/intelligence support) to do it. And finally, we know that this attack may have been the culmination of a multi-stage operation. The earlier stage may have been a successful strike on RSA, an EMC subsidiary. RSA is a crypto-security firm; it manufactures hardware "security tokens" that are the basis of computer security for government and private organizations from the US to Australia.

The sophistication of the attack, the ultimate target, and the fact that it was a "sustained, tenacious" operation involving several stages over several weeks all suggest that the hackers were not teenage amateurs, but seasoned pros on a national payroll. The best guess of security experts is China, which has been waging an undeclared "cyberwar" against the United States for more than a decade.

Lockheed acknowledges that its systems face over a million "incidents" a day. A good deal of their IT security efforts is spent on separating the harmless events from genuine threats. The same is true, to varying degrees, of "high profile" targets from the Federal Reserve to the Department of Defense to Barnes & Noble (NYSE:BKS). This is why the security experts with whom we work are convinced that cyberdefense is almost as important as energy - and are frightened that people seem not to be taking it as seriously.

With this rising cyber threat in mind, we repeat our recommendations for CACI International (NYSE:CACI), Growth Portfolioand, yes, EMC Corporation (NYSE:EMC), in our FundFinds Portfolio. CACI is a defense contractor specializing in computer security and intelligence. It has had twenty years of strong, uninterrupted growth, and has earned an ultra-high security clearance. This gives CACI a powerful incumbent advantage against potential rivals, who would have to work even harder to gain the trust of CACI's major client – the US government.

EMC's core business is information infrastructure, including software and hardware for "cloud computing" and data storage. About 10% of its revenues come from its RSA Securitysubsidiary, which specializes in computer security. The RSA hack in March was embarrassing, but from an investment point of view, it highlighted just how ubiquitous RSA's "security dongles" have become in secure facilities around the world.


MARKET NOTE #2: Fracking the Bakken

Our second story is American shale oil. The discovery and exploitation of oil reserves in formations like North Dakota's Bakken Shale have led some analysts to announce the rebirth of America's domestic oil production – and even an end to our dependence on foreign oil. Sadly, that's unlikely.

First of all, output figures aren't reliable. Reserve estimates vary wildly depending on assumptions about price and available technology. And even if the Bakken were able to produce 3 million barrels a day, that would amount to only a few percentage points in world production by 2020.

Extracting the oil also presents serious challenges. Mining for shale oil involves hydraulic fracturing, or "fracking," a process that demands massive amounts of water – in a region that's currently enduring a serious draught. (Fracking also has a record of contaminating local groundwater, leading to local opposition and increased political and remediation costs.) Extracting and transporting the oil requires infrastructure that hasn't yet been built out, which means a massive draw on resources, from iron to catalysts to oil to power the oil rigs themselves.

That isn't to say that shale oil is insignificant, or not an interesting resource investment. It is – it just isn't the final (or even the immediate) answer to our energy dilemma. With that in mind, we highlight two strong players in the field: Continental Resources (NYSE:CLR) and Whiting Petroleum (NYSE:WLL).

Continental is already a favorite of ours, with 75% of its production coming from "non-conventional" oil sources. This emphasis will serve it well going forward, where its technical expertise will give it an edge as "non-con" sources become ever more important.

Whiting Petroleum is an energy producer with a very impressive 2010 reserve replacement ratio of 141%. About 80 percent of its production by volume is oil, so it's shielded from the still-weak natural gas market.

MARKET NOTE #3: REE alert

As some of you may know, we have a new book coming out on October 19th – Red Alert (Grand Central Publishing). One of the topics is China's dominance of the market in rare earth elements (REEs). We've received some pre-publication criticism for implying that rare earth elements are only found in China.

Obviously, that's not true. Rare earths aren't actually all that rare, and they are widely distributed across the globe. The point we were making is that REEs are currently economically available mostly in China. China now produces 95% of the world's rare earths – and that figure won't change unless the U.S. and other nations make some fundamental adjustments.

REEs are vital in dozens of high tech applications – especially "green" ones like wind power and hybrid cars. They are the basis for the super-strong magnets pioneered in the '90s that became vital to everything from computers to efficient electric motors and wind turbines.

Currently the U.S. has neither the political/economic will to deal with the environmental fallout of REE mining, nor the human capital (i.e. specially trained engineers) to refine and work with rare earths. In 2006, General Motors closed its entire magnet research division and moved it to China.

An exception that proves the rule is the MolyCorp mining operation, one of the vanishingly few U.S. sources of rare earths. Mothballed late last century, it has been reopened and is again producing REEs. But it produces mostly light REEs, not the heavier ones like gadolinium and dysprosium, which are crucial to magnet manufacture (and hence green energy applications).

Creating the infrastructure and training the engineers to make us REE independent and a major wind-power producer may take a generation. In the meantime, we rely on a country that is intimately aware of the value of rare earths, has its own aspirations for renewable energy, and is willing to use its control of REE supply for political advantage – as it did to Japan last September.

That's disturbing, but perhaps the most effective thing to take from it is the need to focus on renewables over which we have more control – like solar power. And of course, once we mention solar, we mention silver, which is key to so many solar power applications. If wind power and hybrid cars are constrained by a lack of REEs, solar and silver become even more important.

Silver hit a short-term bottom at $33 (lower than we expected) and could rally in the low $40s before backing off again. But, as we said, that's the short term. Long term, silver will go far higher as the world becomes more invested in solar power. And that doesn't even consider silver's monetary value. At an availability ratio of 10/1 with gold, we believe silver to be deeply undervalued and in the very early stages of a massive bull market.

With that in mind, we point to our five current silver picks: Endeavour Silver (NYSE:EXK), First Majestic Silver (NYSE:AG), Mag Silver (NYSEMKT:MVG), Minefinders (MFN), and Tahoe Resources (THO.CN, THOEF.PK). All of them have silver operations in politically stable areas with good transparency (not something that can be said of all miners). This helps to ensure steady, consistent levels of output, and makes them solid sources of an increasingly valuable product.

Disclosure: Leeb Group, its officers, directors, shareholders, employees and affiliated entities and/or clients of such affiliated entities may currently maintain direct or indirect ownership positions in financial instruments (i.e., stocks, bonds, options, warrants, etc.) of companies or entities whose underlying exposure is in the companies mentioned in this article.

Source: Stock Plays in Cyberdefense