This Week’s Commentary – August 18, 2007 – Still On Vacation

by JDH on August 18, 2007

Last week I announced that I was going on a two week vacation. Those of you who are good at math will realize that I am now one week into my two week vacation.

I assume, since it’s the “dog days of August”, that nothing much happened this week on the markets, so let me tell you a bit about the first week of my vacation.

For those who are wondering, yes, thanks, my family and I are having a wonderful time.

We left Ontario, crossing into New York at Buffalo. Long line ups on Monday afternoon at the border, therefore no sign of a recession. We proceeded through New York, spent the night in Syracuse, spent the next night in Portsmouth, New Hampshire, and crossed back into Canada from Maine into New Brunswick. We went whale watching in the Bay of Fundy (until the boat broke down and we had to be towed four miles back to shore; my boys thought it was great). As I write this I am sitting in a nice little cottage, over-looking the Bay of Fundy, home of the highest tides in the world.

Apparently the Bay of Fundy acts like a funnel, and thus the water level rises and falls up to 28 feet, every 6 hours or so. It’s pretty cool, actually.

There’s a place called Minister’s Island in New Brunswick. At low tide you can drive across the sea floor to the island. Here’s a picture of the “sea highway” that I took on Friday morning:


Had I returned six hour’s later, the entire road would be underwater. They post signs with the times that you must leave the island each day. On Friday the sign said “All visitors must leave the island at twelve noon”. Apparently tides are predictable; they print in the paper the exact times for high and low tides for the day.

We of course ignored the sign. Here’s a picture of my two boys, flinging stones from the sea highway, shortly before noon.

Flinging Stones

According to the locals, apparently once every week someone ignores the warning sign, and gets trapped on the other side of the tide. Apparently the tides don’t care who you are; if you’re on the wrong side, too bad. You either wait, or wade into the water and risk being drowned.

Well, enough about my vacation. More great pictures next week. (Why is it that pictures of other people’s vacations are the most boring pictures on earth)?

So, anything exciting happen on the market this week?

I haven’t had great internet connections everywhere I’ve stayed this week, so I’ve been blissfully ignorant of most of the market’s movements this week. Apparently, though, there was a crash or something?

Last week, in addition to announcing my vacation plans, I announced that I had capitulated. I sold a bunch of my stocks in my main portfolio, bringing my cash component up to the 30% level, the highest it has been in years. In my other more active trading accounts I sold a lot more than that.

Here was my reasoning from last week:

First, I like to Buy High, Sell Higher. I stock that is making a new low for the year is obviously not going up. (As our friend Mr. Dines is found of saying, don’t think, look). Wishing it will go up will not make it so.

Second, I’m going on vacation for the next two weeks, and I won’t be near a computer to watch things closely, so I prefer to be in cash when I can’t keep an eye on things.

Third, two words: overhead resistance. If you buy a stock for $10, and it falls to $6, and then recovers to $7, what do you do? You say “great, I can recover some of my money”, so you sell it. Explosive moves happen when a stock clears through it’s overhead resistance. When there are no more sellers trying to “get out even”, a stock can go on a run. When a chart looks like Pinetree’s, that is unlikely to happen.

Fourth, if you bought on margin (which is a very dangerous game), and shares are down, you are forced to sell to cover your margin calls. That selling creates downward pressure, forcing more people to sell, and so on. It’s happened in the sub prime market, and obviously is happening here as well.

I went on to say:

We are in for a choppy ride. We will have big down days, and big up days. The trend will eventually assert itself, but it looks increasingly unlikely to me that the trend will resolve to the upside in the next few days or weeks.

The lows must be tested. I thought they were re-tested at the end of July. Obviously I was wrong. We don’t yet know where the lows are. Therefore, we watch and wait and observe until we see them.

Here’s what I think now:

First, pretty good call last week, eh? (Of course it was pure luck; had I not been going on vacation, I probably would not have “cashed up” as much. Still, it’s better to be lucky than good).

Second, if you get caught on the wrong side of the tide, you are in big trouble.

This week, we were caught on the wrong side of the tide.

Apparently if you borrow Japanese yen at 1%, and then invest in mortgages in the U.S. at 8%, you can make a seven point spread. And if you lend money to people with poor credit scores who want to buy a house with no money down, you can charge them higher than 8%, and make even more money. And if you syndicate those mortgages and then re-invest with even more borrowed money, the profits can be huge.

Unless people with poor credit start buying houses on spec, and eventually end up with three or four houses that they can’t pay for, so they start selling them, which drives down house prices, and makes the mortgage worthless.

So to repay your borrowings, you have to sell whatever else you have, including stocks in good companies. Selling those stocks drives down the prices, which means that other people who bought those stocks on margin also have to sell to cover their margin losses. Which drives down those prices. And so on.

It’s a race to see who can get off the island before the tide comes in.

This week, no-one made it.

For example, PNP.TO – Pinetree Capital Ltd., which traded at $15.15 on April 10, 2007, traded at $3.55 on Thursday. That’s a drop of 76%. Ouch. Was Pinetree worth 76% less on Thursday than it was just over 100 days before? The market says yes. I say I’m glad I sold last week. (Obviously Pinetree was trading well above it’s Net Asset Value. Now it’s trading a lot closer to it’s NAV. On June 30 it’s NAV was $4.97. Many of the companies it owns have declined in value since then, but at these levels it may actually be a value play).

(Did I just say that? Pinetree may be a value play? Is the salt air getting to me? Do I need a longer vacation? Is this rhetorical style of writing as annoying to you, the reader, as it is to me, the writer?) Either way, I’m guessing that those warrants, that started trading on Friday, with a $15 exercise price, are a lot less appealing now than they were when they were included as a kicker in the private placement financing that closed on April 16, less than a week after the top. (Good timing on Pinetree’s part).

Apparently our friends at “the Fed” in the U.S. lowered the discount rate on Friday, something they rarely do in between regularly scheduled meetings, and as a result investors are now happy, and the Dow bounced back almost 2%. The Fed is also printing money, so all of our worries are over. Glory be.

(While driving through New Hampshire this week, I noticed that the license plates read Live Free or Die. What’s up with that? Your “Fed” is toying with the market, and just printed untold billions of dollars to prop up the house-of-cards financial system. That means the dollars you have in your pocket are now worth less, and will eventually be worth-less. You’re not free. We are behind a dam, that may burst at any time. The big plunges this week were the start of the leakage. But I digress. And yes, I realize that the Canadian government is no better, probably even worse, but Live Free or Die? How can you be free when Big Brother manipulates the markets as much as it does?).

It’s pretty obvious what will happen from here: The tides will go in, and then the tides will go out.

We will, at some point, reach high tide, and then the the water will rise again. 28 feet in six hours, I’m told.

(What, you think it’s obvious what will happen in the markets from here? I’m on vacation. I only predict the tides, nothing more).

I’ll repeat again what I said last week:

The lows must be tested. I thought they were re-tested at the end of July. Obviously I was wrong. We don’t yet know where the lows are. Therefore, we watch and wait and observe until we see them.

That’s my plan from here. I don’t plan to deploy any additional cash this week. (I’m on vacation, so buying and selling on a blackberry isn’t easy).

We will probably have some good days, but until we see whether or not we have made new lows, I see no point in deploying any new cash.

When I do deploy cash, it will be in “solid” companies, ones that have resources in the ground, or who have extensive drilling programs that may lead to discoveries in the short term. And I will up my weightings of solid gold companies. With the paper money being printed this week, gold has got to do well, probably sooner rather than later.

They print the tide charts in the local paper, but there is no “tide chart” for the market. No-one can tell us whether the market will go up or down tomorrow.

I don’t recall anyone on the Buy High Sell Higher Forum, or Dines, or Casey, or anyone else, saying “most of our stocks will probably have a 40% crash in a week, so move entirely to cash”. I do recall Dines saying a month or two ago that Pinetree would be a buy when it fell to around $10. I guess it’s a screaming buy at $3.55? All of Casey’s top picks suffered a similar fate. The correct play, or course, was to have zero equity holdings in the month of August. I’ve looked through the Forum, and most of us have been waiting for the bottom, but no-one was all in cash. We all took losses this week. I’m down 34% on the year, which is incredibly stupid on my part, particularly after my admonition to myself not to repeat my 38% loss performance from 2001.

Does that mean that Dines, and Casey, and you, and me, were wrong?

Yup, that’s what it means. We blew it. We got caught on the wrong side of the island. (Don’t believe me? Check out the Summer 2007 Predictions section of the Forum. I don’t see anyone suggesting that we “sell everything” and take the summer off, but in hindsight that was the correct answer).

Has the world ended? Will China, India, and the rest of the world decided they don’t need energy? Is nuclear power doomed. Nope, fundamentally everything looks great. The tide went out, but that doesn’t mean we will never get to the island.

The tide will reverse. Just be patient. There is no point in jumping into the water and trying to swim to the other side. The current will drag you away. The sea highway will reappear, and then we can continue our journey. Don’t force it. Don’t try to drive on water. Wait for the highway to re-appear.

(Have I beaten this stupid tide analogy to death yet? No? Okay, let me finish then).

Wait for the bottom. The August 16 lows have to be re-tested. If they hold, then we can start buying. If not, I will extend my vacation for another few months, since there will be no point in returning.

(Is it a co-incidence that the bottom happened on the 30th anniversary of Elvis’s death? I was on vacation with my family in Tennessee back on the day he died in 1977; should I stop taking vacations? For you Canadians, August 16, 1979 also the day that John Diefenbaker (our former Prime Minister) died. Is that a coincidence? Or the same day, in 1920, that Ray Chapman of the Cleveland Indians was hit in the head by a fastball thrown by Carl Mays of the New York Yankees, and died early the next day. To date, Chapman is the only player to die from injuries sustained in a Major League Baseball game, according to Wikipedia. Coincidence? Or my father’s birthday? Yeah, probably just coincidence).

Well, back to my vacation. I have enjoyed reading your thoughts on the Buy High Sell Higher Forum this week; keep up the good work.

We will talk again, probably around the 27th of August, unless I have some brilliant insights, or access to a high speed internet connection, sooner. Tide’s coming in. Gotta go.

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