secret garden: Barron's 2011 Roundtable, Part Two -- All Over the Map

Source:http://online.barrons.com/article/SB50001424052970204853904576090250370348320.html?mod=BOL_twm_fs#articleTabs_panel_article%3D1

By LAUREN R. RUBLIN | MORE ARTICLES BY AUTHOR
In the second installment of the Roundtable, our pros' picks range widely over commodities, previous metals, financial stocks and big-cap tech. Two better-than-bonds plays.

If you read the first installment of this year's Barron'sRoundtable, you already know the sky is falling–but very, very slowly. It could take another year, or two or four, before the dollar tumbles, the euro crumbles and the price of gold, that great hedge against disaster, makes its way to the stratosphere.

Meanwhile, back here on earth, shrewd investors can find bargains aplenty among stocks, bonds, funds and even futures, as well as other neat ways to profit in a high-anxiety, ultra-low-interest-rate world. We rounded up 10 such investors two weeks ago, and sat them down at the Harvard Club of New York for a long day of intense conversation on where in the world to invest in 2011.

Last week we shared the big-picture views of these market savants. This week's installment -- the second of three -- typically features the investment picks and pans of several panelists. But those big, important issues, from economics to policy to politics, kept sneaking back into the conversation all day long, providing the basis for broad, thematic investment recommendations.

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Brad Trent for Barron's

Thus, Felix Zulauf, head of Zulauf Asset Management in Zug, Switzerland, one of the savviest observers anywhere of the global investment scene, delivered a masterful disquisition on the bright past, rocky present and troubling future of the European Union, while Fred Hickey, editor of the not-to-be-missed High-Tech Strategist, published in Nashua, N.H., held forth eloquently on why gold is heading higher (in his case, to Canada) and many tech stocks, lower.

Then there was Pimco's Bill Gross, master of the universe of bonds. Few anywhere could better explain why the Federal Reserve's money-printing policies, which have promoted negative interest rates after inflation's effect, are tantamount to stealing from savers -- or how to profit from the insult.

Only Archie MacAllaster, head of New York's MacAllaster Pitfield MacKay, stuck to script, or plain old stock-picking, without a whole lot of color commentary. Then again, the dividends paid by his favorite financial concerns are colorful enough for almost any portfolio.

All four market pros are featured in this week's issue, along with the rest of the well-informed crew. It makes for lively, thought-provoking reading and, we hope, profit-provoking investments.

Felix, what advice can you give us today?

Zulauf: A lot of the good news already is in stock prices. The market will move sideways this year, but fluctuate widely. There is a lot of optimism around. I rarely have seen as much concentrated optimism in professional circles as I see today. Yet there are plenty of risks that could scare the market from time to time. There could be a crisis in the municipal-bond market. Spain could turn into another Ireland. Bond yields will go up, and so forth. I want to be long volatility. I would buy VIX [Chicago Board Options Exchange Market Volatility Index] futures. This is a small market that trades maybe 30,000 contracts a day. The VIX spot price is 17. The February futures are trading at 21, the June futures at 25. The last time the market corrected, from last April to July, the VIX went to 48 or so from 17. We will see something like that again, probably in the first half of this year.

Schafer: Felix, are you betting on a sharp decline? If stocks go down slowly, you won't get the benefit of a spike in volatility.

Zulauf: I'm betting on occasional scares that shake the market. It is too early for stocks to fall in a sloping, bear-market fashion. That is some years out. A VIX futures contract is 1,000 times the index. If the index is at 20, one contract costs $20,000.

Felix Zulauf's Picks

Long	Ticker	Price 1/7/11
CBOE VIX futures*		$21.00
iPath DJ-UBS Grains Total Return Subindex ETN	JJG	51.12
Uranium Participation	U.Canada	C$8.05
Short
Italian government bond futures**		€109.10
Euro Stoxx Bank Index futures**		158.90
* February 2011 contract. ** March 2011 contract . Source: Bloomberg

The most important factor in the world economy is the rise of emerging economies and their convergence with developed economies. That is a long-term theme, and it brings me to my next idea: agricultural commodities. There is a growing middle class in the emerging world, with growing spending power. As low-income people enter the middle class, they change their diets and take in more calories. Income growth makes for more meat consumption, which is good for grain, because you need a lot of grain to grow cattle and pigs. In addition, agricultural commodities are used for biofuels, which removes supply from the market for food.

Witmer: The federal ethanol mandate results in more than 30% of our corn production being used for ethanol. It is a crazy policy that Congress could and should change.

Black: No one who wants to run for president can be against the Iowa caucus.

Zulauf: In the U.S., annual consumption of meat is 130 kilograms (286 pounds) per capita. In the European Union it is about 100 kilos. In China it is 55 kilos, and it was 39 kilos 10 years ago. In India it is at only seven kilos, so there is a long way to go. In 1980 Taiwan was at a development stage similar to China's today. Since then, Taiwanese meat consumption per capita has doubled from 43 kilos to more than 90 kilos. By 2030, China's meat consumption could be 85 to 90 kilos.

It takes about six kilos of grain to produce one kilo of beef. It also takes 4,000 gallons of water. If I had a good water play, I would discuss it here. On the supply side, available land is diminishing. We can't get water to some land. We are diverting other land to production for biofuels. The situation is compounded by La Niña, a weather phenomenon that cools the Pacific, disrupting harvests. Combine that with constant volcanic eruptions in Eastern Russia, which affect the Arctic, leading to more flooding in Southeast Asia and Australia, which is occurring now. It will lead to stronger monsoons in India and droughts in Latin America, Russia and the Ukraine, and potentially the Northern U.S.

2010 Roundtable Report Card

2010 Mid-Year Roundtable Report Card

That's a lovely forecast.

Zulauf: We can expect below-average harvests in the Southern Hemisphere, and potentially in the Northern. All these factors support the continuation of the bull cycle in agricultural commodities. Prices have run up recently and are overheated. They might correct 5% or so in the next two months, but then I would buy the grains and soybeans. For individual investors who don't play the futures market, there is an exchange-traded fund, the JJG [iPath DJ-UBS Grains Total Return Subindex]. It is 37.5% corn, 37.5% soybeans, and the rest is wheat.

My next recommendation is in energy, because the rise of emerging economies also leads to rising energy demand. Electricity demand probably will double in emerging markets in the next 20 years. I would buy uranium. It is used to power nuclear plants, and it is used for medical diagnoses and research. There are 441 nuclear reactors operating in the world. They require 185 million ounces of uranium per year. There are 331 proposals to build new reactors. Fifty-eight new reactors are under construction, up from 52 a year ago, and 148 reactors are planned, including 110 that will come onstream in the next 10 years. Twenty reactors will be shut down. The demand side looks solid for many years.

And the supply side?

Zulauf: Uranium production is growing, but slowly. Annual production is 47,000 tons. It meets only 60% of demand; the rest is met from utility stockpiles or decommissioned nuclear weapons. Production will increase over time, but it could take 10 years or more until it is sufficient to meet demand. There are a number of uranium mining companies, but I prefer to invest in the commodity through Uranium Participation Corp. [ticker: U.Canada], a holding company listed on the Toronto Stock Exchange. It invests at least 85% of its funds in uranium. The market capitalization is about $800 million [Canadian dollars] and the stock trades at C$8. The high in 2007 was C$18. The low in 2008 was C$5. The company buys and stores physical uranium. It is managed by a subsidiary of Denison Mines [DNN].

Schafer: Does Uranium Participation sell at a premium or discount to the price of uranium?

Zulauf: You are paying virtually the spot price. You can buy uranium futures, but they aren't very liquid. Here you are buying uranium in warehouses -- in Europe, Canada and the U.S.

Black: Does somebody do a physical inventory to make sure it's there?

Zulauf: They may hire you to do that. The price of uranium has moved around. The spot price hit a high in 2007 at close to $140 a pound. Then it fell to $40. It correlates highly with the price of oil.

Gabelli: How does the manager of this company make money?

Zulauf: It gets a management fee. Next topic: the situation in Europe. It is an epic drama, with more chapters to be written. From its birth, the euro was a misconstruction, with different economies, structures and productivities forced to have one currency, interest rate and monetary policy. Over time that creates tremendous imbalances between surplus and deficit countries. The bond markets mispriced bonds for some years, as the yields among the different countries converged. Now spreads are widening again, due to Germany's strength and the weakness in peripheral euro-zone economies. The financial crisis showed that Greece was basically bust.

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Brad Trent for Barron's

From left: Bill Gross, Archie MacAllaster, Fred Hickey and Felix Zulauf

In old times Greece would have devalued its currency and probably defaulted on its debt. The European Union wouldn't allow that, as it likely would have triggered another banking crisis in Europe. So Greece received more credit and has to get its budget in order, cutting spending and raising taxes. The result will be a recession for years to come. Even though they are raising tax rates, tax revenue probably won't go up because the economy keeps weakening. They are trapped in a deflationary spiral, and eventually there has to be a political decision that Greece will default. The bailout financed them fully for two years, so the problem could come in 2013.

Gross: There is another way that leakage occurs. When depositors no longer have confidence in Greek banking institutions, the money goes to the U.S. or Switzerland. It is not just the official debt but the deposits of the country that have to be secured.

Zulauf: That's a good point. You see the same thing now in Spain and Italy; the banking industry's deposit base is going down. In 2009 the banks in Europe bought 90% of all the government paper issued. With the deposit base falling, medium-size banks in these countries can't get cheap financing from the ECB [European Central Bank]. They have to compete in the market, and market rates are going up. Funding costs are at 4% or higher in Italy and Spain. This will probably lead to a financial crisis in the first few months of this year, because the banking industry in Europe will be unable to buy all the paper coming to market.

There are several ways to play this. You could short the euro against other currencies, including the dollar, which is trading at $1.295 to the euro. It could go below $1.20, but not for the whole year. That is why I would trade the position, not approach it as an investor. You could also short the European bond market. There are inefficiencies here. Italy is fundamentally sounder than Spain, but because 60% of Italy's debt is in domestic hands and only 40% of Spanish government paper is owned locally, Spain gets a double-A-plus rating from Standard & Poor's, while Italy gets an A-plus. Yet Spain's 10-year government-bond yield is 5.50%, and Italy's is 4.79%. There will be a refinancing crisis in Italy this spring, as the government has to refinance about €250 billion of debt. You could play it by shorting futures on Italian government bonds. Alternately, you could short the European banks.

How would you do that?

Zulauf: I would short Euro Stoxx Banks Index [SX7E] futures. The index trades at €160. One futures contract costs 50 times as much. The index might bounce in the short term, so it might be best to short the futures step by step. The index has a P/E [price/earnings multiple] of about 13 times 2011 bank earnings. The dividend yield is 3.5%, and the price to book value is 1.2.

MacAllaster: Would you short the Swiss banks too?

Zulauf: UBS [UBS] was the bank with the biggest problem, but it is working on it and has made good progress. It holds relatively little European paper compared with French and German banks, which are the most exposed.

Gross: Germany is at the core of the EU. It has a decent balance sheet and is an export dynamo, and it is prosperous in these relatively unprosperous times. To the extent that almost every other European market becomes infected, Germany is the recipient of funds seeking safety. But if Euroland has another financial crisis, funds in Germany might flee to the U.K. or the U.S.

Zulauf: The U.K. isn't a good place to flee to. But I agree that eventually German paper will be contaminated, because this is a political issue. The euro isn't just a currency. It is the symbol of European integration after the Continent's centuries of bloody battles. No government wants to enter the history books as the one that destroyed the symbol of European integration, and that is why the political will is there to hold on, even if the currency is a misconstruction. If you hold on, however, there are implications. Eventually you have to move from a monetary union to a transfer union. The Germans don't like that idea because they will have to pay for it. All they can do is bargain for a step-by-step approach to limit their potential liabilities.

Finally, I have talked about gold many times. Structural trends are in place for a continued rise of public-sector debt in the industrialized countries, a continued monetization of debt and continued debasement of currencies, all of which are bullish long-term for gold. The price of gold has run up to an extreme point, and gold is technically vulnerable to a big shakeout this year, particularly if emerging markets tighten and lift real interest rates. But shakeouts will be followed by higher prices, and would just represent opportunities to buy. Gold could fall to $1,150 or $1,200 from $1,370 now. I would be a buyer at those levels.

How high is the upside?

Zulauf: Unlimited. What [Federal Reserve Chairman Ben] Bernanke is doing [buying up government debt to force down interest rates], others will do. The European Central Bank has tried to resist quantitative easing. It was the one major central bank that tried to sell part of the paper it bought on an emergency basis during the financial crisis. The first time it tried, it triggered the Greek crisis. The second time, it triggered the Irish crisis. Therefore, the ECB has to handle the European situation in a way that the weakest economies in the EU can survive. That forces it into monetary easing for a long time. That is bullish for gold. I don't know how high it can go, but I will give you a call when I think the run-up is over.

Do you like any gold stocks?

Zulauf: I am not a big fan of the stocks. The real costs for gold companies are rising about 15% a year. I would rather buy the physical stuff. There will be a time when the mining stocks outperform physical gold, but you have to time it.

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Jennifer Altman for Barron's

Felix Zulauf

Faber: How many people in this room have more than 5% of their financial assets -- not their clients' but their own -- in gold? [Hands go up.]

MacAllaster: Ask how many have zero.

Faber: OK, who has zero? [More hands are raised.]

It's about even.

Zulauf: So despite the hoopla, investors don't own a lot of gold. As I mentioned earlier today, the value of the world's gold now represents only 0.6% the market capitalization of global equities, bonds and money-market funds, well below a peak of 3% in 1980. To get back to 3% would require about 65,000 tons of gold, or 20 to 25 years of production.

Cohen: One could argue that a ratio of equity-market capitalization isn't the right way to look at it because there have been so many changes in corporate structure since 1980. For example, 20 years ago the German corporate use of equities was small and the use of public markets wasn't significant, since so much was financed by the banking sector. There have also been large increases in equity capitalization in many emerging markets.

Zulauf: I'm not saying that ratio is the right ratio. I'm just giving you an example of how gold compares to some financial assets. Emerging markets have always debased their currencies, and the same is true for us. Gold traditionally has been the way to store wealth in the developing world, and it has fulfilled its role well. Those who had gold in Indonesia or Brazil or Russia were well off when the currencies collapsed.

Gross: Stocks and bonds and real estate have also been a good store of value. The question is, what would be a better store of value?

Black: Why not platinum or palladium, or diamonds?

Hickey: There are big spreads in diamond prices. How to value them is a problem. With a gold coin or bullion, everyone knows its value.

Gross: That was really good, Felix. Thank you.

Agreed. Archie, you're next.

MacAllaster: I am moderately bullish short-term. The market has had a pretty good run, so it could sell off some. On a one-year basis we will come out all right, and on a 20-year basis we will come out very well. My first stock is Manulife Financial [MFC]. The company is based in Canada and the stock sells in New York for about 17.50 a share. Manulife is a major life insurer. It owns John Hancock and does about 54% of its business in the U.S. Another 25% or 26% comes from Canada, and maybe 16% from the Far East and Japan. The stock sold for 47 a share in 2007, before everything hit the fan. They ran into big problems with their annuities, mostly variable annuities, on which they had guaranteed minimum payments. When the Dow went to 6500 from 14,000 they had to release a lot of the money from reserves, which really hurt them. Manulife probably lost 70 to 75 cents a share in 2010. Tangible book value is between $14 and $15 a share. Earnings peaked at $2.81 in 2007. Traditionally this company and many like it traded at substantial premiums to earnings. They don't anymore. My earnings estimate for 2011 is about $2 a share.

What else do they own?

MacAllaster: Manulife manages a couple of hundred billion of life-insurance assets. It also manages about $450 billion of mutual funds and other assets. Growth in Canada isn't great. The company is growing in the U.S., and growing rapidly in the Far East, perhaps by as much as 50% a year. It pays a 52-cent dividend and yields about 3%.

Archie MacAllaster's Picks

Company	Ticker	Price 1/7/11
Manulife Financial	MFC	$17.75
Hartford Financial Svcs warrants	HIG/WS	19.11
Wells Fargo	WFC	31.50
MetLife	MET	46.07
Delta Air Lines	DAL	13.00
Allied World Assurance	AWH	58.23
Source: Bloomberg

I also like Hartford Financial Services [HIG], another insurer. It closed Friday [Jan. 7] at 27.76. I am not recommending the common but the warrants, which were issued in connection with the company receiving help from the federal government during the financial crisis. The government was given warrants and has sold them. The warrants give holders the right to buy the common stock at $9.79 a share, with an expiration date of June 26, 2019. If you are betting that Hartford is going higher, you could make a much better return on your capital by buying the warrants than the common. Conversely, if the stock goes lower, you will lose a higher percentage on your investment than if you owned the common.

How much are you paying for a warrant?

MacAllaster: About $19. At its peak, Hartford paid a dividend of more than $2 a share, but the dividend has been cut to 20 cents annually. The company could earn about $3 a share this year and $3.50 in 2012. It earned more than $9 in 2007. The stock sells for 62% of book value. Hartford has repaid the government, and should be able to raise its dividend this year. The way I look at it, the company's problems with variable annuities weren't a present-day cost. That kind of liability would have been spread out over many years, so they really weren't in trouble. Practically all the old life-insurance companies are cheap these days.

I'm recommending only one bank, as I'm nervous about how long it will take the banks to get out of the mess they are in. But I like Wells Fargo[WFC] and always have. The stock is 31.50 and the dividend is 20 cents a share, down from $1.36 in 2009. They are asking permission to raise it. Book value is $22.50 a share. The bank earned maybe $2.35 a share last year [Wells Fargo reported 2010 results Wednesday, earning $2.21 a share], and will do about $3 this year, which gets it a P/E of 10.5 times earnings. This is a real growth company. It makes the highest return on capital of any of the large banks, and is an excellent long-term buy.

Let's hope so.

MacAllaster: I like big stocks these days, such as MetLife, which closed Friday at 46.07. The dividend is 74 cents, and has been for two or three years. Book value is $52 a share, above the market value. Earnings for 2010 are estimated to be $4.30 a share, and the company will earn $5.25 a share this year. It sells for 8.8 times expected earnings. The stock was as high as 71 a share in 2007. MetLife has grown a good deal larger with the purchase last year of some of the foreign operations of AIG [American International Group (AIG)]. MetLife paid a lot and the deal won't be accretive to earnings this year, although it will be next year. There is a good chance the company will increase its dividend this year. MetLife is conservatively run. The company's stock got hurt badly in the past few years but its operations didn't. They were never in any kind of trouble. They never borrowed money from the government. The stock was mispriced when it fell below 20 a share in 2008. It is one of the best buys around.

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Archie MacAllaster

Delta Air Lines [DAL] is more speculative and doesn't pay a dividend. Shares trade at 13 apiece. Delta emerged from bankruptcy protection in 2007. It has annual revenue of about $32 billion, and could earn $1.75 a share for 2010. [The company reported Tuesday that it earned $1.71 a share last year, on revenue of $31.8 billion.] It could earn $2.25 in 2011. The P/E is 5.6. The airline industry has had its troubles, but things will turn out differently this time. When you got a little run in the stocks in the past, you sold them, because everybody knew that at some point the companies would all go bankrupt.

Witmer: The industry had no discipline. It just kept adding to capacity.

Zulauf: The airline industry as a whole has never made money.

MacAllaster: Delta made money for years, but not recently.

Gabelli: You know the story. If you want to be a millionaire, you start with a billion and buy an airline.

MacAllaster: I guess you are telling me you agree it's speculative. Four airlines in the U.S. do 70% of the business. It is a quasi-monopoly, and the industry will have some pretty good years. Delta has about $17 billion of debt and hopes to pay off a couple of billion a year for the next two or three years. In that time the stock could trade for as much as eight times earnings. That would make it worth as much as 18 a share by the end of this year, and 24 a share in 2012.

Does Delta pay any taxes on earnings?

MacAllaster: No. The company is still benefiting from tax-loss carryforwards because of the money it lost previously. My next stock isAllied World Assurance [AWH], an insurance company. It was domiciled in Bermuda but moved to Switzerland. The stock trades on the Big Board [New York Stock Exchange] for 58.23. It was formed about 10 years ago by a bunch of institutions, including Goldman Sachs [GS] and Chubb [CB]. Goldman sold a large amount of stock back to Allied at 50 a share about six months ago. Allied specializes in reinsurance. It is expected to show $8 a share in earnings for 2010. Tangible book is $72.40 a share. The company earns about 12.7% on book.

What is your earnings outlook for 2011?

MacAllaster: That is a little harder to figure. The company is a very good underwriter. Some insurance rates have come down in the past year and a half. Allied has turned down some business. Premiums are flat to a little down. The stock ought to sell at least at book value. The company is generating a lot of cash. It pays an annual dividend of 80 cents a share, which it has been raising. The dividend could rise again this year, perhaps to a dollar.

I would like to mention Supervalu [SVU], the grocery retailer, but it isn't a formal pick, as I was selling it in December to take a tax loss. I recommended it last year and it didn't treat me or your readers well. [The stock was down 24% in 2010.] The company has about $38 billion of sales and probably will make $1.20 to $1.30 a share in the fiscal year that ends next month. That could go up to $1.35 a share in fiscal 2012, and then $1.40. It sells for 8.66

Why did it sell off?

MacAllaster: First, they bought Albertsons and ended up with about $7.5 billion of debt. They spent three years paying it down -- they paid off $500 million to $700 million a year -- and then were criticized for not upgrading their stores fast enough. It is hard to do both. The analysts all say "Sell, sell, sell," but here you've got an 8.66 stock that will earn $1.40 a year, and it yields 4%. I don't know what is going to happen, but I have to think some other operator or financial genius can figure out a way to make a buck on this. Supervalu is one of the largest food merchandisers in America.

My six recommendations trade for 8.1 times 2011 earnings, on average, and all but Delta pay a dividend.

Thanks for catching us up. Fred?

Hickey: To start, I have reduced my position in gold because the gold price was up 10 years in a row and it is a little extreme to have 70% or 80% of my wealth in gold. We have already talked gold to death here so I won't dwell on it, except to say that gold has been in a 10-year bull market without the speculative phase occurring yet. That phase is still ahead of us, and I want to be there for it. Felix has been advising me for some years now to have some of my gold outside the country, and I have a pick for that: the Sprott Physical Gold Trust [PHYS]. It is a closed-end fund.

Gabelli: It sells at a 7% premium to net asset value.

Hickey: Not so. The premium has been as high as 7%, but as of Friday it was 1.85%. In fact, it has been as high as 24%. This fund has been in existence for less than a year. If you buy gold coins, you're going to pay a premium of about 4%. So you are getting this at a discount right now. What attracted me is that Sprott stores gold outside the U.S, in the Royal Canadian Mint. The maximum fee management can charge is 65 basis points of assets. I am storing gold outside the U.S. in case I have to leave the country. [Nervous laughter around the room] They will deliver it to me anywhere in the world. You need to have at least 400 to 500 ounces of gold to get it delivered to you.

Fred Hickey's Picks

Company	Ticker	Price 1/7/11
Sprott Physical Gold Trust	PHYS	$11.85
Yamana Gold	AUY	11.86
Newmont Mining	NEM	56.89
eBay	EBAY	27.7
Microsoft	MSFT	28.6
BONDS	Price/Yield 1/7/11
2-Yr Canadian Govt Bonds	$99.61/1.7%

Source: Bloomberg

That won't help you if you're on the run.

Hickey: I am not going to be on the run. I want to store gold outside the U.S. because I am concerned about where this country is heading. Owning this helps me sleep at night. I moved some of the money I had in gold ETFs into this particular fund, which now has a billion dollars in assets. Another advantage is that if you file the right QEF [Qualified Election Fund] form with the Internal Revenue Service, your gains will be taxed at the 15% long-term capital-gains rate.

I also own some gold-mining stocks. Felix said the miners' production costs have been rising by 15% a year, but my research indicates they have been rising by 7% to 7.5% a year. Production costs at Newmont Mining[NEM], the largest gold miner, were $239 per ounce in the middle of 2000. They are $490 now.

Zulauf: I was referring to all costs, including the initial cost of finding an ounce of gold.

Hickey: I would agree with that. The price of gold has risen 16% a year, compounded, in this 10-year bull market. Gold stocks haven't kept up. My two gold stocks will have strong future earnings. The first is Yamana Gold [AUY], which is selling for under 12 a share. The market cap is about $8.8 billion. The company made five major acquisitions over a period of years. It had some trouble digesting them, but now is turning its operations around. In the past few quarters earnings have started to grow. Yet the P/E ratio on 2011 estimates is only 13 times. Revenue and operating cash flow are also growing rapidly.

Black: The stock trades close to tangible book value.

Hickey: If you put a 20 P/E on the 89-cent earnings estimate for next year, you are looking at an $18 stock. That is up 50% from this year. My second gold stock is Newmont Mining. The P/E on trailing earnings was 30 times a year ago. Now it is trading at 14 times last year's earnings, and only 11.8 times 2011 estimates. And those estimates probably are too low. Newmont is trading for 57 a share. It is expected to earn $1.08 a share for the fourth quarter, when the average realized price for gold was $1,220 an ounce. Gold is considerably higher now.

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Jennifer Altman for Barron's

Fred Hickey

Doesn't Newmont mine copper, as well?

Hickey: They have a big copper operation. The average realized price for copper in the third quarter was $3.67 a pound. It moved up to $4.30 in the fourth quarter, which is a pretty big move. Even as the price of gold rose to $1,400 an ounce, analysts didn't change their earnings estimates for the fourth quarter or the year significantly. Newmont is going to have a blowout quarter.

Like Yamana, Newmont has most of its operations in safe locations, which is important to me. Yamana has 80% of its gold in Chile and Brazil, rising to 85% this year. Newmont gets 70% of its gold from Australia and North America.

Gabelli: Didn't Newmont have a hiccup at one of its Australian mines?

Hickey: It had a problem at Boddington, the largest Australian gold mine. That is one of the reasons the stock is so cheap. They found 23% more copper and 12% less gold than expected. However, the company still believes there are great opportunities in this mine. It has a 20-year life at a production rate of a million ounces a year. Right now they are producing at a rate of close to 800,000 ounces. Newmont also has a number of other opportunities–in Hope Bay, in Canada; in Peru and in Ghana. With gold at current levels, the company has tremendous cash flow. It has been paying down debt and increased its dividend by 50% last year.

I don't want to have all my money in precious metals, and I don't like how far technology stocks have run. Tech had a huge move in the past two years and has become extremely frothy. Crazy valuations will be put on LinkedIn and Skype when they come public. The valuations on many Chinese Internet stocks are insane. A number of tech stocks went up last year by hundreds of percentage points. Salesforce.com [CRM] has a P/E of 250.

But you wouldn't short tech stocks now?

Hickey: I wouldn't short stocks, particularly tech stocks, in a money-printing environment. I said that last year, too. In 2007, when I was buying puts against Research In Motion [RIMM],Amazon.com [AMZN] and other Internet stocks, the Fed was tightening. It had raised interest rates 17 times in quarter-point increments. When I was short in 1999 and 2000, the Fed had been raising rates. There is no sign the Fed is tightening here, so it is too dangerous to short. When there is tremendous liquidity coming into the market, investors seem to gravitate toward tech and they lose all concept of valuation. These stocks will get crazier.

The only attractive area in tech is big-caps. Google [GOOG] was down 4% last year. Dell [DELL] was down at 6%. Hewlett-Packard [HPQ] was down 18%. Microsoft [MSFT] was down 8%, and Cisco Systems[CSCO] was down 16%. A lot of the big names didn't go anywhere while everything else was going wild. The big names will catch up this year. I am worried the tech sector is going to have another collapse, as it did in 2007-08 and 2000 to 2002.

That sounds ominous.

Hickey: One thing I'm recommending is Canadian government bonds. I bought short-term government bonds that are yielding 1.75%-2%. Debt levels in Canada are less than in the U.S. Government debt is significantly less. The banking crisis really didn't hurt them. Their banks are considered to be the strongest in the world. Canada raised interest rates three times last year. It has been lowering corporate tax rates. The government lowered the corporate tax rate as of Jan. 1 to 16.5% from 18%, and [Prime Minister Stephen] Harper has said it will fall to 15% in 2012. That makes Canada an attractive place to be.

In addition, it is a great producer of resources, second to Saudi Arabia in oil. Canada is also a leader in foodstuffs, from wheat to barley to oats. The Canadian dollar is at parity with the U.S. dollar right now. It went to 1-to-1 in 2007. Over time the Canadian dollar could rise. My money is safe in Canada and I'll get at least some return.

Gross: There isn't anything inherently attractive about a 1% policy rate. But there is something attractive about a Canadian dollar that can appreciate against the U.S. dollar. That's the play. Canada has a much more conservative deficit outlook than the U.S.

Zulauf: But the Canadian export industry is very exposed to the U.S.

Hickey: A little less so now. The U.S. still is Canada's largest trading partner by far, but China has become a bigger play. It is very interested in Canadian assets.

Gross: One of the negatives about being so good is that when the banks survive a crisis, they have lots of "funds to play with." They go to the U.S. and start buying regional banks, which Canadian banks have done recently. That could weaken the Canadian dollar, but only temporarily.

Hickey: Back to big-cap tech. I like eBay [EBAY], which isn't even as big as some of the other names I mentioned. And it's an Internet stock.

Gabelli: It's PayPal.

Hickey: And it is PayPal, eBay's payment system. EBay is trading for a little less than 28. It has a P/E of about 16 and a $36 billion market cap on $9 billion in sales. There are two pieces to eBay. The traditional online-auction business is about 60% of the business, and it is declining. You can look for single-digit revenue growth from this business in the future. As Mario mentioned, the most interesting piece of eBay is the PayPal division. It was 32% of their business last year. PayPal is the largest online-payment platform in the world.

But you need a credit card to use it.

Hickey: Or a bank account. That suggests PayPal could be very attractive to the traditional banking business, which has offered cards like Visa, MasterCard and American Express. In fact, Visa [V],MasterCard [MA] or American Express [AXP] themselves might be interested in PayPal. There is another kicker: EBay owns 20% of Skype, which has filed to come public sometime this year. EBay sold off 70% of Skype to private-equity investors. Its remaining 30% was worth $855 million at the time of the sale. It could be worth in the low billions now. This IPO is likely to be hot, and give eBay a boost. PayPal, meanwhile, has a lot of interesting opportunities. Facebook has said it will integrate PayPal's new digital-goods payment system.

There is competition, however.

Hickey: There is Checkout by Amazon and Google Checkout. Google's platform is thought not to be very good, and there were rumors that Google may be interested in PayPal as well as eBay. Wells Fargo is trying to establish an online-payment system. But PayPal is the leader right now. EBay is planning to offer PayPal across China in the second half of 2011. It will be used for foreign-exchange settlements, as well. EBay is a fallen Internet company. It isn't overpriced, and there are some catalysts that could lift the price.

Finally, Cisco is losing some market share. With Google, I am worried about the company's spending levels. When the stock cratered back in 2007-08, falling to 270 from the mid-700s, one problem was the company was overspending. Once again, it is involved in all sorts of initiatives–hydrogen cars, alternative energy. They are giving out bonuses and raising salaries. Google isn't a bad play, but there is some danger in all this spending. Given that, I am recommending Microsoft again this year. It is the cheapest of all.

Do you have confidence in Microsoft's management?

Hickey: Management has been criticized, but there are two major misperceptions about the company. One of the biggest is that the refresh cycle [a new round of buying spurred by the introduction of new versions of the Windows operating system] is over. Last year there was significant growth in Windows and it drove growth in Microsoft's business. But the adoption of new software takes time. An estimated 20% to 30% of corporate Microsoft users have adopted Windows 7 to date. The biggest wave of adoptions will occur this year. There will also be a big wave of adoptions of new versions of business software, including Office, SharePoint and SQL Server, which were mostly in the testing phase until now.

Why isn't the stock market responding?

Hickey: It didn't respond to many big-cap stocks last year. Apple[AAPL] was all people talked about because it brought out a great product, the iPad. It sucked the air out of the industry.

But that's not all. There is some concern about the competition facing Microsoft.

Hickey: That is another misperception.

MacAllaster: If the boss man [Bill Gates] keeps selling millions and millions of shares, that's a concern.

Hickey: He has been doing that forever.

MacAllaster: Well, I don't blame him, but it doesn't help.

Hickey: Microsoft actually reduces its share count every year. It generates so much cash that, unlike most tech companies, it buys back stock. Last year it reduced its share count by 3%. Let's look at Google's Chrome Internet browser. A year ago people thought it would be a serious threat to Windows. But it hasn't done well. Shipment has been delayed and delayed. Walt Mossberg of The Wall Street Journal panned it, as have others. Chrome is another in a long line of Linux-based operating systems that have failed to make any penetration against Windows. But that is not the perception on Wall Street. Windows Office accounts for 90% of the market, and that isn't declining.

Then there has been talk of Google dominating cloud computing, but Microsoft is winning all the big deals. It won New York City, Minnesota, the Interior Department, the Department of Agriculture. Nor are there threats to SharePoint. The final piece of Microsoft's business is the entertainment-device division, which accounts for 11% of sales. It used to be a money loser, but now it is profitable. In the fourth quarter, Microsoft shipped Kinect, its new gaming system. It spends more money on research and development in this field than anyone else. Kinect originally was forecast to ship three million units. It sold eight million units at $150 apiece, so that's an immediate billion dollars, not counting what the company gets from additional Xbox sales. Microsoft is kicking Sony's [SNE] butt in the entertainment area.

Microsoft's only money-losing division is its tiny online division, including the Bing search engine. And Bing has been gaining market share.

Witmer: How is Microsoft's Windows phone?

Hickey: It is great. It is primarily targeted for the business market. It will be difficult for Microsoft to make inroads against an Apple- and Android-based world, but there is no market share to lose. They have only 2% of the market. With Microsoft you're looking at a P/E of 12 times trailing earnings and 10 times expected earnings. Each quarter they beat estimates by 14%, on average. They raised the dividend by 23% last year. It isn't a good time to be a tech investor, but Microsoft is a safe place for me.

How do you feel about Apple?

Hickey: I own the stock. [In a follow-up conversation, Hickey said he sold his shares after the unexpected announcement of Apple CEO Steve Jobs' medical leave of absence.] The introduction of the Verizon iPhone will cause an enormous surge in Apple's business. Also, the company will post big fourth-quarter numbers because the iPad did well in the period. The stock is 336 a share. It could go to 400 or so within months, and then I would get out. But it isn't terribly expensive on a P/E basis. If you back out the company's cash, Apple is even cheaper. Longer-term the threat is that Droid-based phones will start to eat into Apple's growth rate.

What will happen to Research In Motion, which makes the BlackBerry?

Hickey: The company has had one stumble after another. It will be a long, slow, painful death. That is what happens with many technology companies.

Thanks, Fred. Bill, you're up.

Gross: With the deleveraging cycle under way, all investors have to be concerned with haircuts.

Schafer: Not me.

Gross: "Haircuts" is a euphemism for surreptitious defaults, which can occur in a number of ways. Haircuts can happen when central banks increase the money supply, producing unanticipated inflation. They can take place as a result of currency depreciation, which is why dollar-based investments should be minimized relative to developing-country currencies. The creditor class can also be haircutted through low real interest rates. That is probably the most pernicious and unobserved consequence of an attempted rebalancing of liabilities and asset valuations. On a longer-term basis, central banks and policy makers are really trying to take money from someone, or some class of asset holders, and give it to someone else.

For example?

Gross: The asset-class holder under attack is the saver, and institutions such as insurance companies and pension funds that hold long-term assets. It is anyone who holds bonds that can't keep up with inflation, or the small saver who holds trillions of dollars in money-market deposits that don't earn any real rate of interest. This is the framework that has been created by policy makers trying to rebalance the imbalances of the past 20 to 30 years. To put it bluntly, they are robbing savers and taking money surreptitiously from longer-term asset holders whose assets don't anticipate future inflation.

Bill Gross' Picks

Fund	Ticker	Price/Yield 1/7/11
Pimco Corp Opportunity Fund	PTY	$17.17/12.05%
Company		Price 1/7/11
Annaly Capital Management	NLY	17.78

Source: Bloomberg

The real interest rate -- the rate adjusted for inflation -- is the most hidden and unobserved. It is low, even negative, and will continue to be low. We haven't talked much today about whether quantitative easing continues after June, but it doesn't matter. It has already suppressed real interest rates and allowed other asset classes, such as stocks and commercial real estate, to appreciate. Once it disappears, how long will the federal-funds rate stay at 25 basis points? That's the critical question to be answered. For a long, long time, I think. Short-term rates will stay there for at least two years and maybe three, because of high unemployment, excess capacity and, at the moment, an inherently low inflation rate. There would be no rationale for the Fed to raise interest rates other than to counter an attack on the dollar.

Real short-term interest rates historically have been 1% to 1.25%. Today when Treasury bills yield about 0.2% and the inflation rate is 1.5%, the real interest rate is a negative. That is why you want to invest in countries that offer higher real interest rates, such as Brazil, Mexico and Canada.

Are you recommending their debt?

Gross: I am suggesting that you get out of the U.S. dollar and get into something that offers you a positive rate of return. Whether it is bonds or stocks, get into emerging markets where the growth potential and the credit solvency are better than in the U.S. Secondly, if you don't want to own assets yielding negative real rates, why don't you borrow at such rates, or find companies that do? The government is borrowing at low real rates, which doesn't argue for owning government bonds. But if you can find companies or other structures that can borrow safely at such rates, that's a good thing for their equities.

Banks invest or borrow at low interest rates. They take deposits at 25 basis points and invest at longer rates, capturing the spread. If they can perpetuate that, they will build up capital and become stronger institutions. That is what the Treasury is trying to facilitate. The government is giving the banks and other levered borrowers time to rebuild their equity base and become more solvent.

Zulauf: Under Basel III [an international regulatory framework for the banking industry] banks wouldn't have to put up any equity capital to buy double-A and triple-A-rated bonds. So you could end up with the banking industry soaking up a lot of government paper that in the end will be junk.

Gross: That is a danger, but one structure that can benefit by borrowing at negative real rates isPimco Corporate Opportunity Fund [PTY], which I recommended last year and am recommending again. It returned 33% last year, including dividends, which is pretty interesting for a bond fund. How was that accomplished? With 50% leverage, which is what many closed-end funds use. PTY borrows half its money, these days at 25 to 50 basis points, and then reinvests it, hopefully safely, at 7% or 7.5%, to generate yields of 12% to 13%. It is vulnerable to rising interest rates, but to the extent that real interest rates stay low, it is well situated.

The fund's use of leverage is mild; it isn't a hedge fund. Twenty-five percent of its asset value is funded by perpetual preferred shares. The costs are locked in at close to Libor [the London interbank offered rate]. People think the fund is invested in junk bonds, but the average quality is investment-grade. Investments include a few GMAC bonds and AIG bonds. Both of those companies are 85% to 90% owned by the government, by the way. Pimco Corporate Opportunity also owns aJPMorgan Chase [JPM] hybrid preferred stock paying 7.5%, and a few New York City BABs, or Build America Bonds–a form of taxable municipal debt. The BABs were issued at 6.65%, and they are a double-A-minus type of credit.

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Jennifer Altman for Barron's

Bill Gross

Is this a fund a you manage?

Gross: Yes, but as I said last year, I am not on the board. I make it a point to talk infrequently to the board. It declares whatever dividend it wants to declare, although the dividends are a function of the bonds in the fund. You have to be careful on dividend yields of closed-end funds, because the funds can pay out of net asset value instead of cash flow. The net asset value of this fund, though, keeps going up, up, up, but the fund sells at a premium of only 5% to NAV. Again, as I said last year, this is the kind of fund I would recommend to the owner of our local donut store. It can go down, as it did in 2008, but if you want to double your money in six years, after reinvesting both the dividends and the proceeds, I don't know a safer way to do it. If you had to put your mother-in-law in something, this would be it.

Schafer: How big is the fund?

Gross: It has a market value of $1.25 billion and trades 300,000 shares a day. But my advice to readers is, don't rush out to buy it as soon as this conversation is published. Wait a week until the interest dies down.

Gabelli: What is the limit on leverage for closed-end funds?

Gross: The maximum leverage is 50% of assets. Closed-ends are highly regulated in terms of how much leverage they can use and how much of certain assets they can own.

Black: Has the premium over net asset value swung dramatically in the past few years?

Gross: It has been as high as 20%. Obviously, 5% is a much better deal. The fund has rarely sold at a discount to NAV. The premium is 5% because the fund has paid a 12% dividend only for the past two years, and investors think it is a short-term thing. Just two weeks ago it paid a special dividend for the second time, and I think that can continue. The big thing that can upset the apple cart is a default by one of the bonds in the portfolio. That, and the Fed could raise rates, and then 25 basis points becomes 3%, 4%, 5%. But my premise is they won't for a long while.

My other pick is a company that borrows short, relatively safely. It owns government-agency mortgages and borrows against them at about 25 basis points, which is the real thrust for both of these investments. The company is Annaly Capital Management [NLY], a mortgage REIT [real-estate investment trust]. It has a $12 billion market cap. The problem with Annaly is that the stock can go down if the company's repo capabilities [its ability to borrow short term using repurchase agreements] are diminished. That happened in 2008 when none of the banks or investment banks would take agency mortgages as collateral.

Where is Annaly trading?

Gross: It's at 17.75. The stock can't go up much because the minute the price gets above book value the company issues stock, as it did in late December. This is a dividend-earning vehicle. You wouldn't look for Annaly to rise from 17.75 to 22.50 in 12 months. But it produces a 14.5% yield. This is a finance company like AmEx or GMAC or CIT [CIT], although CIT is lower-quality than Annaly.

Annaly is changing its personality a little bit, so it has to be watched. But for the most part it owns government-agency-guaranteed mortgages. We're not talking subprime mortgages here. We are talking about floating-rate adjustable mortgages backed by Fannie Mae and Freddie Mac and you and me, the taxpayers. What they own isn't really subject to default risk. It is subject to a lag in interest rates. The rates on these mortgages adjust every six to 12 to 18 months. If interest rates went up by two percentage points tomorrow, Annaly's cost of funding would go up by that amount, but the rates on the mortgages it holds would go up 12 to 18 to 24 months later and the company would have to cut its dividend. So there are risks here, but not in terms of the creditworthiness of the collateral. It is more in terms of the cost of financing, which gets back to my original thesis: the benefits of borrowing at negative real interest rates.

Annaly has a book value of about $16 a share. You are basically buying it at book, and giving the company the privilege of investing money for you, levering it 5-to-1, and offering you a 14.5% dividend yield. In the absence of another crisis, you'll do well.

Thank you, Bill.

secret garden

Saturday, February 19, 2011