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Steve's note: Contributing today's essay is our friend Chris Mayer. No matter what Chris is covering in his advisory, Capital & Crisis, you can count on thought-out ideas and contrarian thinking. For one of his top investments right now, read on... 

The Sinkhole Syndrome

By Chris Mayer, editor, Capital & Crisis
Tuesday, May 8, 2007

Last year was the worst year for sinkholes and sewage spills in U.S. history. This year is shaping up to be even worse.

"From Hawaii to New York, Alaska to North Carolina and everywhere in between, an epidemic of breaking pipes is causing unprecedented havoc," says Thomas Rooney.

What caused them? I'll tell you in a minute. But here is a hint: The answer will make investors in water-pipe makers a lot of money.

In March, I attended Gabelli's Second Annual Water Infrastructure Conference, held in Manhattan. Of all the presenters, Thomas Rooney, president of Insituform Technologies, had the most eye-opening story. He told attendees about the looming crisis arising from our decaying water and wastewater infrastructure – namely, leaking and breaking pipes.

But more importantly, he gave us some tangible evidence that shows just how bad things are getting. The most important was the record number of sinkholes and sewage spills in the U.S. last year. Leaking or breaking pipes are the biggest causes of these things in our cities.

A water pipe that leaks (or breaks) either allows dirt to get in the pipe or allows sewage to get out. If dirt gets in the pipes, then the pipes carry the dirt away. Eventually – even if the pipes carry only tiny amounts of dirt away each day – this weakens the ground above the pipes.

This ground lies below – and supports – our roads and buildings. Sooner or later, the ground gives way, creating the gaping sinkholes that swallow up cars and houses and even lead to people's deaths. One such sinkhole in Los Angeles was 30 feet deep and shut down a stretch of highway. Last December, a massive sinkhole in Portland swallowed a big-rig truck. Another in Grand Rapids, Mich., cut off the water supply to residents, who then had to live under a "boil water advisory."

That's scenario one. Conversely, sewage may leak out. If sewage leaks out, then you have major health issues in the surrounding environment. Last year alone, more than 3.5 million people became ill from E. coli and other toxins released from over 40,000 sewage spills in the U.S., according to the EPA. Then there are the beaches.

More than 1.5 million people get sick in Southern California every year because of bacterial pollution in the ocean – much of it coming from broken pipes, according to a study by UCLA and Stanford. And in Hawaii last year, Waikiki Beach had to close after 40 million gallons of raw sewage flowed into the water after a water main pipe broke.

What you don't see under the sink, behind the walls, and under the ground are the working parts of water infrastructure. These are easily forgotten, old economy things – pipes and valves and other parts made from stainless steel, brass ingots, cast iron, and more.

However, because people can't see these things, they have a harder time believing there is something wrong. As long as water is cheap, as long as their faucets and showers provide clean water, and they don't get sick after a weekend at the beach – well, they don't worry.

When this water infrastructure breaks down – because it is old and in desperate need of repair – then those expectations will no longer hold true.

In many parts of the country, we are at that breaking point. As Rooney said: "Just because you aren't standing ankle deep in sewage doesn't mean it won't affect you." He used the analogy of the aging power grid before the big blackout in 2003. Before that, no one cared about the aging power grid. Afterward, all kinds of wheels were set in motion to correct the problem.

"Most water and sewer pipes in the United States were built 60 years ago – but were meant to last 50 years," Rooney says. "Do the math."

Even when cities start to tackle the problem, they have little awareness of the extent of the problems. Rooney told a story about Atlanta, where his company is part of a pipe-rehabilitation project. After completing work on 100 miles of pipe, the city held a celebration to mark the occasion. Rooney notes there are 15,000 miles of pipe in Atlanta.

This is the problem in many cities.

Things get even worse, as hard as it is to believe. Rooney's company deals with small-diameter pipes. A little-known secret, Rooney said, is the fact that the large-diameter pipes – those 40-50 inches in diameter, often made of concrete – are starting to leak in Los Angeles, New York, and other major cities.

When these pipes go, it will be front-page news, disrupting the water supply and affecting the health of millions.

Good investing,

Chris Mayer

Market Notes


Legendary investor Jeremy Grantham says low interest rates and strong economic fundamentals have produced a leveraged, worldwide bubble in all assets. From Chinese art to Panamanian land, Grantham says, the entire world has gone mad with speculation.

You could hardly come up with a better way to track this bubble than watching the share price of Goldman Sachs. As the richest and most powerful investment bank on the planet, Goldman benefits from all things leveraged and liquid.

Goldman helps raise funds for new businesses... it helps sell those businesses to stock investors... it manages funds that trade those stocks... it does back office work for other funds who trade those stocks... and it makes billions by trading everything under the sun. With a profit of $360,000 per employee in 2006, these guys rise and fall with the market's appetite for risk.

As you can see from today's chart, Goldman is doing its job well. Yes, most assets are expensive right now. But until Goldman shares suffer a meaningful breakdown, you can count on the bubble getting bigger.

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