AIG - New Value Line Report Out - May 25

I am not sure if I have ever discussed AIG previously on the site, although I have discussed it previously with friends and it is a major holding in an investment club I am a member in. Basically I am optimistic that this stock could be a double for investors over the coming years. During the scandals which hit a few years back involving the former CEO (Greenberg) the stock price was decimated and the stock lost the premium PE multiple that it had enjoyed for many years (15-30 range). Since then the stock has stabilized under new leadership and the business has been reporting good operating results.

The interesting thing is that the stock trades with a PE in the 10 area. (Projected FY2007 earnings are in the $7 per share range and current stock price is around $72 per share). The stock has ranged between 60 and 70 over the past year. I am not typically a big fan of using the PE multiple alone as we have discussed somewhat regarding the mortgage lenders (WAMU and Countrywide) and the funny money accounting that they are currently following. Still AIG was forced to get its act together after the scandals hit and they had a lot of regulatory scrutiny on them forcing the corrections.

I guess that with the solid earnings growth they are experiencing, I find it very unlikely that the PE will go significantly below 10 - I see it as a reasonable floor on valuation for arguably the #1 insurance company in the world (while.....maybe #2 - berkshire hathaway isn't all bad either.....) Anyways - the point of the value line article which may be too optimistic is that if 10 is a reasonable floor for the PE - what if PE can move close to the historical 15 - 20 range. This multiple expansion could drive significant share price growth. The company's valuation is huge as is - around $190 billion - so a double in share price would put it in near Microsoft and GE in company size. So this is absolutely NOT a ten bagger. That said I think a double to triple is possible, especilly if the current bullish / bubblish sentiment in the market keeps hold.

I am not optimistic with much of the rest of the financial sector (re: mortgage lenders, brokers, banks) - so it is possible that the AIG valuation remains depressed as it is lumped in with the aforementioned sub-sectors that have a lot more exposure to the housing market and mortgage market than they are letting on.

Here is the link to the Valueline report: Click here

Best regards,

Ben

Gold and Silver Underperformance

While many commodities (e.g. corn, uranium) continue to make new highs in 2007, gold and silver have failed to lift off to the next level and have underperformed both the domestic and international equity markets as well this spring. Can this be expected to continue through the duration of the year? I am not sure....... but let me offer a few ideas:

1) I consider the continued strength of the gold and silver bull markets as dependent on a significant and furthered decline of the dollar relative to other currencies and commodities over the coming six months. If the dollar was to fall an additional 10-20%, I think that gold and silver will begin to trade more as an alternate CURRENCY as opposed to a speculative inflation hedge and could make another sizeable move upward.

2) How do we get a significant dollar decline that has been talked about for years now? I think it is tied to the Fed policy on interest rates and two fallacies linked to the eagerly expected interest rate drop by Bernanke later this year:

Fallacy #1: We want the housing market to continue to weaken because it will stabilize inflation and slow growth and give the Fed room to cut rates.

I do anticipate a Fed rate cut but I think that this argument ignores the significance of the housing market to our current economy and puts unreasonableness emphasis on other industries and businesses that supposedly will bail us out as the rate cut occurs. I think it also fails to consider the extent to which our current consumption levels in the USA have become precariously tied to asset values - mainly real estate, which up until recently could be freely borrowed against.

Fallacy #2: Once the Fed cuts rates it will be off to the races again and the stock market can hit new highs - re: 15,000, 20,000 Dow, etc.

If we look back to as recently as the years 2000 and 2001, the interest rate cuts by the Federal Reserve took two years to firmly take hold in the economy and filter through to improved stock market performance. To argue that the Fed rate cuts would instantly bolster the underlying fundamentals and encourage further speculation in the stock markets ignores the lag that fed policy takes for its effectiveness.

Many of the poor fundamentals are evident in the current economy such as the Q107 GDP number coming in around 1.3% and expected to be revised down to below 1% in the next reading. It is also quite evident that any sectors levered to the consumer or real estate are hurting. Investors and money managers have decided to ignore these fundamental developments and instead focus on large-cap earnings which are being juiced from overseas growth (much of it the result of currency gains), as well as relatively low interest rates that make it easy to borrow and continue the speculation in asset markets around the world.

Current challenges to this analysis: Money flow into worldwide stock markets including the United States must be currently favored over investment in gold and silver as the metals stagnate in value while stock market indexes ramp higher at extremely high rates of return re: 25%+ around much of the world.

Conclusion: When the interest rate cuts materialize later this year I expect the result to be a declining dollar relative to the rest of the world's currencies. If the precious metals make another significant bull move I expect it to be less the result of speculation and more an attempt to place assets in an alternate currency that has more credibility as a store of value than the Dollar or even the Euro or Yen.

I do not see the threat of further inflation or world crisis/terrorism as major drivers for the precious metals bull market going forward, although in some ways the expected Fed Rate Cuts and resulting abundance of dollars does argue for a dollar inflation / depreciation relative to commodities and other currencies around the world.

Best regards,

BG