A 40% RETURN ON YOUR CASH IN TWO YEARS... NO JOKE

Leon Black learned the ropes of junk-bond investing as Michael Milken's right hand man at Drexel in the 1980s. Black was a dealmaker... In order to keep him on board in 1989, Drexel offered $20 million in pay, regardless of the profitability of his business. When Milken's world exploded, Black started Apollo, his own firm... and started doing deals like this one...

Executive Life Insurance had bought billions of dollars worth of junk bonds from Milken. By 1990 those bonds were deep underwater. Instead of allowing Executive Life any chance to recover, a bungling California bureaucrat insisted Executive Life liquidate its multi-billion dollar bond portfolio all at once.

While most investors shied away from junk bonds in those days, Leon Black knew exactly what was in the portfolio. Hidden in there were large concentrations of bonds (which could turn into big chunks of ownership) in Vail ski resorts, Samsonite, Culligan Water, and literally hundreds of other companies. It was a who's who of American business, and Leon picked the whole lot up for $3.2 billion. (Of course, Black did not have the $3.2 billion, but that's an interesting story for another day.)

Long story short, Black and his investors made a ridiculous amount of money on this deal... and this is just one of the large deals Black has done in his 20-plus year career of dealing in "distressed assets." Since going on his own in 1990, he's arranged more than $100 billion in debt financing for over 150 companies in 30 industries. 

Leon doesn't just do junk bonds... he's really just a "value" investor... buying real estate, taking over troubled businesses, you name it. Whatever he's doing, it's working... According to Citigroup/Smith Barney, investors with Leon have averaged returns of over 40% a year.

Judging by his track record of buying things for nothing and extracting large fees in the process, you don't want to be on the other side of the table from Leon Black. 

But what if you could ride his coattails?

For the first time, individual investors like you and I have that opportunity. Leon Black has just started a new fund that trades like a stock. Fortunately, the more money he makes for us, the more money he gets to keep for himself. It should lead us to returns on our cash of between 30% and 50%. Let me explain...

HOW WE'LL MAKE A RIDICULOUS RETURN
ON OUR CASH, THANKS TO LEON

The business we'll be investing in is typical of Leon Black. He will make short-term, high interest rate secured loans to "middle-market" companies – businesses that are too small for the "big boys" (the investment firms) and too risky for the now-conservative banking industry. Leon will charge 10%-15% interest, and he'll extract a pound of flesh (likely some stock in the business).

It's a good business, if you can get it. These are not junk bonds... this is short-term, secured financing. And Leon has the decades of corporate dealmaking experience to make it happen, earning a high rate of return on cash.

Leon should be able to bring home returns in the 10%-15% range. And he'll pay out 98% of this high return to us as shareholders in the form of dividends. And this is where the opportunity starts...

The fund is brand new, so it pays no dividend yet. But as soon as Mom and Pop America start seeing a relatively safe 12% dividend, they'll start buying up the shares. A fund that pays 12 cents on the dollar could easily be bid up to $2, as that would be a dividend of 6%. And that's what will happen... shares of Leon's fund will rise to a significant premium over their current value, within two years time.  

As a conservative estimate, I expect Leon's fund will trade at 140 cents on the dollar in two years time. If we buy now, we're in line for a 40% capital gain... in addition to whatever income comes our way in the next two years from Leon's dealmaking...

HOW TO GET A "FREE"
40% GAIN...

Shares of Apollo Investment, Leon's new short-term loan business, went public at $15 a share in April. What that means is the company raised cash from investors... cash that Leon can loan out as he finds the deals. Apollo raised about $900 million in cash.

Right now, Apollo's shares are trading for less than $14. That isn't crazy, actually. Once you subtract the investment banker's commission from the IPO (6%+) and Leon's first year management fee (2%), you're left at just under $14 in cash.

While Apollo is trading right at book value right now (just below $14), I fully expect it will trade at least at a 40% premium to NAV in two years time. If that happens, it would still be cheaper than the other companies in the same business...

There are a handful of similar businesses out there right now, and they're all trading at significant premiums to book value... as investors are attracted to their high dividend yields:

HOW TO BE SAFE AND
MAKE 40%-PLUS

Leon only has cash right now. He's going to at least earn interest on the cash in the first year as he looks for deals. It will likely take him until the end of the second year in business to finally get the portfolio filled out.

So for maximum safety, here's what we'll do...

We'll buy Leon's fund today, paying a dollar for a dollar. And we'll sell Leon's fund in two years, likely pocketing $1.40 for each dollar we invested. (We'll probably pick up an additional 10% along the way, in the form of two years of dividends, I'm guessing we'll see something like 2.5% in year one and 7.5% in year two.)

We'll catch all of the appreciation as it rises from its cash value to being priced for a high dividend. And we'll avoid nearly all of the risk...

If there is any risk, it might be the pressure on the fund to get such a large pile of money invested in a short period of time. The risk is that Apollo makes a bad deal or two along the way. It wouldn't knock ‘em out, but if we can avoid being around for any risk, let's do it. And we can avoid risk.

In these types of investments, writedowns of bad deals don't generally occur within the first two years. So in theory, Leon's business shouldn't show a bad deal in the time that we own it. Also, the company has the ability to leverage the portfolio to increase the income it pays, but that also increases the risk. Chances are the company won't even be in a position to use any leverage until year three. We'll be gone by then.

One of the complaints about Apollo Investment is the potentially large fees that Leon Black could make if the portfolio does well (Black's fees are like a hedge fund – roughly 2% a year plus 20% of portfolio profits). Two comments about this... first, if Black makes us a pile of money, then I'm okay with those fees... But second, and more importantly, Black will just be filling out the portfolio over the two years we own it.

In short, we knew Leon would extract his cut, of course. And that's why I'm only suggesting that it could rise to 1.4 times book value, instead of 1.6 times book value, like its peers. But ultimately, since the underlying portfolio itself won't show big returns (or big losses, for that matter) in the first two years, there's no big cut for Leon to take.

We're primarily investing our cash for a rise in the stock market price based on existing stock market values for similar businesses. We're not investing for the increase in the value of the underlying portfolio of short-term loans. We're buying cash at a dollar, and selling it at $1.40 in two years. We're happy to collect an additional 10% in income in the process, thanks to Leon getting things invested. In two years, Black won't have taken too much of a fee, and the investment will start paying double-digits. At that point, it will start to look attractive to the rest of the world. People will start buying.

The shares closed yesterday at $13.30. Buy up to $14.50. Don't go crazy, paying any price, as there's no need to. There's no hurry to pay too much. Get your price...

Black won't be paying a big dividend for a while. Outside of fellow True Wealth readers, there is no other source of buying for Apollo right now... And there won't be, as there are a few other companies just like Apollo waiting in the wings for the right moment to go public. So please, use a limit order. No need to get fully invested here in one day.

If those new Apollo-like companies waiting in the wings drop below their cash value a few months after their IPOs, like Apollo did, we'll likely buy them, too. And we'll do the same thing we're doing with Apollo, we'll sell within two years, before there's a chance for a writedown (a deal that goes bad) in the portfolio.

If you don't remember anything else, remember this: Buy Apollo below $14.50, and sell it above $19.50; otherwise, sell in two years. For the specific recommendation:

Buy shares of Apollo Investment now (symbol AINV) up to $14.50, with up to 8% of your cash. Do not use a trailing stop, but sell two years from the date you buy. You are free to take profits on your own whenever the stock price exceeds $19.50. In two years, if the stock is trading at 1.4 times book value, and has paid a total of 10% in dividends, you'll actually pocket 50%... on your cash. 

It's RED LIGHT mode now, and with an overvalued stock market and a Fed set on raising interest rates, it looks like we'll be here for a while.

In RED LIGHT mode, stocks fall at a rate of nearly 10% a year. That's a good number... it's based on weekly data going back to 1927. 

First, we need to play good defense.  We've already done a good deal of this, selling out of a dozen positions. (We need to make it a baker's dozen, as we're selling EZU in this issue.)

I've outlined my "River of Losses" scenario in many issues now, where cash beats other assets in the near term. My River of Losses prediction has been dead on... and it should continue. Read the back issues again (available on the www.pirateinvestor.com website) if you need a River of Losses reminder.

Second, we need to play smart offense, and take advantage of the opportunities staring us in the face.

Two great opportunities are Apollo Investment, where we have the possibility of 40%-plus gains on our cash in two years, and the Rydex Venture 100 Index Fund (RYVNX)...

BUY EVEN MORE RYVNX

Buy RYVNX with as much money as you're comfortable putting in...

I've done a good deal of research on the Nasdaq in the last few weeks, looking back over its history. And I'm convinced that right now is an incredible opportunity to profit from a fall in the Nasdaq 100 Index.

Last month, I recommended you buy RYVNX once again. RYVNX, is the very best way for you to profit from a fall in the Nasdaq 100, even in your retirement accounts. Simply put, if the Nasdaq 100 Index falls by 1%, RYVNX will rise by 2%. These gains compound, too.

Since the beginning of July, RYVNX is already up 14%! There's much more to come... Let me explain...

The big picture for the Nasdaq 100 is very ugly. Nasdaq stocks are extremely expensive as I outlined in last month's issue (please review it if you need to). But up until this month, that was the Nasdaq's only problem. Now, as of this month, it has two new problems...

The Fed is now raising interest rates AND the Nasdaq 100 Index is now below its 45-week moving average. If I had a 1-2-3 Model for the Nasdaq 100, it would be in EXTREME RED LIGHT MODE, where all three factors that matter are against the Nasdaq right now.

Even worse, the short-term picture for the Nasdaq 100 is extremely ugly as well, which should cause the Nasdaq 100 to fall right now. Investor sentiment can dictate the short-term swings in the market. And investors are downright complacent now: Volatility on the Nasdaq (as measured by the VXN Index) is at an all-time low, and investors are overly bullish based on the surveys of investor sentiment. When you see these two things, a downturn is imminent. And with RYVNX already up 14% in July, it's already started.

Last month, I covered how overvalued the Nasdaq stocks are, and I showed how perfectly correlated RYVNX is to market volatility. So this month, let me show you why I pay attention to the 45-week moving average in the case of the Nasdaq 100...

After an 80% rise since October 2002, the Nasdaq 100 has now closed below its 45-week moving average. In short, the conclusion is that you don't make any money in Nasdaq stocks when the index is below the 45-week average. It's obvious when you see the chart:

Since inception in 1985 until today, the Nasdaq 100 has risen at an annual rate of 24% a year when it's above its 45-week moving average, and it's risen at an annual rate of 3% a year when it's below its 45-week moving average. 

Yes, I recognize that the index did rise a little in the past when it was below the 45-week moving average. Keep in mind that a buy and hold strategy offered an extraordinary 17%-plus return a year over that period. I expect, going forward, investors will lose money when the Nasdaq 100 is below its moving average.

Valuations are high. The Fed is hiking rates. Market action is deterioriating.  Sentiment is overly optimistic. And volatility is low. It's time to buy RYVNX with as much as you're comfortable buying (not exceeding 8% of your investment portfolio). As this will be extremely volatile, stick with our 33% trailing stop on this one.

We picked up small gains in most of the investments on our recommended list since last month's issue, with the exception of Yukos, the Russian oil giant...

Yukos is down 17% since we entered last month. Remember what I said about it in last month's issue... "Buying Yukos is a complete speculation. Don't invest any more money than you are willing to lose, because you may wake up one morning and it may all be worth zero... Of course, triple digit returns... are possible as well."

What's happening? It still looks ugly... but the trend in both Yukos shares and the overall Russian market is up in the last two weeks. The perfect time to buy is when everyone hates an investment, and yet it is starting to rise. I like this as a speculation. I'm willing to risk a little here to make a lot.

For the trailing stop, it's easy to calculate now, unfortunately. The day we bought Yukos was the day it closed higher than any day since. So, 33% below that is roughly $25.30.  That's our stop. 

For the rest of the recommended list... no changes in recommendations. It's been a ho-hum month of mild rises on the list (excluding Yukos). Just the way we like it.

In unrelated news, my wife took me out to look at buying a new home...

I couldn't believe what we saw, and what you can get for your money. Here on the Atlantic coast of Florida, million-dollar homes are just starting points – a place to consider knocking down and starting over. I really couldn't believe how little you get for your money. It doesn't show in the statistics... yet. But my guess is that homes near the coast in Florida have nearly doubled in price in the last three years... 

Getting back to our financial assets, the River of Losses is still the overriding theme in the investment markets. Playing good defense is key, and Apollo is good defense for the next two years. There will be times to take some risks too... like Yukos, or Japan, or RYVNX. Take risk as you see appropriate... but for the most part, play it safe. Investments in every category are overpriced right now.

I'll continue to deliver the best recommendations I can (like Apollo) in the coming years, as I have in the past with REITs, virtual banks, housing stocks, gold plays, and more. I sincerely want to thank you for your subscription to my letter. As I've always done, I'm doing my best not to let you down, and to help you generate True Wealth.

Good investing,

Steve