Story Time with JDH

by JDH on February 21, 2009

This blog is my attempt to make sense of the markets. Each week I force myself to take a look at where the markets are going, and try to predict what will happen. I read news reports, I look at charts, and I use “gut feel”. So, how does my gut feel?

Not good. Here is a chart of the DOW since 1997:

On May 30, 1997 the DOW closed at 7,331. On February 20, 2009, the Dow closed at 7,366. That means that over the space of 4,284 days, or almost 12 years, the Dow has basically remained unchanged. No movement. No gains. No profit. I guess we will have to stop making fun of Japan’s lost decade, since we are now experiencing our own lost decade, which may well be our LQC, or Lost Quarter Century by the time this is done.

How can this be? How is it possible that we have shown no progress, made no profit, for twelve years, with no redemption in sight? Why do we have no insight?

We have no-one to blame but ourselves.

I now present the first ever installment of Story Time with JDH.

Story #1

Four years ago we renovated our basement, and I finally got my big screen TV. Really big. A projector mounted on the ceiling projected the image on the screen that’s about eight feet across. Very cool. (There is never anything on TV so I never watch it, but that’s not the point. It’s big).

About six months ago we noticed an annoying blue smear appearing, and it grew over time. A call to the guys who sold it to us said yes, the something-or-other was going, and it’s not worth fixing. They would sell us a new and improved projector for about what we paid for the last one. My wife couldn’t believe that a fancy TV can only last four years before needing to be replaced.

And that, my friends, is one of the things wrong with this world. We build products as cheaply as possible, because we only care about price, not quality or value. Our society is disposable.

Story #2, and #3, and #4, and #5

I can tell the same story again, except this time the thing that broke was a washing machine, or a dryer, or fridge, or stove, or car, or whatever. It’s all the same.

I have never, in this blog, revealed what I actually do for a living. I prefer to remain “JDH”, the guy with initials, but no name. But here’s a hint: I work with people in financial trouble. I spend my days working with people who have more debt than they can handle.

Story #6

This week I met with Tom and his wife Jane. Tom and Jane are not their real names. They are not even real people. But, their story, with very minor editing, is completely real, and it is a story I hear at least ten times per week.

Tom and Jane had good jobs, so they bought a house in 2004 for $200,000. They had no savings, but they were able to qualify for a “no money down” mortgage. They had access to credit, so they used their credit cards and lines of credit to furnish their new home, and to take a nice vacation.

By 2006 they had accumulated $40,000 in credit card debt. But, not to worry, the housing market was great, and their house was now worth $300,000, and interest rates were low, so they were able to add $50,000 to their mortgage, pay off all of their credit card debts, and even have an extra $10,000 for the down payment on two new cars, that they leased, and to take another nice vacation.

By 2008 they had accumulated another $40,000 in credit card debt. They had bought more furniture, had nice clothes, frequently ate out, and took nice vacations. Realizing they were paying a lot in interest, they phoned up their bank manager and asked to refinance their house, just like they had done in 2006.

Unfortunately, by the end of 2008 their $300,000 house was now only worth $270,000, so it was impossible to borrow against the house.

Then Tom, who was working in an auto parts factory, was laid off. Jane was still working, but her hours were reduced, so her income had dropped as well. They began to fall behind on their monthly credit card payments, so the credit card companies began charging late fees, over limit fees, and they raised their interest rates, putting Tom and Jane even farther behind.

They came in to see me for advice. I told them they should give up their two leased cars, and walk away from the house, since there was no equity in it anyway. “We can’t lose our cars and our house”, they said, “because we worked hard for those things and we don’t want to lose them!”

I am a compassionate person. I have both sympathy and empathy for people in financial distress. It always pains me to have to tell them that no, you didn’t really “work hard” for those things. You borrowed money to buy those things that you could not otherwise afford, and now it’s time to pay the piper.

And that, my friends, is what’s wrong with this world. We don’t work for things anymore. We borrow to consume.

Last week I mentioned my now departed mother. Today, a story about my father.

Story #7

There were four children in my family growing up. There was me, the oldest, and of course my siblings JEH, CRH, and SEH. (Weird that my parents gave us initials and not names, eh?). My father was a school teacher; my mother was a “stay at home Mom.” We had one TV set in the house. We didn’t get a colour TV until just before the Reagan presidency. (I may be exaggerating, but not by much). Not that it really mattered, since we were not allowed to watch TV during the week, and my brother and I had to go to bed after the first period of the hockey game on Saturday night, but I digress.

We never owned a new car. The family station wagons (a type of car popular before the minivan was invented) were always bought used. We were not poor, and my father always paid cash. No leases. No car loans.

We lived in the same house from the time I was seven years old until I moved out on my own. My parents bought the house because it was in a small town on the outskirts of Toronto. It was the best house they could afford, but it was not more than they could afford. Eventually all of us moved out. In 2000 my mother died, and in 2007 my father sold the big old house, at the peak of the real estate market, and bought a smaller house, again on the outskirts of town. As a result of the “downsizing” may father had a nice chunk of cash.

In the fall of 2007, a few weeks after he had moved into the new house, I got an e-mail from my father telling me he had bought two new cars. I was stunned. Between the ages of 16 and 70 my father had never owned a new car, and now he had bought two of them? I immediately called him and asked him what he had bought. He had bought a pick up truck, to haul gardening supplies, and a car big enough to transport his grandchildren when needed. He bought a 2004 Ford and a 2004 Highlander.

“I thought you bought two new cars”, I said to my Dad. “I did”, he said. “But Dad, it’s 2007, and the cars you bought were made in 2004. That’s not new.” “Yes, they are practically new” he replied.

And that, my friends, is the difference between people born between 1960 and 1990, my generation, and people like my Dad, born during our last “Lost Decade” between the crash of 1929 and the end of the War in 1945. To my Dad, a three year old car is a brand new car.

I lease my cars on three year leases. I turn them in after three years and get a new one. To me, a three year old car is obsolete.

See the difference? I think a three year old car is obsolete, and my Dad thinks it’s brand new!

My Dad is retired and living comfortably, with no debt. My peers all have fancy cars and fancy houses, but we all have car loans, car leases, and mortgages we can’t afford.

Why has the Dow not moved in 12 years? Because we have not created any wealth in the last 12 years. We have borrowed to consume, but we have not saved any money, we have not created any wealth.

The sub-prime mortgage mess in the U.S. was created by people with inadequate income buying houses they couldn’t afford. The government is now discussing a “mortgage bailout” to help pay the mortgages of people who should never have gotten the house in the first place.

Have the bankers created any new real products in the last twelve years? Is the banking system more efficient? No, they have just given mortgages to people who should not have mortgages, and for that they received fat bonuses, and billions in bailout money.

Have the Detroit automakers created any truly new cars in the last twelve years? Do we have super-fuel efficient cars, or real hybrid cars? Do we have cars that run on alternative energy? Are cars significantly safer and cheaper than they were twelve years ago? Well, Detroit created the SUV and the massive pick up truck, exactly what we didn’t need last year when oil hit $140 per barrel. Their reward for their incompetence? Billions in bailout dollars, and millions more in bonuses for the executives, even as tens of thousands of factory workers lose their jobs, their health benefits, and their pensions.

As we all know, the First Law of Thermodynamics states that energy can neither be created or destroyed.

JDH’s first law of Money-Dynamics states that wealth can be created by work, or destroyed by waste and incompetence, but it can’t be created by borrowing or fancy bookkeeping.

Alas, we are guilty of fancy bookkeeping.

We believe that borrowing to buy a house, two cars, four high definition TV sets, three vacations a year and a meal at a different restaurant every night means we are wealthy. We are not. We are just in debt.

Marketers can create the Perennially Changing Perennial, but it’s not; it’s just the same flower we bought last year, dressed up in a fancy package with a higher price tag. Buying more stuff, on credit, does not make us wealthy. Ultimately, it makes us poor.

The Solution

What is the solution for Tom and Jane, who can’t afford to pay for their house, cars and credit cards? They have to clean house. Unfortunately selling their house and cars won’t solve their problem, because they don’t own their house or cars; they only rent them from the bank. The laws are different in many parts of the United States, where it is possible to walk away from a house and owe nothing. In Canada, that’s not the case. If you walk away from your house, the mortgage holder will pursue you for the shortfall, and the solution for a record number of Canadians is quite simple, and quite final:

Bankruptcy

If your income is drastically reduced, and if you owe more than you can ever repay, bankruptcy may be your only option. According to the Toronto Star:

Consumer bankruptcies led the rise, spiking by 50.1 per cent year over year to 7,821 people, one of the biggest year-over-year jumps in history, according to some observers. “I can’t remember an increase like that. That’s kind of blown it off the charts, frankly,” said Douglas Hoyes, a bankruptcy trustee with Hoyes, Michalos & Associates Inc. “I would have said maybe a 25 to 30 per cent increase based on our call volumes. But 50 per cent? That’s stunning.”

Yes, I would say an increase in personal bankruptcies of 50% is “stunning”, and is “blowing it off the charts.” You think that may be one reason why the stock markets are making new lows?

If you are a country, built on credit, with no wealth created in 12 years, there is only one solution.

Bankruptcy

Now yes, I realize a country can’t technically file bankruptcy. But a country can devalue their currency and renege on their existing debts by printing more money. And that, alas, is what is happening.

It’s simple math. Long term you can’t continue to borrow more than you can repay. At some point real wealth must be created, and if it isn’t, economic calamity is the result.

The point, dear readers, of this long winded, disjointed, pedantic dissertation on this cold and windy Saturday morning is this: we created these problems over a long period of time, and they will not be solved quickly.

In Canada, if a person declares bankruptcy, in most cases the process ends in nine months. Their credit report is negatively impacted for seven years, but after nine months their debts are gone, and they can get back to living. Continuing to borrow money at ever increasing interest rates only serves to delay the inevitable result.

The world economies should have taken their medicine, allowed the defaults to happen. Instead, governments are injecting “stimulus”, and are propping up failed enterprises, which is akin to borrowing from a loan shark. They have not solved any problems; they are only delaying the inevitable result. If we had let the failures happen in 2008, by 2010, after a very difficult 2009, we would be on the road to recovery.

As it stands now, 2009 will be worse than 2008, and 2010 may well be even worse.

Which is why the price of gold is on a run. It is becoming obvious that the fiat currency system is dying, so we have no choice but to put what little wealth we have into vehicles that are no someone else’s liabilities. And that’s gold.

I predicted that gold would be $1,200 per ounce by March 31, 2009. Given that fell to almost $800 about 35 days ago, and is now around $1,000, $1,200 is possible by the end of March. Very possible. However, I suspect my prediction will be wrong.

I know believe that, with everyone predicting that gold will go to moon, we will probably see a pullback. The $1,000 level was significant resistance a year ago, and I suspect that will prove to be the case again this time around. The RSI and MACD levels are looking over extended, and a $200 run in one month is probably not sustainable. I will therefore continue to maintain my small gold stock position, and remain with the rest of my portfolio in cash, in anticipation of better buying opportunities over the next few weeks.

World governments have committed to spending trillions of dollars in pork (I mean “stimulus”). They don’t want to see the U.S. dollar crash, and gold to soar, before their plans have at least a few weeks to work, so I assume they will keep a lid on gold, for now, just as a cook keeps a lid on a boiling pot. (Until, of course, the pot boils over).

I must of course point out that I have been completely wrong up to this point. I have been reducing my gold holdings all the way up over the last two months, when I should have been buying.

On January 31 I gave you all a list of my stink bids on gold and silver stocks; as of today, I have not been filled on any of them, so they remain as follows:

ABX.TO – Barrick Gold Corp. at $39

AEM.TO – Agnico-Eagle Mines Ltd. at $59

K.TO – Kinross Gold Corp. at $20

G.TO – Goldcorp Inc. at $33

SLW.TO – Silver Wheaton Corp. at $6 and

SSO.TO – Silver Standard Resources, Inc. at $22

The only caveat to the above numbers is that I may start to dabble at slightly higher numbers.

For example, I have my K.TO – Kinross Gold Corp. stink bid place at $20. That looks like a reasonable retracement point to me, but I may attempt to pick up a few shares at $22, to go with the shares I already own, as insurance against a quick spike in gold. More specifically, if I want to ultimately own 1,000 shares of Kinross, and I currently own 200, I may buy another 200 at $22, and then fill in the remaining 60% of my position on down days with my stink bids.

Or not. I have a gut feeling that the $1,000 level will prove to be significant resistance, and my stink bids may well get filled in the near future.

Cash is not a bad thing in these volatile times, and patience is a virtue, so I will sit and wait a bit longer.

And where is the Dow going? I predicted 8,000 by March 31, 2009. Looks like we already blew through that level.

My best guess now is that the Dow will retest the 1987 levels around the 2,000 level, which makes sense, since that will probably happen around the time gold hits $2,000, for a nice symmetrical 1 to 1 ratio.

Am I crazy? Have I spent too much time with people in financial distress, which has made me too cynical?

Maybe.

But for now I will hold cash, continue to dabble with some put options on the S&P 500, and look to increase my gold holdings on any pullback in the gold price.

I have talked enough. Now it’s your turn to comment on the Forum. Thanks for reading, and see you next week.