Minneapolis Portfolio Management Group | info@mpmgllc.com | 612.334.2000
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…they laughed at Fulton (part two)

Market Summary – 2nd Quarter, 2004

If Harry Potter fans can forgive author J.K. Rowling for taking too much time to release her next book, we hope you will be as charitable to us in waiting eight months to bring you part two of our “page-turner” about the world of energy. A funny thing happened on the way to the sequel– we became a new company within the framework of the money management firm you’ve come to know and hopefully love (or at least respect).

Minneapolis Portfolio Management Group, LLC (MPMG) is now an independent operation. We are no longer working under the auspices of a larger brokerage firm. It is, as the saying goes, a new beginning, or a rebirth. But we won’t go so far as claiming to be born again. Because while our corporate alliance has changed, the names (and qualifications) of those making the investment decisions remain the same. So has our investment style. We continue to pursue stocks that offer attractive value across all capitalizations in the market.

We also welcome some new faces. Anthony Shink, steps into the role of Institutional Director, working with investment professionals who bring our services to their clients. Laura Harvey has also joined our staff, providing administrative support.

Another face you may become familiar with is the symbolic tortoise at the top of the page. Expect to see this logo on the various communications you receive from us. The symbolism should be apparent. We’re not looking for the hares of the market. They had their heyday in the go-go 1990s, but our style is more time tested, and we believe more productive in the long run.

Back to Fulton
In December, when it seemed clearly out of favor with most people, we made the case for owning selected energy stocks. At the time, the spot price of a barrel of West Texas Crude was just shy of $30. There was little enthusiasm for the energy market among most investors. But the real story already happening then and continuing today is that demand for oil is up sharply, and likely to stay that way. As the chart here shows, oil usage today is up to about 82 million barrels a day, and is rising at a rather dramatic rate. That’s a big increase from just a couple of years ago. Put another way, that means we’ll burn through almost 30 billion barrels of oil this year alone.

q204

The World’s Increasing Thirst for Oil

Fulton (continued)
Sure enough, higher demand has created price pressures. In August, the price for a barrel of crude jumped to $46. As we anticipated, many of the stocks added to our portfolios benefited from this environment. And suddenly, the conventional wisdom is shifting. More and more analysts are predicting that the problems we’ve experienced this year in terms of price and supply will become more commonplace. One prediction is that oil production will peak in 2005 and then we will slowly (very slowly) begin exhausting supply. Whether that’s true, nobody can say with certainty. But it adds to the argument that the bounce for energy stocks isn’t a flash in the pan. We wouldn’t be surprised to see a dip again in the months to come. There are always short-term swings in the oil market. The long-term situation shouldn’t change. The simple fact is this – demand for fossil fuel is growing, new discoveries combined with existing reserves are not matching that rate of growth. It adds up to a depleting supply. Until new technologies surface to help level off the demand, oil is sitting pretty.

This story is bigger than oil alone. A number of energy-related stocks are benefiting from the environment of higher demand that is fueling energy prices. Natural gas is particularly attractive, because the reserves are found here, in the U.S., and this is a clean fuel. A cost-effective way to liquefy gas and ship it long distances (from other countries) is a few years off, so natural gas companies have a window of opportunity right now. The supply-demand story here is not unlike what we’ve seen with the oil market. A number of analysts believe a recent hike in
the price of gas is more than a blip, but rather a long-term trend. In order to take advantage of this opportunity, you will find some or all of the following natural gas stocks in your portfolio (closing market prices as of 8/24/04):

Dynegy (DYN – 4.31) – Once caught up in its own Enron-like difficulties, it is getting back on its feet, and offers good value given the profits it generates from its unregulated businesses.

Oneok (OKE – 22.83) – A gas utility that also has a very profitable trading and marketing operation.

Western Gas (WGR – 28.37) – Another diversified gas company involved in a variety of aspects of the business.

MDU Resources (MDU – 24.63) – Serving primarily the Dakotas and Montana, it generates significant revenue from non-regulated businesses.

Although a number of these stocks have already performed well, we consider this a long-term play given the general trend of natural resource depletion. If these stocks lose value temporarily, we may see that as another buying opportunity in order to capitalize on the extended trend of higher energy prices.

q204 cartoonInterest rates, inflation, the dollar & gold
The Federal Reserve is drawing much interest these days because it has recently reversed its course of the previous three years and has begun to nudge interest rates higher. Given that the short-term rates the Fed controls were at historically low levels, this appears to be a no-brainer.

At the same time, the dollar, already quite weak in recent years, could actually lose more ground. With recent signs of economic sluggishness, huge trade deficits now commonplace and lots of dollars already floating around the world, it is highly possible that many foreign buyers will, before long, say “thanks, but I have enough dollars (or dollar-denominated securities) already!” That could further weaken the dollar.

On top of this, there’s that never-ending concern regarding inflation. The general belief is that inflation has not really been a problem for our country since the early 1980s.

But in reality, inflation never went away. Ask anybody paying for health insurance or medical costs, college tuition or even, this past spring, an ice cream cone. Buying a home hasn’t been a bargain either. While the overall rate of inflation may remain modest, the costs for real items that affect most people’s lives, has skyrocketed. Over the long term, the impact of rising prices, even if the average is rather modest, is significant.

Interest rates (continued)
All of these factors point us to a commodity that could benefit – gold. In times of uncertainty, currency weakness and inflation, gold tends to perform reasonably well. With some exceptions, the past decade hasn’t been very kind to gold investors, but now, it appears that this is a more attractive opportunity.

Two stocks we have been investing in for our portfolios include:

Newmont Mining Corp. (NEM – 42.85) – Newmont sets the gold standard in the business, one of the biggest in the production and exploration business. If you believe in the gold market, you almost have to include Newmont in a portfolio.

Goldcorp Inc. (GG – 12.41) – This is a smaller player in the field, but with a lot going for it, including zero debt, an innovative approach to the business and even its own storehouse of gold bullion, a nice asset if inflation becomes a bigger issue.

2nd Quarter Review
Looking for Cheery News
The spring and summer months in the stock market have been a case of looking for a silver lining. Amidst a heated political landscape, continuing problems in Iraq, and economic news that was less than stirring, even a bronze lining would have been acceptable. But even that was elusive. We’re living through one of those periods where good news is hard to find.

Where the market stands

Where the market stands

The environment has seemed somewhat depressing ever since that tragic day nearly three years ago when terrorists attacked our country. We’ve heard it repeated over and over again – “September 11th changed everything.” We certainly don’t want to discount the tragic nature of the event, or the seriousness of our war on terrorism. But if you really think about it, our nation has been through plenty of events that would have seemed to change everything.

Let’s just go back thirty years. In the summer of 1974, America suffered through a significant “first,” the resignation of President Richard Nixon. The economy, at the same time, was struggling with its first oil crisis spurred on by the Arab Oil Embargo, an event that forever changed the cost of energy for Americans.

In 1979, America was shocked by the Iranian hostage crisis, an event that would drag out for more than a year. That was the same year that Business Week touted in a cover story “the death of equities,” (as Mark Twain would say, a prophecy that proved to be greatly exaggerated). In 1987, the stock market suffered its largest one-day downturn, and the financial markets had to stave off the potential of an investor panic. In 1991, America went to war again, this time in the Persian Gulf, an event that at its outset had the potential to create another economic shock. Inflation returned and many seemed prepared for more troubles ahead.

What came out of all of those problems over the last thirty years? As the table below indicates, stocks have withstood these seminal events and then rebounded. Not always immediately, mind you. As we approach the three-year anniversary of the World Trade Center/ Pentagon attacks, we thought it instructive to compare the three-year record of the markets after each of those events.

Keep in mind how far the market has come since then. While the rebound may have taken some time, it shows that investors demonstrate continued faith in our free market system.

Event Dow close on that day Dow close 3 years later
President Nixon resigns – August 9, 1974 777.30 879.42
Hostages taken in Iran – November 4, 1979 818.94 1050.22
Stock market crashes – October 19, 1987 1738.74 2520.79
Terrorist Attacks – September 11, 2001 9605.51 ?

Other stocks of note
Amidst this summer of doom and gloom, we continue to find what we believe are diamonds in the rough. Here are a few stocks that are worth noting:

Andrew Corporation (ANDW – 11.22) – If you believe that wireless communication isn’t just a passing fad, but instead, a trend that will continue to grow, you have to believe in Andrew Corporation. This is a “behind-the-scenes” company that plays a big role in the world of wireless phones. Along with making coaxial cable for wired connections, Andrew’s product line is quite familiar to many of us – cellular towers and satellite base stations, for instance. We began to purchase Andrew when it was priced in the single digits. It rose to $20/share, but recent weak earnings reports brought the stock price back down. The recent price drop, in our eyes, created an attractive buying opportunity. The long-term story on cellular communications is still quite solid. While cell phones may appear to be ubiquitous, the truth is that usage in the U.S. lags behind many other developed nations (where cell phones are more reliable than land lines). So there’s room to grow and the future for Andrew is bright.

Leapfrog Enterprises (LF – 18.69) – Not your typical game company, their niche is education. This company found a way to edge itself into the hard-fought toy market, by making toys with a purpose. Its flagship product, the LeapPad, is regarded as a standard-setter in its segment, electronic educational toys. The company’s success at making learning fun has won the hearts and minds of kids, not to mention parents (who, after all, foot the bill for the toys) across America.

Even the U.S. government, not noted for toying around, has purchased 20,000 LeapPads as a tool to help teach basic hygiene to women in Afghanistan. While the company is facing increasing competition, most notably from toy powerhouse Mattel, we like their record, their prospects and their clean balance sheet with zero debt.

Apple Computer (APPL – 31.95) – If you can remember back to our last update in December, we sang the praises of Apple Computer at that time. The stories we talked about then – the emergence of the iTunes (Internet music downloads) business and Apple’s powerful G-5 technology, are still in tact. But there’s another aspect of Apple’s success worth mentioning. Apple’s visibility has increased thanks to its attractive retail stores. While other companies, such as Gateway, have failed in their retail efforts, Apple’s sexy stores have attracted more than just Macintosh aficionados through its doors. Apple’s stores generate sales (on a per square foot basis) that are five times higher than the average for a typical mall store. Sales at the company-owned retail stores represent more than 10% of Apple’s total sales. Most important, it is one way Apple has been able to extend its brand to non-Mac users. This stock has worked well for us, but we continue to believe in its upside potential, as this innovative company continues to find new ways to generate revenue and keep its base of Apple fans happy.

The Opportunities Ahead
We’ll put it right out there on the table–there are plenty of hurdles for investors to contend with these days. The Fed is bumping interest rates, the economy is not exactly on fire, and to top it off, we’re in the heat of another political season, which creates its own issues.

But no matter what the hurdles, there has never been a time in the history of U.S. investing where opportunities did not exist. Portfolio success does not require an environment where “a rising tide lifts all boats.” Instead, it centers on finding companies that offer products and services designed to solve problems and with an ability to generate profits while doing it. Today’s market is one that rewards good stock selection and that plays into our style. In fact, the uncertainty that exists for investors and is keeping the stock market as a whole in check can actually work to our advantage. It allows us to find more stocks of companies that are attractively priced without carrying significant market risks.

Don’t get us wrong – like everybody else, we’ll be thrilled to see the next bull market. But our focus today is to position our portfolios to succeed for the long term, regardless of current market conditions.

~MPMG

Although the information in this document has been carefully prepared and is believed to be accurate as of the date of publication, it has not been independently verified as to its accuracy or completeness. Information and data included in this document are subject to change based on market and other condition. All prices mentioned above are as of the close of business on the last day of the quarter unless otherwise noted.

The information in this document should not be considered a recommendation to purchase any particular security. There is no assurance that any of the securities noted will be in, or remain in, an account portfolio at the time you receive this document. It should not be assumed that any of the holdings discussed were or will prove to be profitable, or that the investment recommendations or decisions we make in the future will be profitable. The past performance of investments made by MPMG does not guarantee the success of MPMG’s future investments. As with any investment, there can be no assurance that MPMG’s investment objective will be achieved or that an investor will not lose a portion or all of its investment.