June 7, 2006 – The Rooster

Well, Friday was a big day for oil, and not a great day for the U.S. economy. Oil prices surged for the second straight day, with the July light crude contract closing at $138.54, beating the $135.09 record set back on May 22.

To make matters worst, the U.S. Labor Department reported that the unemployment rate rose to 5.5% in May (as compared to 5% in April), for the the biggest monthly jump in more than twenty years. The economy lost 49,000 jobs in May, marking the fifth straight month of job losses. That’s probably why the Dow was down 395 points

Don’t worry, dear readers; I’m not trying to turn this blog into CNBC or Bloomberg; let me translate for you:

The economy sucks.

We all know that most numbers released by the government are doctored, so if even the government is admitting to a big bump in unemployment, the economy is in very bad shape. Obviously the higher unemployment numbers won’t help the foreclosure mess either; more people will continue to lose their homes.

Even poor old Ed McMahon is suffering through a house foreclosure.

I love this quote from Ed: “Well, if you spend more money than you make, you know what happens.”

And that’s the point, really. For many years we have been spending more than we make, and now the rooster is coming home to roost. The U.S. government has been running massive deficits, and they’ve financed them by printing money. As a result, no-one wants to hold dollars, so the dollar is tanking, which long term will kill the U.S. economy.

Consumers, following Ed McMahon’s lead, have also been spending far more than they earn for many years. Consumer credit has fueled economic growth, but again, at some point you have to pay the piper. And that time is now. Mortgage foreclosures and a declining dollar are not the problem; they are the symptom of the problem. There is no free lunch, and now we are paying for it.

(Hmmm, two cliches in the last two paragraphs; better keep an eye on that).

There is no doubt that interest rates are going higher. As the government continues to print money like drunken sailors (oops, another cliche), the value of the remaining dollars decreases. That’s inflation. To compensate me for lending you money that I know will be worth less when you pay it back, I require a higher interest rate. Hence, interest rates are on the rise. So, what to do?

First, if you have a variable rate mortgage, or a mortgage that is due to mature in the next year or two, call your lender and switch to a fixed rate. If you plan on having a mortgage for at least the next five years, lock in the rate for the next five years.

Second, pay down your debt. Over the last two months, as I have documented many times in this blog, I have been raising cash. A year ago my line of credit was maxed, and I had significant investments on margin (which is fine in a rising market). Today I have none. I have sold virtually all of my non-registered investments (ie. investments outside of my RRSP (retirement savings account, similar I assume to an American IRA), and I have paid off the line of credit I was using for investment purposes. I own no stocks on margin. That way, if the market does tank, I don’t magnify my loses.

As an aside, if you are carrying credit card or other high interest debt, pay it off. In a weakening economy with high interest rates, holding debt does not make sense. I have no objection to a mortgage or a car loan if it’s necessary, but beyond that, get out of debt. Reduce your expenses and conserve cash.

Third, buy some insurance. The only stock I own traded on an American stock exchange is RSW – Rydex Inverse 2X S&P ETF, which in simple terms is an Exchange Traded Fund that increases when the market goes down. Not surprisingly, it was my best performer on the week, up over 5%. If the market does crash, I make a profit.

Finally, buy gold, or gold stocks. My second best performer this week was G.TO – Goldcorp Inc., up 5.2% on the week. If the government keeps printing more dollars so as to make them worthless, what can you put your money in that they can’t print? Gold.

Now, here’s the kicker: I am not fully invested. I am still holding 50% in cash, because I still believe there will be better buying opportunities ahead. As the chart of Goldcorp shows, the argument can be made that we are still in a downtrend that started in March, so until the downtrend line is decisively broken, I won’t be a big buyer.

Here’s the HUI:

The Gold Bugs Index is now about where it was back in April 2006, which I assume will be a significant base at which to continue purchasing. In other words, the time to start buying is probably very soon, probably within a matter of days or weeks.

To that end, I have placed my stink bids on all of my favourite stocks (you can see the list here on the Buy-High-Sell-Higher.com Target Portfolio).

I have put in bids at the prices indicated. In some cases I have only put in bids for half of the holdings I want. For example, if I want to eventually have 8% of my portfolio in a certain stock, I may buy half of it now, and the other half (4%) later in the event of even greater volatility.

I have set my stink bid prices below the market; they may be near the bottom of the current trading range, or near other support levels, such as the 50 or 200 day moving average.

Some of these stocks have already hit these levels, so they are now in my portfolio. Others will be acquired over time. This week I didn’t hit on any stink bids, but the bids are still there.

As I said last week, this strategy could of course back-fire if the market goes on a sustained run for the next few months, like gold did this week. If it does, I guess I’m waiting on the sidelines. That seems unlikely to me, so I’ll play it this way for now. The beauty of stink bids is that I can place the orders now, with expiry dates two weeks out, and then I don’t have to stare at my computer screen all day (I do have a real job, you now).

So, am I being overly pessimistic? Has the gold rally already started, and have I missed it? Let me know on the Buy High Sell Higher Forum, and thanks for reading and contributing.