DRUCKENMILLER'S OPPORTUNITY,
PART II

Helmut from Hamburg only had one answer to every question I asked him.

What's it like in Germany right now? It's bad… How are business conditions there now that the euro has strengthened by over 50%?  It's bad… Taxes? Bad. Politics? Bad. Bad, bad, bad.

Helmut is a True Wealth subscriber. I met him at the New Orleans Investment Conference over the weekend. He's probably in his fifties, and he's a small–business owner. He's a lot like many True Wealth readers, except that he lives in Germany, where things are apparently bad.

Of course, Helmut may not have realized that I like bad. 

You see, you make the most money in investing when things simply go from bad to less bad. You don't make ridiculous returns when things go from just fine to good. You make hundreds of percent by buying when there is no hope, and seemingly out of nowhere a glimmer of hope appears.

That's what we're doing this month. We could double our money, or more, in two to three years. Even better, we're doing it extremely safely, with very little downside risk.

Making great returns with little downside risk may not seem possible. But we've been doing this same type of thing for years now in True Wealth. Our recommended list currently shows nice, safe gains across the board, with no losers on the list at the moment. 

To make outstanding returns, you've got to buy something that nobody else wants. You've got to buy it when things look bad. And then give it a few years. The problem is, these things don't come along every day. But we currently have an opportunity to do that right now with the euro, and in Germany. Let's not miss out on it…

THINGS LOOK BAD, SO GET EXCITED

Thank goodness for Marty Whitman.

Marty is the manager of our recommended Third Avenue Value Fund. It's up nearly 70% since we bought it. Marty took over Kmart when things looked really bad, by buying up its debt. The stock was worthless, and Marty was getting excited.

Just this week, Kmart announced it's taking over Sears, and the new shares of Kmart are now worth over $100 each. Things went from bad to less bad, as Kmart is still no match for Wal-Mart or Target. But we were rewarded with hundreds of percent in returns inside our Third Avenue Value Fund as things went from bad to less bad. Thanks, Marty!

Another example is Israel. Things have been getting less bad there for the last two years, and stocks, like our recommended Koor, are up hundreds of percent in that time. We're up 20% in just one month alone on our new recommendation of Koor in Israel, likely due in part to the death of Yassir Arafat. 

Shares of Koor have risen from roughly $8 to $10 for us. But as recently as early 2003, these shares were close to $2. What happened? Quoting the November 15, 2004 issue of Forbes: "When [Benjamin] Netanyahu became finance minister in February 2003, Israel stood at the brink of financial catastrophe… [Things were bad!] Yet despite war, terrorism and labor strikes… Netanyahu put forth a slew of economic reforms. His goal: to transform Israel from a heavily regulated, bureaucratic tax–and–spend welfare state into a free-market economy. In the space of 20 months he cut government spending; began privatizing… and reduced the top marginal tax rate from 64% to 49%. [Things got less bad, and Koor has risen from $2 to $10 in less than two years.]"

You get the idea.… The really big money is made when things go from bad to less bad.

So things are bad in Germany, eh Helmut? "You wouldn't believe it. Over half my income is taken from me in various taxes.  Meanwhile, the big multinational companies don't pay taxes."

Ah ha, I see. And what about the euro? "Everybody knows the euro will go up and the dollar will go down. But it's killing us." Helmut is not being an alarmist here by predicting the continued demise of the dollar. Even the normally sensible Economist magazine proclaimed in its October 28, 2004 issue: "A further steep decline in the dollar seems inevitable."

Just about everyone agrees. Germany stinks, and the euro will continue to rise. And this is where we come in…

We are low-risk speculators. True Wealth has been built on buying things of exceptional value safely when nobody else wants them. And right now, we have that opportunity in Germany and with the euro.

Since you probably understand stocks better than currencies, let's start with German stocks…

GREEN LIGHT MODE NOW IN GERMAN STOCKS
AS CHEAP AS THEY'VE BEEN IN 20 YEARS!

You're probably familiar with my 1–2–3 Stock Market Model that I tested using weekly data going back 80 years. My 1–2–3 Model switched into RED LIGHT mode in late 1999, saying "Get out of stocks!"

People didn't want to hear about it. It was a time when everyone wanted to be in stocks… stocks were the sure path to riches, everyone was certain. As it turned out, everyone was wrong, and the 1–2–3 Model was right. Stocks today are still below their highs five years ago.

In Germany, it's now switched into GREEN LIGHT mode. Stocks are cheap. The European Central Bank hasn't messed with interest rates in a long time, and the trend in stock prices is up.

It's time to buy.

But how can we buy when things look so bad in Germany? Helmut is not alone. Everybody believes what he believes. It is the exact opposite of 2000. For example, the November 2004 "ZEW" survey of Economic Sentiment in Germany came in at 13.9, down from it's October 2004 level of 31.3. 

For comparison, the ZEW survey recorded an 89.6 – it's highest level of optimism in recorded history – in early 2000. At that time, Germany's DAX stock market index was around 8,000 at the time. Now the DAX is around 4,000 – a fall of 50 percent. Folks, you don't want to buy when people are optimistic.

Unlike the States, German stocks are relatively cheap. They bottomed out recently at the cheapest they've been in 20 years, as the chart here shows:

As for No.1 in our 1–2–3 Model, how can U.S. stocks be expensive now, while German stocks are cheap? Think of it this way… in the U.S., the Dow Industrials are barely down from their highs five years ago (the Dow peaked above 11,000, and we're near 11,000 now). But Germany's DAX is now down 50% (from 8,000 to 4,000). No doubt, a 50% fall in blue chips has affected sentiment.

As for No.2, Germany differs from the U.S. here again. Alan Greenspan has consistently been raising interest rates in the States. He raised them again earlier this month. In Europe, unlike the States, short–term interest rates have not changed all year. 

As for No.3, the trend is up. After trading in a narrow range all year (just like U.S. stocks), Germany's DAX just broke out of that trading range on the upside this month. 

This is exactly what I like to see… a cheap and hated investment, just entering an uptrend. Time to buy!

There are all kinds of opportunities to buy, and all kinds of reasons why you'd buy one or the other. What we're going to do is take the simple approach: We're going to buy the whole market…

Buy the iShares MSCI Germany Index Fund (AMEX: EWG). German stocks are cheap and hated, and an uptrend has just begun. Buy shares of EWG with up to 4% of your financial assets. Downside should be limited. And upside earnings potential could be enormous, as I'll show below.

DRUCKENMILLER'S
OPPORTUNITY, PART II:

THE CATALYST THAT WILL THRUST GERMAN STOCKS MUCH HIGHER

Why was Druckenmiller so certain of this trade? 

"One of the reasons I was so bullish was a radical currency theory proposed by George Soros in his book, The Alchemy of Finance. His theory was that if a huge deficit were accompanied by an expansionary fiscal policy and tight monetary policy, the country's currency would actually rise.

"The dollar provided a perfect test case in the 1981-84 period. At the time, the general consensus was that the dollar would decline because of the huge budget deficit. However… the dollar went sharply higher.

"When the Berlin Wall came down, it was one of those situations that I could see as clear as day. West Germany was about to run up a huge budget deficit to finance the rebuilding of East Germany… I went headlong into the Deutsche mark. It turned out to be a terrific trade."

We've had great success so far with our first "Druckenmiller's Opportunity" trade. Back in the September issue, it seemed almost silly for me to predict a potential 45% gain before year's end. And it seemed almost silly for me to buy my first tech stock in the history of True Wealth. 

But I did it, and so far, so good. BEA Systems (Nasdaq: BEAS) is up an amazing 27% so far. Our other speculation at the time, the Korea Fund, is also up by double digits. We have a tight 15% stop on these two speculations, so we should end up a winner in both of these when we sell them in late December. This trade was our first "Druckenmiller" trade, as we bought heading into the election, and it's been a big winner.

Now we're on to our second Druckenmiller trade. Today, the general consensus is exactly the same as it was in 1981-1984 – that the dollar will decline in part because of the huge budget deficit. But just like 1981-1984, the dollar could actually confound the experts and go much higher!

It is my belief that the bull market in the euro is near the end of its run.

I am practically alone in this belief. Everyone, from the man on the street (Helmut in Hamburg) to the most esteemed publications (Economist) to even the world's greatest money managers (Bill Gross), believe the euro is headed much higher.

But I find comfort in being alone here. Consider this, and see if you're with me…

The euro bottomed in mid-2000, and stayed there until 2002. I looked back at what the "experts" were saying in mid-2000. I didn't have to look far. I found what I was looking for in my first article – the June 5, 2000 issue of Barron's: 

"It's been a big failure," laments Criton Zoakos, chief economist at Leto Research, who sees the euro finishing the year at 70 cents. It's still down roughly 25% from its level when it was launched January 1, 1999…

"Looking forward, however, it's unlikely the euro will soon find a bottom… It's not hard to understand why the euro is weak and will likely stay that way… ‘You have a recipe for a full–blown currency crisis,' says Jeremy Fand, international economist at Fleet Capital Markets."

How wrong they were. The euro has strengthened by over 50 since 2002, to near 1.30. As recently as 2002, nobody had a nice thing to say about the euro. And yet, the euro had crashed since its introduction, and was super cheap (as you can see from my chart)… It would have been the perfect time to buy euros.

Now we're in the equal and opposite position.… Nobody has anything nice to say about the U.S. dollar, yet it has already crashed horribly. Now may just be the perfect time to take a position. I think we're pretty darn close to a top in the euro.

MY 1-2-3 MODEL FOR THE EURO

My 1-2-3 is built on three things – value, interest rates, and market action/sentiment. I size up currencies basically the same way as stocks. And right now, based on my 1-2-3 Model, you wouldn't want to buy the euro. Let's take a look…

First of all, for value, there is none with the euro. Now that the euro has strengthened by over 50% versus the U.S. dollar, we can't consider traveling to Europe. It's too darn expensive. The technical term for this is "purchasing power." And right now, the euro is roughly 15% overvalued by my math. With history as our guide, you generally don't want to be accumulating euros when it gets this expensive. Look at the following chart to see what I mean:

Second are interest rates. Remember this: Money flows to where it's treated best. Not so long ago, Alan Greenspan had cut rates to 1% in the States. Money was being treated better in Europe than at home. Hence, money flowed out of dollars and into euros. But now times have changed. Both the European Central Bank and Greenspan have set short–term interest rates at 2%. Advantage, nobody.

Lastly is market action/sentiment. There are two pieces to the puzzle here... the first is market action. There's no denying it: The euro is in an uptrend. And you don't want to fight the prevailing trend, particularly in currencies. But the second piece – sentiment – is something you do want to go against…

Any way you want to size up sentiment, we are at a bullish extreme in the euro. Just ask Helmut. Or to be more technical, speculation in the euro on the futures markets is at an extreme. Also the major sentiment surveys (Market Vane and Consensus) show over 80% bulls. In short, EVERYBODY is betting against the dollar. 

Said another way, there is NOBODY left to bet against it. Things are bad. If things just become only a little less bad, the dollar will likely start its run higher. 

And if the dollar starts to strengthen, it could do amazing things for German stocks…

Consider BMW, as an example. It basically pays people in euros. But it sells a good number of cars in dollars. If the dollar strengthens versus the euro, that would cause BMWs profits will rise, and yet their costs will stay the same.

Even in the face of the strong euro, BMW was able to report record numbers in its latest earnings report, on track for record numbers for 2004. Yet the stock is cheap, with a single digit P/E based on 2005 analyst estimates. The stock is cheap, because everyone believes the euro will continue to rise, hurting BMW's profits. The expectation of a higher euro is already built into the share price.

So if the euro confounds the experts and weakens, BMW shares should soar. According to the November 8, 2004 issue of Barron's, BMW has not fully hedged it's currency risk because "BMW expects the euro will drop back toward a ‘fair value' of $1.10 to $1.15 from $1.30." I expect the same. 

If the euro weakens, it will dramatically improve earnings at German companies like BMW, and share prices will have to react. Shares could double or more in two to three years. And as goes BMW and the euro, so goes our investment in shares of EWG.

THE RISKS TO THIS SCENARIO…
AND ANOTHER WAY TO PROFIT

There are two major risks to this scenario. The biggest risk is that the euro continues to rise. You absolutely, positively, do NOT want to go against the trend in currencies. As legendary economist and speculator John Maynard Keynes said "the markets can remain irrational longer than you can remain solvent."

The second risk is the fact that global stock markets are fairly correlated. If the U.S. stock market falls, the German market tends to fall. Sometimes countries move together, and sometimes they don't. Our hope is that Germany's cheap stocks and a weakening euro will outweigh any correlation to U.S. stocks, and allow German stocks to rise whatever happens elsewhere.

So we will buy EWG now, and use a 25% trailing stop to protect ourselves in case we're wrong or simply way too early. I expect that we could possibly double our money here in two to three years, as the earnings of the German multinational companies that make up EWG soar as the euro weakens.

Also, I have another, totally different way to play this trade…

One of the nice things about having over 60,000 subscribers now is that financial firms are willing to create products that meet the needs of my readers. I've met with Frank Trotter, the CEO of Everbank, on a few occasions, asking him to create unique financial products that meet our needs. Hopefully you'll see some innovative, limited–downside, unlimited–upside products in 2005. For now...

Frank has created a nifty product where we can profit from the fall in the euro AND earn some interest. Frank is calling it the Dollar Bull CD, where you basically make a percent for every percent fall in the euro, plus you get paid a small amount of interest. So if the euro falls by 10% in the next year, you might make 10%, plus 1% interest. Something like that. I think we could do even better than that…

We did extremely well on our "dollar bear" CDs with Everbank – I'm talking about our commodity currency CDs. We made about 32% on these CDs. 32% in CDs! Those CDs were a classic True Wealth play – big gains with very little risk.

Now it's time to move along. When your commodity currency CD matures, swap the proceeds into Everbank's new Dollar Bull CD.

The Dollar Bull CDs are not available now, but will be by the end of the year. And that's a good thing, because I don't want to fight the current uptrend in the euro. (For the track record, I will consider our entry price and date to be the day that Everbank starts officially filling orders.)

What you can do now is open a FreeNet account with Everbank, and earn about 2% while you wait to buy the Dollar Bull CD. I expect we'll be in this trade for two to three years.

Remember, I don't want to fight the trend. The way to time your purchase of the Dollar Bull CD is to wait until the euro has a weekly close at €1.25 or lower (the euro is currently around €1.30). Buy half then. And then buy the other half when the euro's weekly close is below €1.20. This way, we're trading with the trend – as we did in our Commodity Index CDs – not against it.

To reiterate, the Dollar Bull CD is not available yet, but it should be in a few weeks. When your Commodity Index CDs mature, roll the money into the Dollar Bull CD. If you don't have money with Everbank yet, you can either park money there in the FreeNet account, or wait until the euro closes below €1.25 and then give them a call. Contact Chuck Butler (or anyone on his team) at 800-926-4922 or chuck.butler@everbank.com (minimum investment: $10,000).

COMMENTARY ON OUR
RECOMMENDATIONS

I usually reserve this space to comment on our recommended list. But our entire recommended list is firing…

With the exception of one virtual bank (ANH), everything on our list is within 5% of its highs… no risk of stopping out.

If it ain't broke, don't fix it. The only thing that requires commenting on is our recommended coins...

The coin market is overheated. There is simply not enough supply to meet the demand. When it comes to our recommended coins, please be aware that most of my recommended coins have risen a good deal in value, and are now at or above my "buy up to" prices (see chart below).

Our 7-piece set is particularly hard to come by. The best advice now is to let the market cool. Our graded coins are our 7-piece set are a "hold" now, not a buy. We've made 40% in a year-and-a-half here. But we're risking moving the market now. We can't do that. Hold, for now.

I'll comment briefly on AINV and LQD as two very good, safe ways to make double-digit total returns that both pay interest. Just make sure you follow my instructions, and get out of AINV within two years of our initial recommendation.

Lastly, it was a pleasure meeting many of you at the New Orleans Investment Conference. Please join me at a conference in the future if you can…

Good investing,

Steve