Grow Your Portfolio the Intelligent Way

February 2006 Issue

By Richard C. Young

4.67 = Discipline & Patience…

The Boston Red Sox, in dramatic style, blew the 2003 American League Championship Series against the New York Yankees. As Alan Schwarz shows in his terrific The Numbers Game (buy it), Sox Manager Grady Little left in pitcher Pedro Martinez beyond his designated pitch count limit. Data from STATS, Inc. clearly indicated to the Sox that Martinez allowed a low OPS (on-base percentage plus slugging average) of .574 between a pitch count of 1 and 105. But over a pitch count of 105, the wheels came off for Pedro. His opposition OPS soared to .845. Early in the 8th inning, Pedro was over 100 pitches, but manager Little, with "gut feel," defied his pregame mandate based on STATS, Inc. intelligence and left Pedro in. Wham, wham. The Sox were done, and so was Grady (soon fired). The statistically best-prepped baseball team in the world had been derailed by a "gut feel" and lack of discipline. Absolutely stupid.

Learn Discipline

The Red Sox, like their statistically prepared cousins, the Oakland A’s, had been built on the discipline and patience of wearing pitchers out. Last year, Sox newcomer Kevin Youkilis led the majors by taking 4.57 pitches per at bat. Such discipline and patience help wear out the opposition’s starting pitchers, like Pedro, and improve a team’s chance of winning. The lack of discipline and patience at the plate, such as displayed most dramatically last year by former Red Sox and now LA Dodger Nomar Garciaparra and his 3.19 pitch per at bat number (#379 of 386 major leaguers recorded), violates the code of discipline and patience.

Working 100% against the theory of D&P, the poor Dodgers recently hired not only injury-riddled and undisciplined Nomar, but also Mr. "Gut Feel" himself, former Sox manager Grady Little. And in the process, the Dodgers have jettisoned one of the most adroit and statistically prepared GMs in the game, Paul DePodesta. Look out below.

Retirement Compounders Discipline

At Young Research, we follow an ironclad track of discipline and patience. Our in-house Retirement Compounders portfolio is the research basis for most of what I write about in these monthly strategy reports. Last year, with the Dow down 0.61% and the NASDAQ up just a scootch, our high-yielding Retirement Compounders portfolio produced an 9.56% (unaudited) total return. Our model of discipline and patience is built on a portfolio of 32 stocks—no more, no less. And our discipline and patience is rigid. Here’s why: If you hold one stock in a portfolio, you double your diversification going to two stocks. A great move. Diversification doubles again by moving to a four-stock mix and once again by jumping to an 8-stock portfolio. We can all agree such moves are practical for most investors. But how about another doubling to 16 stocks? Tough for a lot of investors, but still sensible. Finally, an advance to a 32-stock portfolio again doubles diversification. But following 32 stocks is well beyond the scope of most investors. It, however, is the number that makes most sense if money and competent research is no object.

The Number Is 32

A 32-stock well-diversified portfolio gives you well over 90% of the diversification of owning, for example, the whole NYSE. One more jump to 64 stocks is a non-starter, at least for Dick Young. The diversification gained is minimal, and the hassle and time, as well as the cost of ramping up to a 64-stock portfolio, is a true head splitter. OK, it’s 32 stocks on the nose—not 31, not 33. This exacting discipline forces us to eliminate a stock before adding a new name. It’s a discipline I aspire to for you.

Our RCs portfolio is based on discipline of both the number of stocks in the portfolio and the necessity of a dividend for each stock. It is also based on patience. Our view is long-term. We have no preset target price for elimination or ideal holding period. But should conditions change, we are prepared to make a change immediately. In truth, this is a rare occurrence, but we are not put off by such a necessity.

The current yield for our RCs is 3.63%, double the yield on the Dow and, of course, that much higher versus the S&P 500 and NASDAQ yields. And the dividend-paying, balance-sheet-strong nature of our RCs stocks makes the portfolio much less volatile than the stock market as a whole.

Counterbalancing

The strategy of teeter-totter counterbalancing is key to our research success for you. We like stocks with low volatility as well as a yield and a strong balance sheet. And we especially like stocks with high barrier-to-entry characteristics, stocks in foreign countries that we consider to be safe havens, and stocks of companies with powerful brand franchises. Finally, we like stocks that can benefit from the voracious raw materials needs of China and India. We, however, do not invest directly in any of these countries.

Burkina Faso?

You may have seen the recent Heritage Foundation report on the group’s Index of Economic Freedom. Hong Kong, Singapore, and Ireland ranked #1, #2, and #3 as economically free. Following a long list of mostly free countries, including #21 Czech Republic, #37 Taiwan, and #60 Mexico, was a long list of mostly unfree countries. Trailing even lowly Burkina Faso at #102 were China at #111, India at #121, and Russia at #122. Brazil looked positively stellar by comparison, ranking #81, but trailing even Lebanon, if you can believe it. Ask yourself, would you invest in Lebanon? OK then, we stick to countries on a little thicker ice. And we love hard and soft commodities.

Your Gain Last Year—43.8%

Perhaps my most strongly advised counterbalancing mutual fund in recent memory has been Vanguard’s Precious Metals & Mining Fund. Last year alone, your stake and mine jumped an astounding 43.8%. Your three-year average gain, as I write in early January, is 37%. Also, in just the opening round of 2006, you and I are ahead by another 6.5%. Shocking isn’t it? Well, not really when you look at my featured chart this month on America’s current account deficit. And check out Chart #24 on gold’s hypothetical value as a reserve asset; Charts #25, #26, and #27 on the collapse of the dollar; and Charts #29, #35, and #37 on the relative cheapness of gold. During December, gold hit a 25-year high, with February futures peaking at $544.50/oz.  And late in the year, platinum prices topped $1,000/oz keyed to powerhouse industrial demand. Like gold, it has been 25 years since platinum prices were this high. And the outlook for platinum is bright. Johnson Matthey (smart folk and well-regarded worldwide) reports that platinum hit an all-time high in 2005 as demand exceeded supply. South African production (where most of this stuff comes from) just can’t keep up. And JM figures demand will remain hot in 2006. Palladium demand is also hot, as jewelry has moved up to the #2 position in terms of applications for palladium.

A point missed by many investors in the gold market is that gold advanced strongly last year even as the US$ temporarily rebounded on the back of a series of Fed interest rate increases. Normally, gold prices decline as the dollar advances. Gold not only advanced as the dollar advanced, but it even outpaced gold shares in the final quarter of last year.

My positive view on gold is keyed to (1) the end of the two-decade bull market in bonds, and
(2) the U.S. trade deficit accompanied by the undervaluation in foreign currencies. With these twin factors overlaid on my gold charts, it’s easy to see how gold, along with the other precious metals, makes great sense as a portfolio counterbalancer.

Vanguard Precious Metals & Mining

Here’s a look at the companies that make up big positions in VGPMX: (1) Lonmin PLC, a huge producer of platinum. (2) Anglo Platinum, another platinum major. (3) Impala Platinum, third among the big-three platinum producers and at the top of the fund’s list. (4) Rio Tinto, a company you already know. (5) Aber Diamond has a 40% joint venture interest in the Diavik Diamond Mine, located off  Canada’s Lac de Gras in the Northwest Territories. High-end diamond retailer Harry Winston accounts for about one-third of Aber’s consolidated revenues. Winston retails diamonds through eight salons in N.Y., Beverly Hills, Las Vegas, Tokyo, Osaka, Taipei, Paris, and Geneva. Nice list. (6) Meridian Gold Company, the 27th largest gold producer in the world. Go to my Web site at YoungResearch.com for a link to a list of the world’s major gold producers. The company’s primary facility is the El Penon Gold-Silver deposit in northern Chile. (7) Peabody Energy is involved in coal production. (8) Placer Dome, a gold company of which you already know. (9) Compania de Minas Buenaventura S.A., a South American gold and silver producer. (10) BHP Billiton, the giant worldwide miner. All in all, this is a nice global mix of significant natural resource producers, including a big precious metals component. I could see VGPMX closing to new investors, so take action now so as not to get closed out. My long espoused view on precious metals is to hold a position and hope it goes down because almost everything else you own is likely to rise. But in an environment where precious metals are in demand, there is generally a good reason why, and you can ill afford not to be on board.

I’ve recommended streetTRACKS Gold Shares (a listed fund started in 2004) as a way for you to own gold. Continue to buy this nice portfolio counterbalancer.

I’ve regularly outlined my view on the rare one-ounce China gold Pandas. The rarest coins in the group are hard to buy. It’s been a struggle of late for my favored dealer PandaAmerica to round up an adequate supply of my favorites. You may well be on a waiting list especially for the exceedingly rare 1982 gold Panda. Continue to add these beautiful one-ounce gold coins to your stash. Go to PandaAmerica.com for your gold Panda needs.

Remember here, the environment for gold in the new century has flip-flopped from the environment of the 1980s and 1990s. The end of the two-decade bull market in U.S. bonds in concert with the U.S. trade deficit has reversed the rules. It’s a whole new ballgame.

Your 29.9% Gains

T. Rowe Price New Era has also been at the head of my list for a long time. Last year alone, you scored close to a 30% gain. And as I write in early January 2006, your three-year average annual total return is over 33%. New Era is an energy-based natural resources fund. Along with a broad list of energy holdings, you get a nice mix of other natural resource companies including Alcan, Archstone-Smith Trust REIT, BHP Billiton, Inco, International Paper (I like IP as a restructuring deal. Buy it.), Newmont Mining, Peabody Energy, Prologis REIT, Rio Tinto, St. Joe, Teck Cominco, and Weyerhaeuser. New Era is a decades-long core holding for me and should be big for you as well.

Third Avenue Funds = All Stars

I have owned all four of the excellent Third Avenue funds for many years and, based upon my relentless prodding, so should you. In 2005, you scored as follows: International +18% (my #1 favored mutual fund worldwide); Real Estate +14%; Small-Cap Value +11%; and Value 16% (rounding off). Your three-year average total returns are, respectively, +33%, +27%, +23%, +26%. I write more about these four funds and, for that matter, Vanguard Precious Metals & Mining and New Era than does any other strategy report writer in the country. I’ve kept you up to the minute, and I’m delighted with the results you received. Unfortunately, two of the four super Third Avenue funds are closed to new investors. Value and Small-Cap Value, however, remain open for now. The number of worthwhile funds available for you today is miniscule. As shocking as this may be, it is so. Most cannot justify the fees they charge you, especially the nasty front-end loads and back-end 12b-1 marketing scabs. As such, I would not be surprised if Third Avenue closed its final two funds. It would be a shame for sure and nothing Third Avenue would want to do. But forewarned is forearmed, so clamor on board before the train leaves the station without you.

Fidelity International for You

You know how much I like Australia, Hong Kong, and Singapore for international counterbalancing. Now you can establish a real estate foothold in these countries, as each has representation in Fidelity’s International Real Estate Fund. Today, the fund is small, and you can still be part of the team. By the time I finish writing about the fund this year, I expect the assets will be much greater, so pick up the phone now, and establish your toehold. About 21% of the portfolio is Aussie. Hong Kong counts for 15% of the portfolio and has some real nice names, including Sun Hung Kai properties.

Three More Winners

You want to own (1) iShares Singapore Index Funds (I like the Singapore REITs, and you get positions in Ascendas and Suntec); (2) iShares Australia Index Fund; and (3) Canadian General Investments Ltd. Among the fund’s largest holdings is the Saudi Arabia of uranium, Cameco (NYSE: CCJ).

One-Two Punch

I love both Wellesley and Wellington Balanced funds from Vanguard and often chart them for you on the last page of my Economic Supplement. Wellesley is 60% to 65% bonds, with the balance in high-dividend-paying common stocks—about as conservative a mix as you can get. It’s ideal for retired investors and the most paranoid among you.

Wellington is the mirror image, with stocks accounting for 60% to 70%, and bonds the balance. And Wellington’s stocks will take on more of a growth look with minor emphasis on dividends—
a nice mix for investors in their 50s.

Vanguard Equity Income

The fund is one of my oldest and largest positions, and, despite Vanguard bringing all the money in-house or to Wellington, I will continue to hold. Other outsiders have been dumped. The results may be even better over time. I’m willing to wait and see, but I am not adding for now.

Dodge & Cox Funds Are Winners

I love the Dodge & Cox committee. Unfortunately, two of D&C’s four funds are closed. You can still get into Dodge & Cox International, which is a good bet.

Blue-Chip Holland Balanced Fund

Performance has not looked great of late due to the Dow being down in 2005. HBF is a strictly blue-chip stock (mostly Dow) and full-faith-and-credit Treasuries fund. With rates moving up last year, Treasuries were only fair performers. As such, the fund’s one-two punch was not where the action was in 2005. Forget 2005, and look ahead. Blue chips are real cheap versus lesser lights. Interest rates will pose less of a threat in 2006 than in 2005. HBF is a fund for old-line, white-shoe conservative investors willing to hold the line through thick and thin. It’s not a fund for the nervous, hyper, or basically uninformed.

Brand New Buy Advice

Strictly for your IRA, I love (1) BlackRock Enhanced Dividend Achievers Trust. The fund is a listed closed-end fund that invests in domestic dividend-paying blue-chip stocks. To generate additional income, it writes covered calls on a big percentage of the holdings. The current dividend is $1.22. With a price of $13.33/share, your yield is 9.2%. And the fund sells at a discount to NAV. Pile into this cash generator for your IRA.

BlackRock Global Opportunities Equity Trust is the international version of the fund above. A nice mix and match for you. The dividend is $2.28 at $23.75/share for a 9.6% yield. Dividends are paid quarterly. The fund sells at a 6% discount from NAV.

PIMCO All Asset Fund

Bob Arnott’s eclectic mix of PIMCO Fund blends domestic and international plays to give
you a counterbalancing effect over a worldwide spectrum. The fund is one-of-a-kind and run by the editor of the erudite Financial Analyst Journal. Continue to buy.

Fixed Income

AAA municipal bonds maturing in 8/15/2005 today provide a tax-free 3.86% yield. This works out to a tax equivalent 5.76 for an investor in the 33% tax bracket and 7.7% for a resident of N.Y., R.I., or CA, for example, in the 50% bracket. Not a lot to hate here.

With short rates likely to continue ticking up
in the early going in 2006, I continue to like Vanguard’s Short-Term Investment-Grade (4.5% yield, 1.8 year duration) as a good way to ride up with the rate increases. By year-end, your yield could be over 5%.

Our in-house preferreds list now has an average yield of about 6.2%. Where you need cash to meet expenses today, you want strictly investment-grade preferreds in your IRA or your taxable portfolio. Do not pay any attention to volatility in the statement value of your preferreds. You are seeking a steady stream of cash—period. You do not buy preferreds for capital gains. And you hold each until called, unless sale is mandated by a negative shift in a company’s financials. For your non-IRA portfolio, I like the tax-advantaged Royce Value Trust 5.90% (AAA) yielding about 6.13%. And I’m keen on new issues, so have your broker alert you to some.

Full Faith & Credit

U.S. Treasuries always belong in your portfolio as stabilizers. Zeros and STRIPS work real well in your IRA. I would own a mix of maturities with an average maturity of about five years. Avoid long-term maturities.

GNMA

Among big bond funds, my strongly advised Vanguard GNMA Fund was last year’s #1 performer. I own this longtime favorite. GNMAs are the only agency securities with a full-faith-and-credit pledge. Today, the yield is pushing 5%, and the duration is short at 3.7 years. Buy!

New Equities Name

I’m adding Macquarie Infrastructure Company Trust (NYSE: MIC) to my Monster Master List. The indicated dividend is $2/share. At a price of $30.91, it provides a 6.47% yield.
The trust owns, operates, and invests in infrastructure businesses in the U.S. and other developed countries. The company’s businesses consist of airport services, airport parking, a toll road, a water utility in England, and a district energy business that provides chilled water from five plants in downtown Chicago—an eclectic mix to be sure.

2006 Investment Themes

Finally, on the individual stock front, I’m keen on three themes for 2006: (1) rails, (2) apartments, and (3) U.S. infrastructure. To participate, I like Norfolk Southern (NYSE: NSC) and Union Pacific (NYSE: UNP), Equity Residential (NYSE: EQR), and Archstone-Smith (NYSE: ASN), along with Macquarie, listed above. Now on to your questions.

Your Questions,
My Answers

Q: My broker isn’t able to purchase some of the international stocks listed on your Monster Master List.   

Your best bet for purchasing international names on my Monster Master List is to go through Fidelity. Fidelity has a dedicated international desk, and will help you determine if you are better off purchasing on a foreign exchange or on the pink sheets in the U.S. You should also be able to purchase many of my international names at Vanguard, but their international trading capabilities are more restricted. 

Q: What is the difference between U.S. Treasury TIPS and STRIPS…what is the best plan to incorporate and build them into one’s portfolio…how and where does an individual buy them?

TIPS are Treasury Inflation-Protected Securities. They provide investors with protection against inflation. The principal of TIPS increases with inflation and decreases with deflation. The inflation rate used to adjust the principal is based on the consumer price index. When TIPS mature, you are paid the adjusted principal or original principal, whichever is greater.

The interest you earn on TIPS is also adjusted for inflation. Interest payments are based on the adjusted principal value of the bond, so when the principal value increases, so do your interest
payments. 

The best way to invest in TIPS is through Vanguard’s Inflation-Protected Securities Fund. It has a rock-bottom expense ratio of 0.17%. Investors looking for income will enjoy the more frequent quarterly distributions. Individual TIPS make semi-annual interest payments. 

Today, TIPS don’t play a large role in my fixed-income investing, but if yields get up in the 3% to 4% range, I’ll start to load up. 

Treasury STRIPS are zero-coupon bonds backed by the full-faith-and-credit pledge of the U.S. Government. They trade at a deep discount to face value and pay all of the interest and principal at maturity. Don’t buy STRIPS for income. You’ll be disappointed. 

STRIPS are great in tax-deferred accounts. Today, keep your maturities under 10 years, and let compound interest work its magic. 

Q: How does one protect against a drop in the purchasing power of the dollar?

Precious metals are a good inflation hedge. History has proven that gold especially can be more reliable as a predictor of inflation than many of the economic measures such as the consumer price index (CPI) and the GDP deflator. Think globally. What countries stand to benefit from rising prices? Resource-rich Australia is sure one big beneficiary. You can access this market with iShares Australia (EWA). Add to your holdings in common stocks such as BHP Billiton (BHP) and Rio Tinto (RTP) too. Notice a trend here? Commodities are the way to go to protect against any loss in the dollar’s purchasing power. They are hard assets and during inflationary periods, the value of hard assets rises. 

Q: Should I purchase Master Limited Partnerships in a retirement account?

Owning MLPs in your tax-deferred accounts will be hazardous to your wealth. Remember, the beauty of MLPs is that they avoid taxation at the corporate level. Owning them in tax-deferred accounts means there is nobody left to pick up the tax bill, and we all know how the government feels about getting cheated out of tax revenue. If you earn more than $1,000 from MLPs, you will have to report the income as unrelated business taxable income (UBTI). In the end, you will wind up paying taxes in a tax-deferred account. I love MLPs, but only in your taxable accounts. 

Q: Can you spend more time on the financials and less time on politics?

No. The link between politics and finance is so powerful it would be downright neglectful of me to avoid political issues in my writings. I’ll point you to the front page of January’s IR and the accompanying charts.  The Presidential Cycle Charts show just how big of a role politics can play in market returns. It’s not just stocks; GDP and bond returns are all influenced by the Presidential Cycle as well. And don’t forget the effects politics can have on individual companies, sectors, and/or industries.  Regulatory issues, legislation, and tax changes can sharply alter your returns in almost any asset. Just think back to the recent passing of S. 397, which drastically limited the liability gun manufacturers face when selling their products. If you think that didn’t have any major effect in the financial world, I bet the folks at Sturm, Ruger (NYSE: RGR) and Smith & Wesson (AMEX: SWB) would beg to differ. Politics also play a large role in global investment opportunities. An isolationist shift in Washington does not bode well for China or Japan, both net exporters to the U.S.

Q: I just purchased BlackRock Dividend Achievers Trust within the last month, and it’s down. Is BlackRock Dividend Achievers going to be a non-performer in 2006 like it was during 2005? 

BlackRock Dividend Achievers is a closed-end fund comprising a highly select group dividend-paying stocks that have increased their dividend in each of the last 10 years.  In 2004, out of the 15,000+ publicly traded companies, only 298 made the cut. From that set of 298, BlackRock selects between 65 and 90 companies by considering sectors, industries, capitalization, volatility, and future prospects. The fund’s managed distribution policy makes it an ideal selection for investors looking for income or for an IRA. At today’s price, the fund yields 7.2% and trades at a 13% discount to net asset value. That’s like buying $1 for $0.87. BDV continues as a solid choice for investors saving for retirement or in retirement. And remember, the blue-chip Dow was down last year as well.

Q: Why don’t you recommend corporate bonds?

Individual investors are at a huge disadvantage to the institutions who dominate the game. The commissions on corporates are opaque. Smaller quantities can be illiquid, and it’s difficult to build a diversified corporate bond portfolio. Individuals should stick to exchange-traded preferreds and no-load, low-cost Vanguard bond funds.     

Q: Dick, we (as a country) are unprepared for any type of disaster, especially a large-scale attack. The lack of preparedness from the population in New Orleans is an example because if you or I like it or not, there is a "sub class" that exists in our country and they and the "ambulance chaser lawyers" are ready to grab any cash they think they can. If I was the leader of a country such as Iran or China who was looking to exploit any weakness they could discover in the U.S., the tapes of riots and looting in N.O. are examples of what I would look to use to guide my policy. How would you advise investors to invest in light of this thought?

For your family’s personal defense, your first investments should be a QUALCOMM satellite phone, a Special Operations series ultra-high output flashlight from Sure Fire, and a 0.45 Caliber Super Redhawk Alaskan from Sturm, Ruger or a Smith & Wesson monster 460 XVR 0.45. Put Black Ice on speed dial, and stock up on boxes of ammo for your 0.45. If things get ugly, like they did in New Orleans, you’ll absolutely want to be prepared to keep your family safe. 

With your portfolio, you want to follow my four-point plan:

1) Make sure your blue-chip fixed-income component is maxed out. When fear engulfs the market, there is a flight to safety. Safety means full-faith-and-credit U.S. Treasuries. Your fixed-income component will vary based on your age, risk tolerance, and investment objectives. Investors nearing retirement should consider nothing less than 30%. Those in retirement will want up to 75% fixed. 

2) Go global. If the U.S. is attacked, foreign companies will fare better than their U.S. counterparts. Avoid countries where corruption is rampant, disclosure is poor, or the natives are hostile. Some countries I favor for going global are Australia, Canada, New Zealand, Norway, Singapore, and Ireland.

3) Own some gold. Gold is your number-one doomsday ally. It has an unsurpassed history as a store of value and is the only currency universally accepted in every country in the world. You can add gold to your portfolio through my favored street­TRACKS Gold Shares or by purchasing my advised gold stocks. And, of course, gold Pandas, as well as Canadian, American, and South African bullion coins, are always nice holdings to put in your safe. 

4) Be patient. Don’t liquidate your portfolio in a frenzied panic and fall victim to emotionalism—an investor’s nastiest foe.  The U.S. economy and stock market have shown amazing resilience in the face of past wars, terrorist attacks, and major natural disasters. Funds like the fortress-like all-blue-chip Holland Balanced Fund work well in times of market stress.

Q:  During retirement, you advocate a 4% draw from an investor’s portfolio. If my portfolio doesn’t generate 4% in income, what should I do?

My 4% draw is based on a combination of income and capital gains. In today’s low-yielding environment, if the income generated on your portfolio falls short of 4%, don’t sweat it. You can make up the difference by selling off a small portion of your holdings. As long as you aren’t satisfying the majority of your draw with sales, your portfolio will be fine.      

Q:  How and where can I sell my gold Pandas?

Your gold Pandas aren’t meant to be traded. They are long-term investments. Put them away someplace safe. Down the road, if you want to sell, PandaAmerica will purchase them from you. Price will depend on supply and demand of the specific coin you are selling.

Q:  I was out of the country for four months. I get home to read my back issues of IR. In September, you advised that one "load up" on T. Rowe Price New Asia. I get to the December letter, and now the advice is to sell. I’m confused…with regards.

The famous British economist John Maynard Keynes used to say, "When the facts change, I change my mind. What do you do sir?"     

Some of you sent in questions about stocks that have underperformed this year. I’ll address each below.

Pipeline Master Limited Partnerships

Included in this group are Kinder Morgan Energy Partners (NYSE: KMP), Valero L.P. (NYSE: VLI), and Buckeye Partners (NYSE: BPL). The price of MLP stocks has sold off in the last couple of months. Concerns over rising interest rates and a flood of new issues have caused investors to overlook the outstanding investments that are pipeline MLPs. At today’s depressed prices, you earn a tax-advantaged yield of more than 6.5%. You can expect distributions to grow with inflation, maybe 3% per year. Add the two together, and you are looking at an estimated long-term return of 9.5% on a low risk business. Continue to buy.

Coal Master Limited Partnerships

Alliance Resource Partners (NASDAQ: ARLP) and Natural Resource Partners (NYSE: NRP) are included in this group. Coal MLPs have been pressured by the same things affecting the pipeline MLPs. Plus the price of coal has come down over the last couple of months. Coal is used to generate over 50% of the electricity in the U.S., and it’s a much cheaper alternative than natural gas. The price weakness is an opportunity to add to your positions in Alliance Resource Partners and Natural Resource Partners. More conservative investors will want to stick to the more conservative royalty coal exposure that NRP offers.   

Meanwhile, Polaris (NYSE: PII) shares have been hurt by an industrywide slowdown in ATV sales. Call it a rough patch, and look for better days ahead. Polaris is a leading innovator in the industry and a well-run company. The shares sell for less than 15X earnings and yield 2.3%. The company has little debt and buys back loads of its stock each year. Stay with Polaris.

Q:  Why do you recommend Vanguard Short-term Investment-Grade at a 4.47% yield when Vanguard Long-Term Investment-Grade yields a much higher 5.39%? Can you invest in Long-Term now and switch to Short-Term if interest rates go higher? 

My research has shown that over long periods there is no reason to take on the gut-wrenching volatility of long-term bonds. Intermediate-term bonds often provide a higher return with substantially less risk. The higher yield on Vanguard Long-Term Investment-Grade is a result of the fund’s lower average credit quality and higher average duration. Duration is a measure of a bond’s sensitivity to interest rates. For every 1% increase in interest rates, a bond’s price will decrease by its duration, in percentage terms. Vanguard Long-Term Investment-Grade has a duration of 11.1 versus 1.8 for Vanguard Short-Term Investment-Grade. 

Q:  Some of the preferreds you recommend are rated BBB+. I thought you said to only buy A rated preferreds and higher. Should I reinvest preferred dividends, if not, how can I compound interest on preferreds if they don’t reinvest? 

You can purchase preferreds rated lower than A if I recommend them in my report. If you are building a preferreds portfolio that includes names I haven’t included in my report, you should stick to A rated or better. 

You can make the call on whether or not you want to reinvest the income generated on your preferreds. If you don’t reinvest preferred dividends, you can use the income they generate as a source of cash to purchase new issues. You’ll still compound the income they generate because they will be swept into an interest-bearing money market account until you can put them to work in another high-yielding preferred issue. 

Down the Road

You know the importance I place on the Presidential Cycle. The tough years in the current four-year cycle are 2005 and 2006. With history as our guide, the big years should be 2007 and 2008. Thus it is probable that as 2006 progresses, stock market risk will be reduced. Interest rates in 2006 will not be the problem they were last year. You need to set yourself so that by the close of 2006 you have for you what is a satisfactory exposure to equities. Conservative investors will always stick exclusively with dividend-paying stocks. Given the structurally weak position for the US$ and the U.S. trade deficit, a substantial international portfolio component is mandated. And natural resources, including precious metals, work well in this regard. My Top-10 Countdown (Economic Supplement) is your place to look first for new names to add to your equities list. President Bush is doing a whole lot better than the liberal media would allow, as my Economic Supplement demonstrates. It’s not a bad start for the new year. Make it a good month.

Warm regards,

Richard Young signature

Richard C. Young

P.S. China has a voracious demand for commodities of every type. For example, China now consumes annually 20% of the world’s copper supplies and imports nearly one-third of its oil, 45% of its iron, and well over 40% of its needs for 10 nonferrous metals. And serious water shortages and shortages in various soft commodities add to the country’s import needs. Next month, I’ll have a lot for you on China as well as India and the implications for U.S. investors.

P.P.S. Apple’s iPod is a huge success. Go to YoungResearch.com for info on two really neat products for iPod owners. If you’re still not on board this breathtaking music product, you soon will be. Also, posted for you is my updated essential music suggestion: this month—from the guy who backboned all those great R&B sounds from Stax records in the 1960s—something quite special.

P.P.P.S. Next month, a look at the super-fast-rising leader of the conservative wing of the U.S. House; the country ranked by IMD as the most resilient economy in the world; and the vital energy status of ethanol, including the country that is the Saudi Arabia of Ethanol.

Richard C. Young’s Intelligence Report® (ISSN 0884-3031) is published monthly by Phillips Investment Resources, LLC, 9420 Key West Ave., Rockville, MD 20850. Please write or call if you have any questions. Phone: 301/424-3700 or 800/301-8968. E-mail: service@intelligencereport.com. Web address: . Editor: Richard C. Young; Group Publisher: Michael Bell; Chairman: Thomas L. Phillips; Associate Editor: Deborah L. Young; Marketing Manager: Jim Brinkhoff; President: John J. Coyle; Research Director: Jeremy Jones, CFA; Sr. Managing Editor: Shannon Miller; Business Manager: Thomas C. Burne; Research Associate: Rebecca L. Young; Editorial Assistant: Danielle Hart; Sr. Vice President: Christopher Marett; Subscriptions: $249 per year. © 2006 by Phillips Investment Resources, LLC, Founding Member of the Newsletter Publishers Association of America. Photocopying, reproduction or quotation strictly prohibited without the written permission of the publisher. While the information provided is based upon sources believed to be reliable, its accuracy cannot be guaranteed, nor can the publication be considered liable for the investment performance of any securities or strategies mentioned. Subscribers should review the full disclaimer and securities holdings disclosure policy at /disclosure.php or call 800/219-8592 for a mailed copy. Periodicals postage rates paid at Rockville, MD, and at additional mailing offices. Postmaster: Send address changes to Richard C. Young’s Intelligence Report, Phillips Investment Resources, LLC, 2420A Gehman Lane, Lancaster, PA 17602.

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