The Independent Investor: Guess What Dirty, Smelly Investment Has Caught My Interest?

Trashed by environmentalist, near and far, it is the bad boy of the energy arena. Environmentally hazardous, its producers and consumers are notoriously lax in even attempting to do something to control the pollution they spill into our atmosphere. You know these boys. Their industry usually hides under the proverbial wood pile minting money, only reluctantly revealing themselves in daylight when called to explain yet another mine disaster or ruined river. So why is the demand for coal and those that produce it gaining popularity on Wall Street?

Coal, for those who don't know, is divided into two categories: metallurgical or coking coal, which is used for steel making and thermal or steam coal, which is used for heating and electrical generation. "Met" coal is a high-priced, low-volume product that boasts a high heating value. Here in the U.S., we only consume about 15 million tons of Met and the rest (30-40 million tons) we export to places like China.

Met coal is used in 70 percent of global steel production and accounts for 10 percent of world coal production. It is steel's primary energy source and takes 1,300 pounds of coal (called coke) to produce one ton of steel. The demand for this kind of coal has been rising steadily for some time as country after country in the emerging markets produce more and more steel for building infrastructure and export.

The recent earthquake and tsunami disaster in Japan has opened up an enormous new market for steel and the coal to produce it. Japan has already embarked on the expensive and necessary task of rebuilding. Investors figure Japan is going to need a lot of steel (and therefore coking coal) to accomplish that. Together with the already robust demand from emerging markets, the stocks of these coal producers are in demand.

But that is only one side of the coal market. Thermal or steam coal production dwarfs that of its pricier cousin. Thermal's primary use is in power generation. Worldwide, over 7 billion tons of this stuff is consumed each year. The U.S. uses about a billion tons a year, but because it's heavy and expensive to ship, not much (about 22 million tons) of it is exported.

The fact that over 40 percent of the world's electricity is derived from coal-fired power plants explains why in an era of solar, wind, natural gas and other green alternative energy sources, old King Coal keeps rolling along. It took many years and trillions of dollars to build this coal-based system of power generation. It will take a lot more time, effort and money to convert that system to alternative fuels.

Here in the U.S., 48 percent of our electricity comes from steam coal. Once again, thanks to the ongoing crisis in containing and preventing a radioactive melt down in Japan's Fukushima plant that percentage of use could increase if nuclear power generation is derailed in this country. Worldwide, politicians and voters appear to want at least a moratorium on building new nuclear plants until further studies are done analyzing their safety and other factors. Since we all know how long studies take, this delay can take time and any energy gaps will be filled by additional coal consumption. Investors are quick to realize that this presents further opportunities for additional coal consumption.

Coupled with these developments is China's new status as a net importer of coal beginning in 2009. Most of the 126 metric tons of new imports have come from Australia, but there is some discussion on whether the U.S., which some call the "Saudi Arabia of coal" with 238 billion tons of proven reserves, could figure out a way of exporting our coal cheaply to Asia. That would translate into a big jump in the price of coal stocks.

Does all this new coal demand mean that we will have to settle for coal and its residual pollution as a major source of energy in this country forever?

Not necessarily. It is true, according to the Environmental Protection Agency, that 44 percent of the coal-fired plants in this country currently have no pollution control equipment. There are 400 coal-fired plants spread across 46 states. Their emissions result in about 380,000 tons of black garbage that is spewed into our air each year. Mercury emissions alone around these plants are killing 17,000 people each year and causing 11,000 hear attacks, not to mention the impact on children, whose health is affected most by these poisons.

Even the billions in bribes the industry has paid to Washington for decades to overlook these "minor nuisances" no longer work. Americans have demanded and government has finally agreed to take action. As a result, the industry has been warned that they either retrofit existing facilities with counter measures or close them entirely over the next few years. The EPA's new emission restrictions require a removal of 90 percent of mercury emissions by 2015, along with 80 percent of sulfurous oxides and 52 percent of nitrous oxides by 2018. These new standards will apply to 31 states and the District of Columbia.

It will mean an enormous expense and effort on the part of power generators. Of course, much of the expense will be passed on to consumers in the form of higher monthly energy bills, but even then I suspect that some plants just won't be able to continue to functions. As a result, I expect to see cheaper (and cleaner) natural gas replace coal in the generation of electricity over the next few years. That's good news for all of us and for natural gas producers. Did I mention that I like that sector as well? I guess that will have to wait for a future column.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

The Independent Investor: Who Pays for Japan?

It appears that the ongoing disaster in Japan will not end up on the doorstep of the world’s insurance industry. Total damage estimates now range from $200 to $300 billion but insurers will “only” be saddled with 10 to 20 percent of those costs. That still makes it one of the costliest disasters in the history of the insurance sector and there are some nagging details that could cost them even more.

Considering the spate of natural disasters so far this year (New Zealand’s earthquake and Australia’s flooding), not to mention the wave of calamities since 2004, Hurricane Katrina, erupting volcanoes in Iceland, earthquakes in Chile and Haiti – it is a wonder the insurance industry is still around to pay anyone.

The earthquake claims alone (excluding the tsunami and radiation damage) against reinsurers (insurance companies who insure insurance companies) are estimated to run as high as $35 billion. This just may further deplete an industry whose capital is dwindling daily and just about guarantees a first quarter loss for most companies in that industry with exposure to Japan.

Big reinsurance companies are starting to total up their exposure. Swiss Re says they face $1.2 billion in claims, while AIG allows for at least $700 million. Munich Re and Hannover Re, two large European insurers, aren’t ready to guess and the French reinsurer, Scor SE, believes its losses will total no more than $262 million. Warren Buffet’s Berkshire Hathaway Inc. also has some exposure through its reinsurance companies, but has not yet released estimates.

One reason the big insurers have escaped the majority of catastrophe claims is the insular nature of the Japanese. Unlike most countries, the Japanese prefer to insure their own property and businesses against catastrophes and other risks. Unfortunately, analysts believe that Japan historically has tended to under-insure most of its productive assets such as auto factories, semiconductor plants, consumer manufacturers, farm land and everything in between.

Nuclear risks like the present fallout from the Fukushima plant tend not to be insured by private companies. The quasi-government-owned Japan Earthquake Reinsurance Company will most likely bear the brunt of those losses (although this government agency might only insure half of the losses or less).

Actually, few if any insurance companies worldwide will insure against a nuclear accident, which makes the ongoing concern over the Indian Point nuclear unit in New York that much more serious. The reactor sits atop a fault line, that if worst came to worst could conceivably expose radiation to 6 percent of the nation’s population and a comparable amount of this nation’s assets.

Of far more serious concern to the insurance industry are supply chain disruptions that are occurring, and will continue to occur thanks to the devastation in Japan. The prospects of long-term supply disruptions are highly probable as Northern Japan’s factories have been shut down by limited power supply and are failing to produce and ship parts and products that are essential to high tech, electronic, auto and other industries worldwide. By some estimates, Korea, for example, depends on Japanese parts for 23 percent of its finished products.

On Thursday, for example, Toyota told its plants in the U.S., Canada and Mexico to prepare for a possible shutdown due to the lack of parts availability. General Motors has already stopped production of a truck plant in Louisiana and a related engine plant in New York.

Business interruption coverage is a routine insurance product which insures a business against just such an interruption. Just about every business worth its salt has such a policy or policies. While a business’s supply chain  generally has a few weeks of safety stock supplies, there isn’t a lot of time for companies to find new suppliers, shift production or try to make spot purchases before they run out of parts. Costs skyrocket as several companies in the same line compete for scarce parts.

Possible shortages of Japanese-made components can significantly impact profits across the globe as businesses fail to deliver products to market on time. You can be sure that some insurance company somewhere will be on the hook to make up for that cost of lost production. It is this supply chain problem that has the managements of insurance companies staying awake at night.

The insurance industry is keeping mum about this potential problem. I can understand their reticence, but until we get all the facts I would not go bottom fishing in that sector.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

The Independent Investor: 'Hurry, Hurry, Get Your Red Hot Iodine Here'

Like hucksters selling hot dogs in the ball park, the media is having a field day with the Japanese nuclear crisis. Americans, fearing for their safety, immediately bought out the nation's supply of potassium iodide tablets. Investors are panicking worldwide, dumping trillions in equities, commodity and currency investments indiscriminately. There are so many rumors, falsehoods and downright lies flying around the airways that I am astounded we continue to tune into this drivel. I believe we all need to calm down and turn our TVs off.

As a former Fulbright Fellow to Japan, who has lived and spent a great deal of time in that wonderful country, I pray for a successful end to this nuclear crisis and a speedy economic and social recovery for the Japanese people, as I'm sure we all do. Events around the Fukushima reactor in Japan are precarious as I write this. Yet the knee-jerk response of the world's governments, citizens and investors, as illustrated by the volatility in the financial markets, once again proves my point — the markets are not efficient, never will be and there, my reader, provides the opportunity for you to prosper.

The Efficient Market Hypothesis (EMH), a theory concocted by academicians and followed stringently by those on Wall Street, maintains the current prices of securities reflect all information known about the security. They argue that investors cannot expect to outperform the overall market consistently on a risk-adjusted basis. Day-to-day changes in the market prices of securities cannot be predicted with any reliable degree of accuracy. Therefore any trading, security analysis or buy and sell strategies are of no value.

If these same market participants took the time to analyze the information coming out of Japan this week, I can't see how even a countrywide nuclear disaster in Japan will impact stocks in the U.S. or Europe or numerous other countries throughout the world.

Assurances that the fallout from these reactors, in a worst-case scenario would not create a Chernobyl-type calamity, have fallen on deaf ears. Dire predictions that this catastrophe will set back economic growth in Japan for years do not square with history, nor do forecasts that Japan's problems will put an end to our own recovery.

Most studies of similar disasters throughout the last few decades indicate Japan may suffer a quarter or two of slower economic growth followed by a pickup in GDP as reconstruction spending takes hold. In addition, the disaster occurred in Sendai, in northern Japan, which accounts for less than 2 percent of Japanese output.

The risk of nuclear fallout floating to this side of the Pacific has such a low probability that buying up iodine tablets on eBay for over $200 (more than 10 times the usual price) may make sense if you lived 25 miles from the Fukushima reactors, but here in the U.S. it makes no sense.

It also makes little sense to talk of abandoning nuclear energy as an alternative fuel source. I find nothing wrong with checking the 104 reactors in this country for possible weaknesses. I think that should be done on a regular basis anyway. America has not built a new nuclear energy unit since the Three Mile Island disaster. It would be a shame to once again abandon this strategic energy source because of events in Japan.

So what are my recommendations in dealing with this debacle?

This sell-off has created so many buying opportunities in so many sectors that this should be called the great global giveaway in equities. In my opinion we are very close to a bottom. In last weekend's column I wrote that I expected no more than a 5 percent decline in the S&P 500. We have already dropped 3 percent of that total. Some obvious places where the selling appears to be overdone are the nuclear energy sector and, of course, Japan. For long term investors, I wish you happy hunting.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

The Independent Investor: ETFs Are Tax Efficient

Tax time is drawing closer and as it does, the annual barrage of questions concerning investments, portfolios, dividends and capital gains distributions are keeping financial advisors and accountants quite busy.

"One of the most frustrating issues to me," writes a Long Island investor, I'll call Joey G., "are the mutual fund capital gain distributions."

As a large holder of mutual funds, every year, between November and December, Joey is hit with substantial taxable capital gain distributions from the mutual funds he owns.

"I have no idea how much they are going to be or when they are going to be distributed until it's too late, so there's no way I can plan for them tax-wise."

Joey G. is not alone in voicing this complaint. For readers who are not familiar with mutual funds capital gains distributions, it works like this:

During the year, mutual fund manager try to buy stocks low and sell those same stocks at higher prices, generating capital gains, the more successful the manager the higher the capital gains.

That's the good news.

The bad news is that the fund manager then passes on all these taxable gains to the holder of the fund, in this case Joey G., Depending upon the size of your holdings; this tax bill can be many thousands of dollars. To some this may seem to be a high-class problem since the higher the capital gains distributions, the more expected appreciation in the price of the fund but not always.

There are years such as 2008, when, as the market declined, fund mangers sold stocks they had held for a long time. Those sales generated huge capital gain distributions for their investors. At the same time, because the markets were declining, investors sold out of mutual funds in great numbers sending the price of mutual funds to multi-year lows.

"Not only did I have to pay a huge tax bill that year," laments Joey G., "but the very same mutual funds that gave me this tax bill were now selling at deep discounts to my purchase price."

For those who are tired of these capital gains issues, I would suggest looking at exchange-traded funds or ETFs. Since they are index funds, once their indexes are created, they rarely change (no need to buy or sell) so there are relatively few, if any, capital gains distributions.

On occasion there may be a gain (or loss) generated but only if the underlying index the ETF tracks changes in composition. For example, if you purchased the SPDR S&P 500 (SPY), that ETF tracks the performance of the S&P 500 Index. If at some point the S&P were to replace one or more stocks in the index, the ETF manager of SPY would also do the same. In that case, there could be a gain or loss (and a distribution) in the ETF. Those kinds of changes occur infrequently.

There are exceptions to this rule; however, since not all exchange-traded funds are created equal. There are some "black box" ETFs that are actively managed. Their marketing managers claim that because of their internal strategies, their ETF can out perform whatever index they represent. Sticking with the S&P 500 example, the actively-managed ETF might only select a sub-set of the index, or buy and sell various stocks within the index, in an effort to provide outperformance. The results of these black box beauties are checkered at best. To me, these hybrids rarely fulfill their promise while their expense ratios are higher than plain vanilla ETFs and there can be capital gain distributions as well.

Since more than 75 percent of mutual fund managers fail to outperform the indexes anyway, ETFs make sense on the performance side as well. They are cheaper to own, the tax advantages are clear and the next time you compare an ETF to a mutual fund remember that the mutual fund performance does not include the taxable consequences of capital gain distributions.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.

The Independent Investor: Emerging Markets Are Still on Hold

A few months ago in my market column, I warned investors that emerging markets overall were pulling back and additional downside was probable. Thanks to the problems in the Middle East and elsewhere, that forecast has been fulfilled. Now what?

At the time, I advised that any further downside could prove to be a buying opportunity. The lower the stock markets of places like China, India and Brazil decline, the more tempted I am to begin to nibble at stocks and other securities in these countries.

In the second week of February, investors pulled $5.45 billion from emerging market funds and invested it into developed nations such as the U.S., Europe and Japan. That was the largest inflow of money into those regions in 30 months. Since the beginning of the year, worried investors have withdrawn 20 percent of the $95 billion that was invested in the region in 2010. China alone has lost more than $1 billion of outflows since the beginning of January.

The stock markets of these countries have taken it on the chin this year as a result. Emerging markets have suffered an overall decline of 3.8 percent year-to-date, while stock markets in the U.S., for example, are up close to 6 percent. The one big exception has been Russia, one of the four BRIC countries that also include Brazil, China and India.

Thanks to Russia's vast oil and other natural resources, that country is considered a hedge against future inflation. Investors are also betting that, after years of abusing foreign investors, the Putin-controlled government is getting serious about treating all investors equally. Time will tell if Russia is blowing smoke or truly has turned over a new leaf. In the meantime, however, its equity market has more than kept pace with the U.S., gaining 11.3 percent, while India is down 12.6 percent and Brazil is off 4.4 percent year-to-date.

As readers may recall, the chief reasons for the emerging market sell-off is climbing inflation rates which has been met by tightening monetary policies by central banks in just about all the "hot" countries. Brazil, for example raised rates yet again last night in an effort to slow the economy and reign in inflation. These actions have been the impetus to trigger corrections in all these markets after two very good years for equity investors. Indonesia, for example, was up 46 percent last year so a 5.1 percent pullback so far this year is small potatoes, in my opinion.

The recent upheavals in Egypt, Tunisia and the ongoing strife in Libya have unfortunately lengthened the shadow that has darkened the prospects for emerging markets in 2011. Higher oil prices may also keep a lid on the economic prospects for some countries that have not been blessed with energy reserves.

As a contrarian, I like to buy securities when "the blood is running in the streets" as Baron Rothschild once described this style of investing at the bottom. As of yet, I don't see that bottom. Keep your powder dry for a few more weeks (or maybe months) but keep an eye on these markets. Their long-term economic prospects are extremely attractive. Their present attempts by their governments to reign in inflation just bolsters the investment case for this group of countries whose governments and economies are finally coming of age.

Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or e-mail him at wschmick@fairpoint.net. Visit www.afewdollarsmore.com for more of Bill's insights.