Searching for Stability

Diversify with this Brazilian Iron Ore Play

PLAY: Buy the RIO January 37.5 Calls (VOH AU) at market, good for the day. Place a protective stop limit at $1.20 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).

Dear Bottarelli Research Member,

As the Dow broke down to a new 52-week low on Thursday, I received a note from LEAPS member J.S. that read, “Bryan, the DIA is reaching the low of January of 115.80. Do you think it will be a good opportunity to buy January leaps at this moment?”

My answer to that question is quite important, and that’s why I’ve decided to share it with you here in today’s newest LEAPS alert. I replied, “I certainly think it’s a good idea to buy LEAPS on the strongest companies in the strongest market sectors right now. Names that we currently own, like WFT, OSG, PBR, ETR, and coal plays (we sold FDG) are great buys at these levels. And Saturday’s newest pick (which I’m working on now) is another great one too!”

To continue on this point, I firmly believe that carefully adding longer-term LEAPS picks on strong companies experiencing weakness in a bearish market environment will hand us tremendous returns over the course of the next 6-8 months. The trick is to allow yourself enough time to withstand the weak market conditions. That way, we’re not exposed to the daily (and weekly) price swings. As I’ve mentioned in my daily options alerts, June of 2008 will most likely go down as the single weakest market month in 6 years. That’s quite a remarkable statistic. And it clearly illustrates that adding longer-dated call options at these dramatically over-sold levels could handsomely pay off when the markets eventually stabilize and recover.

Another important question that I’d like to address comes from member M.T. He wrote, “Hi Bryan. If we are in a period of secular, not cyclical, bear trends then would it not be prudent to time the market a bit more and trade some more puts?”

My response to M.T. was, “It’s hard shorting anything at such extremely oversold levels. But if I need to play puts in Bottarelli Research LEAPS, I’ll certainly play them. I don’t have any restrictions on upside or downside plays. After all, the name of the game is winning trades. That’s the one and only goal.”

If we’re indeed transitioning over into a longer-term bear market, then we can (and will) begin purchasing longer-dated put options here in Bottarelli Research LEAPS. After all, I have no bias against upside or downside plays. I intend to recommend whatever plays can make us the most money. That’s my primary goal.

But from a market-timing aspect, it’s tough to enter into a new put play when you’re coming to the end of one of the worst market months in six years. So for now, we’ll continue our strategy of adding calls on companies that I feel will continue moving up for the remainder of the year. And if I see signs of further weakness, we’ll begin adding puts to our LEAPS ledger as well.

So on that note, let’s dive into this week’s newest pick, which comes in the form of Companhia Vale do Rio Doce (RIO – NYSE).

As we suffer through a recession that has taken a devastating toll on sectors such as housing, financials, technology, aerospace, and retail (just to name a few), it’s smart to own upside exposure on the powerful collection of companies that benefit from demand-driven markets.

Steel, fertilizer, energy, coal, and oil all fall into this category. And when it comes to metals — historically viewed as a “safe haven” investment in times of recession — gold typically is the metal that receives all the attention. But let me tell you, the times are changing. Today, the more powerful “safe haven” investment comes in the form of steel and iron ore.

For example, the price of gold is actually down 2% from mid-January, but steel prices are 50% higher. Prices of hot-rolled steel (which act as the industry benchmark) have jumped from $600 per metric ton in January to $1,000 per metric today. And in terms of steel stocks, a collective grouping of top steel names have averaged 22% returns this year, while a similar grouping of top gold names have actually lost 3.5% over the same time period.

Why has steel been so strong? Well, when you look at the rapidly growing “BRIC” economies (which include Brazil, Russia, India, and China), it’s easy to see why steel has enjoyed such tremendous upside. In 2007, for example, steel usage increased:

• 18.6% in Brazil.
• 13.5% in Russia.
• 13% in China.
• 11.3% in India.

Now here’s the thing: While most savvy investors recognize that steel is in high demand, most of these same investors do not realize that steel cannot be manufactured without its key ingredient: iron ore. That’s why iron ore prices have increased 50% since January — setting in motion the catalyst for today’s new LEAPS play.

You see, the world’s largest iron ore producer is Brazil’s Companhia Vale do Rio Doce (RIO – NYSE).And while it hasn’t been widely reported in the financial media, RIO has just increased their prices by 65%. Now ask yourself, what other company is able to successfully increase prices by 65% in this “global recession” we’re facing? In short, there aren’t too many. Perhaps even none. That’s why I feel that RIO makes for such a powerful LEAPS position right now.

Not only that, but Brazil just announced a $27 billion plan to double its iron ore production. This ambitious plan aims to increase iron ore production from 350 million metric tons to 650 million metric tons over the next four years, which should bode extremely well for RIO.

Another upside catalyst is the fact that RIO has been aggressively diversifying its revenue base by acquiring other metal companies. In fact, RIO’s CEO Roger Agnelli has completed 14 acquisitions since taking over in 2001 (including an $18 billion takeover of Canadian nickel producer Inco in 2006), and this growth through acquisition should continue to fuel the company’s earnings power.

Right now, rumors persist that RIO could be looking to make a run at a company like Anglo American (worth $85 billion), Freeport McMoran (worth $44 billion) or Alcoa (worth $32 billion), but RIO stressed that they’re not currently negotiating any new strategic acquisitions. Either way, any rumors could offer a nice upside boost!

Chart-wise, I like how the stock is bouncing right off its 200-day moving average (noted by the short-term chart below):

And get this: The longer-term RIO chart looks even better. As you can see, the stock is currently hammering out a bottom right at the 50-day moving average, offering you two strong support points on both a shorter-term and a longer-term chart!

Best of all, the January 2009 LEAPS are wonderfully priced. As I write, you can buy the RIO January 37.5 Calls (VOH AU) for $3.50 per contract. These calls are currently $2.50 out of the money, which means the entire premium is made up of time (or extrinsic) value. With seven months of time premium for the total cost of $3.50, you’re paying the rock-bottom price of $0.50 per month to carry this position.

Put it all together, and paying these cheap premiums to own upside exposure on the world’s top Brazilian iron ore producer (that just raised prices by 65% without batting an eye) is probably one of the very best deals available anywhere on Wall Street today. So on that note, here’s your latest LEAPS pick…

PLAY: Buy the RIO January 37.5 Calls (VOH AU) at market, good for the day. Place a protective stop limit at $1.20 and implement our scaled-selling technique to lock in portions of your profits as these calls achieve 50% returns (and greater).

UPDATES

WFT January 2009 50 Calls (WFT AJ): Despite a horrible market, shares of Weatherford International (WFT – NYSE) actually closed the week by hitting a new 52-week high. This strong move has pushed your WFT January 2009 50 Calls (WFT AJ) up to a high of $6.30, good for a 43.18% gainer. Going into next week, be sure to take half of your profits off the table at the 50% profit mark, and then hold the remainder for further gains.

FDG September 90 Calls (FDG IR): We took the remainder of our profits this week, so congratulations on a really nice winner in the midst of a horribly-weak market environment. I continue to love the movements of coal-related plays, so we could very easily revisit a similar play in an upcoming LEAPS alert.

OSG January 95 Calls (OSG AS), PBR January 90 Calls (PMJ AR), & ETR January 140 Calls (ODF AH): All three stocks experienced modest weakness, but I continue to love them all. Echoing my comments from above, all three of these positions represent strong companies that should continue to benefit in today’s market environment. All remain strong holdings in our LEAPS portfolio.

AMX January 2009 70 Calls & HOV January 2010 12.50 Calls (YZX AV): These are our two “turnaround” plays, and I continue to feel that each position will recover and hand us strong returns. They just need time to gain upside traction, which isn’t easy in a market environment like this. But that’s why we have plenty of time on our side! Hold.

Sincerely,