Quarterly Commentary:
April 2007

The Quarter in Review

Aside from two weeks in February, it was an uneventful and relatively inactive quarter for your humble advisor.  Most of the securities we own were too cheap to sell, and many of the securities we may have otherwise considered were too expensive to buy.

Problems in Shanghai and the residential subprime loan market gave hint to the speed in which market sentiment can change.  Emerging foreign market securities fell 25% or more within a week.  Some subprime lender shares fell 80%.  The subprime loan problems are a surprise because there was no apparent catalyst.  Thirty lenders have collapsed into bankruptcy all on their own, without a spike in interest rates or some other external event; suggesting much weaker fundamentals than the market currently discounts.

Markets appear to have recovered as the quarter ends.  The easy money attitude has returned (for the moment), as tougher lending standards are apparently not yet tough enough to be a deterrence.

Most of our “speculative” positions have done quite well, with gains ranging from 15%-60%.  Our largest “safe” investments continue pay a dividend but otherwise drag down our overall performance.

Strategy for the Second Quarter

Lingering arguments regarding the residential housing market’s imminent recovery seem to have vanished.  However, if the subprime bust is indeed contained and easy lending conditions persist, I suspect there will be a bullish bias, as investors chase yield and buy-out activity continues.  If the subprime bust is not contained, and tighter lending standards topple the next tier of homeowners, then credit spreads will widen, interest rates will rise, and the exist from the market will be swift.

Tactics for the Second Quarter

• I plan to raise cash as the markets rally this quarter.  A fully-invested portfolio prevented me from repositioning during the market drop in February.
• Our commodity positions, weak for much of the first quarter, are now quite strong.  I have lightened up on our natural gas.  Our remaining positions are more than adequate should that market improve, and I want to raise cash for the inevitable pull-back.
• About 5% of our assets are in Rydex inverse funds, which appreciate in value as markets fall.  These funds hedge our long positions, and offer a direct profit opportunity in a bear stock market.
• Our adjustable rate bank loan fund positions are up about 10%, while also paying 8+% interest.  This income is taxed as ordinary income, so I am not inclined to add to these positions.
• I will also sell down our positions in our oil and gas royalty trusts investment to a more appropriate percentage of our portfolio.  These trusts currently pay in excess of 10%, and historically appreciate in price as well with the underlying asset.  However, our current positions have not appreciated nearly as much as other non-dividend stocks.  I will diversify, and perhaps re-establish a larger position if I can improve my basis.