This Week’s Commentary – January 26, 2008 – No, Kids, We Aren’t There Yet

Are we there yet? – any kid who has ever gone on a car ride lasting more than 10 minutes

Well, that was a fun week.

The Asian markets broke down last weekend, and the Toronto Stock Exchange started the week down 605 points, or about 4.5%. At the end of the day Monday I was down 10.8% for the year.

Fortunately for my American friends, the U.S. markets were closed on Monday, so I guess that means that Martin Luther King Jr. is now the investor’s best friend. Before the opening on Tuesday the Fed woke up (they’ve been asleep for the last few weeks, apparently), and cut interest rates by 75 basis points, which of course meant that all was well with the world.

There are no more problems.

So, on Tuesday, Toronto recovered up 508.75 points, or just over 4%, and my portfolio recovered so that I was only down 4.8% on the year.

Then the Wednesday swoon happened, and I was down 8.2%. By the end of the day Thursday the market had rallied and I was only down 6.6% on the year. Friday was another down day, but I did some selling early to lock in some gains, so Friday was an up day for me, and I ended the week down 4.8% on the year. It’s as if Wednesday, Thursday and Friday never happened.

What does all of this mean?

It means “we aren’t there yet.”

The Toronto Stock Exchange peaked at 14,625 in late October. The Tuesday close at 12,640 is still a drop of almost 14%, which in my book is a bear market. By Friday the TSX was back to 12,895, but that’s still a big 12% drop in just over three months. That’s not good.

Interest rates are being cut because the American economy is in a recession. A recession means that people lose their jobs, and their buying power drops. That’s not good for stocks.

Ultimately cutting interest rates will be great for gold, because as the dollar gets hammered, people will want a store of value, and that’s gold.

But again, I repeat, we are in a bear market, and as richmanch reminds us on the Buy High Sell Higher Forum, “When you encounter a bear, you’re supposed to play dead.”

I agree, so here’s my plan:

I have increased my cash component. I am now up to 62% cash. I have sold all of my weak players. If this is a bear market, I don’t want to be holding companies that might start producing in five years. I want to hold producers and blue chip stocks.

I will be over-weighting in gold and silver stocks, because as the drunken sailors running the U.S. government start sending cheques (I guess in America they are called “checks”) out to every man, woman and child in America, the deficit will increase, the dollar will collapse, and gold will soar.

But, that won’t necessarily happen tomorrow, or the next day. We will continue to see volatility. We will have huge up days, and big down days.

So, on the gold side I want to hold AEM.TO – Agnico Eagle Mines Ltd, G.TO – Goldcorp Inc. and K.TO – Kinross Gold Corp. (For uraniums, I don’t yet know what exactly I want to hold, because given their recent performance there really are no “blue chips”).

But, I don’t want to “set it and forget it.” This is the stock market, not the Ronco Rotisserie Oven.

If we have a big down day, I’ll be buying. If we have two or three big up days, I’ll be selling. If nothing much is happening, I’ll be sitting in cash.

Does being in cash mean I may miss the next big up move?

Perhaps, but how many big up moves do you see in a bear market? Not many. If things were all going up, that would be a bull market.

After the August 16, 2007crash I said that we needed to retest the lows before a new upturn could begin. In fact here is a direct quote from me:

“I still believe a re-test of the August 16 lows is inevitable, so I will take this week to sell some of my losers that have bounced (nothing wrong with a little tax loss selling). I will continue to hold lots of cash (I’m at 32% cash now), and I will do some selective buying.”

I said that in my commentary on August 25. And I was correct (too bad I didn’t take my own advice and just stay on the fence). Obviously the retest of the August 16 lows happened for a lot of stocks this week, and for many of them the lows didn’t hold. Here’s and example: PNP.TO – Pinetree Capital Corp., a stock I haven’t owned since August 9, 2007:

Have you ever seen a more obvious “bear market” than this chart? From a peak of $14.98 on April 13, 2007 to a steady and virtually un-interrupted fall to close on Friday at $3.36, a decline of an amazing 78%! Can you believe that there is at least one newsletter writer who continues to recommend this stock! Hold or buy all the way down????? Obviously you do not want to buy this stock until the downtrend is broken. In other words, don’t buy until it actually starts to go up!

And that’s the point of a bear market. Stocks go down. And they keep going down. And they keep going down until they start to go up. That’s why a retesting of the lows is so important. We think we have hit a bottom, but we don’t know it’s a bottom until we restest the lows. Obviously in Pinetree’s case the lows from August 16 did not hold (see the green vertical line), so down we go. Until it starts going up.

Here’s a good example of re-testing the lows, K.TO – Kinross Gold Corp.:

Kinross bottomed at $11.75 on August 16, re-tested again down to $11.92 on August 28, 2007, and has remained well above those lows ever since. Of course all gold stocks have been very choppy, as Kinross demonstrates: up to $19.21 on November 6, then down to $16.18 on December 17, and then a high of $23.86 on January 14, before falling to a low of $19.66 on January 21, finally closing this week at $22.28.

The action in Kinross is exactly what I expect to see over the next few weeks, and probably over the next few months. Big ups, then big downs. So here’s how I’m going to play it:

If we have a big run for two or three days, I’m selling. If we have a big down day or two, I’m buying. And mostly I will be sitting on cash until the final blow out happens, and we start to see some uptrends.

Could I be wrong? Did the blowout already happen, and are we now set for a new uptrend? Perhaps. Perhaps the money creation by the U.S. government will stimulate the economy. Perhaps another 25 or 50 point rate cut by the Fed this week will cause a rally. Perhaps the prospect of a new president will get things going.

More likely, however, is the fact that the average Canadian is now carrying debt equal to 128% of their annual disposable income, the highest level in history. Consumer debt in Canada has now grown at 10% per year for the last four years. (I assume the American numbers are similar). How many people have seen their wages grow by 10% per year for the last four years? Not many. In fact, most people’s real wealth is falling, as their home value collapses, and their investments go down.

I fear that when the next wave of mortgages come up for renewal in the March through June traditional home buying period, and they go into default because the borrowers can’t afford the new higher mortgage rates (higher because of the decreased property values and increased risk), the whole subprime mess will hit the news all over again.

And them some “rogue trader” will default a French bank for $7 billion, and no-one will notice. (Oh, wait, that already happened…..)

Then will come the credit card defaults, which have also been packaged and sold like mortgages. That will be more bad news, and that will put further downward pressure on the market.

Now I suppose you could argue that the fact that I am now 62% in cash is a sure sign that we have reached the bottom, and a new upturn will begin. Perhaps. But take a look at the chart of Pinetree again. Does it look like a new uptrend has begun?

When my kids ask me “are we there yet” I tell them “no, we aren’t there yet, I’ll tell you when we are getting close. In the meantime, listen to your iPod, watch a movie, read a book, or just look out the window to pass the time. We’ll get there when we get there.”

And that’s the way it is in a bear market. You can’t force it. You can’t tell the market to go up. You have to wait until it happens.

Our friend Mr. Dines can put out an Interim Warning Bulletin with a “buy” signal for your “attack capital”, but how many of his followers have any “attack capital”? There are four keys Mr. Dines does not have on his computer: S-E-L-L (I guess that’s only three different keys, but I’m not sure he actually uses a computer anyway).

You only have “attack capital” if at some point you sold something to raise it, and selling is not something Mr. Dines likes to recommend, even if his favourite stock, his “blue chip, safe, conservative” stock goes down by 78%.

I am of the view that Mr. Dines is like the father driving the family car on vacation. He has a road map, but refuses to use it. As a result, he gets lost.

Mr. Dines knows the way. He knows that when an uptrend is broken, you sell, and you don’t buy again until a new uptrend resumes. You don’t try to pick the exact top or bottom. Unfortunately, for whatever reason, he refuses to follow his own advice. Perhaps he has too much of his own money and reputation invested in some of these stocks, and he thinks if he keeps holding them they will eventually recover. That’s not exactly the “high state of service”, is it?

I’m not going to make the same mistake. I’ll let the market reveal itself, I’m not going to try to force it.

I’ll keep my eye on the road, and eventually we will get there.

As always, thanks for reading, and feel free to post your thoughts on the Buy High Sell Higher Forum.