Bombs Bursting in Mid-Air, "ARM"ageddon unfolding

In the first salvo of the unfolding assault on the housing market, two sub prime mortgage related bombs have exploded. In the last 5 years nothing has astounded me more than the reckless lending by the mortgage industry. Now two sub prime Mortgage lending institutions have now folded up and they are Ownit Mortgage solutions of Agoura California and Sebring Capital partners of Dallas Texas. The egalitarian and optimistic nature of real estate investments, clearly evident in their names. These are but a small part of the Predatory, foolhardy and reckless lending which has unfolded on an unprecedented scale. Buyers were financed with nary a nod to ability to pay or income qualifications. Anyone that could breath could qualify for a loan, 20% down? OK. 10% down? OK. 5% down? OK. 0% down? OK. 120% of the home value? OK. Mortgage payments equaling up to 40% of income? OK. Inflated appraisals? OK. And of course these borrowing decisions were based on several factors.

First and foremost was the widespread belief that housing prices don't decline. Housing was a sure thing. Every magazine and newspaper touted the bandwagon that was the housing market. That Stocks and bonds may be speculation, but housing was a "Good investment" for everybody. Just like putting money in the bank. And for a while it was, as below market interest rates fanned the bidders into buying frenzies as "MOM and POP" finally could get into the game and win big. And get into the game they did, going from savers to investors. As the assets they held went up just like a bull market in stocks or bonds. And based on history it has shown to be a good bet.

But not now!!! As the next chart illustrates the price of housing going back 110 years, till the 1890's. It is different this time. It is not a sure thing as many are now finding out. Housing markets have gone through many times of ups and downs but overall have remained a good holder of value and long term investment. And a fine preserver of purchasing power as the central banks of the world have inflated away the value of money at a steady pace for the last century. They couldn't print the house so the money that went into them could not be inflated away, the value of the house just went up to preserve the purchasing power of the original money spent on the home purchase, plus inflation.

I still remember my astonishment as Alan Greenspan fanned the fires of irresponsibility by exhorting people in his Humphrey Hawkins testimony to Congress, to use the low interest rates to extract money from their homes. And MOM and POP took the "Maestros" advice as well to go on a spending spree. Withdraw money from the "Bank" er excuse me, from their home equity.

As they came to believe Asset inflation was just like money in the bank. Homeowners saw no difference between their savings and the "ATM" like qualities of their home equity. And they took the next step to the "ARM"ageddon we are now seeing unfold. They went from investors to speculators, and started to run their finances like hedge funds, with unbelievable leverage. All on the mistaken belief, fanned by the media and Federal Reserve chairman that housing was a sure thing, not a speculative investment.

Courtesy of virtually every "lending institution", dropping every prudent loan qualification from their considerations. Lenders became like Santa Claus, dishing out the dollars to make peoples dreams of Sugar Plums, and "something for nothing" seem to come true to the masses. Of course there is no such thing as something for nothing. "Somebody always pays", and in this case it will be the poor people who bought the hype. Not the builders, not the sellers, and not the banks (as they sold the mortgages in Mortgage backed Securities packages). Keeping only the best risks in their own loan books, and selling the trash to yield hungry investors and institutions. Many of these securitized loans are guaranteed by Fannie Mae and Freddie Mac, those quasi government organizations with the implied US government guarantees. And of course, the dopes holding the bags are who else? The US Taxpayer...

As we can see from the chart that since about 2003 housing values have become unglued from histories fingerprints. And if you don't think it is going to revert to histories range of values, I have a bridge for sale. Give me a call. The bloodbath that will be the housing and real estate markets has just begun. Buyer beware.

A great buying opportunity is on the horizon, the far horizon!!! 12 to 18 months as these people trapped in these investments default, as no one will refinance them. Because those mortgage are held in mortgage securities. Why would any lender take a mortgage bomb off another group's balance sheet? They won't. And you can bet on it. When this chart has retreated back to its historical range is will be time to buy, and with the momentum it implies as it declines back to historical range, you can expect it to overshoot on the downside. At the bottom, load up, but be aware the headlines will be dripping people's blood, and if you talk to someone about investing in real estate they will look at you as if you are crazy. It will be a once in a hundred year buying opportunity.

The Exodus Continues, "At The Margin"

As America blissfully celebrated Thanksgiving, and the wonderful blessings we have received over the last several hundred years. A peace of coal was loaded into their Christmas stocking, as the rest of the world took the opportunity to show us which way the wind is blowing in terms the future prospects of the dollar and our economy. The dollar was rocked out of its slumber and recent trading range, to the downside. Signaling the coming slow disintegration of the US currency and economic prospects.

Although we see the war in IRAQ, a new war is unfolding. And it is going to be fought in the financial and currency markets. And it is going to be fought with Russia, China, the Middle East, Venezuela, etc. These countries are choking on dollars, worthless pieces of paper that roll off the printing presses in limitless quantities, used to meet any expense; Iraq war, Katrina, oil imports, emergency spending. Any unexpected expense that can be imagined. Steal the money right out of the bank and savings accounts of American citizen or business, as they lower the value of every dollar by printing one more piece of fiat currency, which pulls down the value of every other dollar in circulation. And as the vicious debt cycle spirals out of control, both today's new debts and tomorrows future obligations. An example of this spiral can be seen in the table below which outlines the growth of on balance sheet debt. Look at it closely and weep. Weep for every person or business that uses US dollars as a means of exchange. This a up to date look at the last month through December 12, 2006;

Look at the breathtaking growth of this number, now at over 600 billion dollars a year and growing. Look at the rate of growth, it is astonishing. Then realize that it understates the problem by over 45 TRILLION dollars, of the unfunded liabilities of federal pensions, Social security and Medicare, etc. to name a few. Do you really believe that these sums are payable from government revenues. That 45 Trillion dollar number was just 20 Trillion in 2000. It is up 150% in just six years. These numbers are courtesy of the GAO (Government Accounting Office) and the US Treasury. You can thank every member of Congress and the President of the United States for this gift to current and future generations of citizens who will forced to address this obscenity. Smaller Government, what a laugh. Fiscal responsibility, forget about it. And more government, more regulations and higher taxes are not the answer, but it is the plan of the new Congressional majority democrats. So we will get less business, less jobs, working longer and harder and getting less. Doesn't sound like a good plan to me.

And what does it mean to all the holders of dollars around the world? It means that every dollar they accepted in payment will be constantly devalued as the US Politicians and government tries to postpone the day of reckoning to a time when they are not at the wheel of power. Buying votes today to be reelected and putting off the practical solutions to today's problems to tomorrow.

Our counterparties to trade are accumulating no more dollars and not yen, as the only bigger debtor in the world as a percentage of GDP is Japan. They are moving into Gold, the Euro, British pounds, and foreign government bonds, anything but dollars. They get them in payment for their goods and services and are immediately unloading them, for something else, anything else. Of course they are doing it quietly, but it is being done a little at a time throughout the world as holders of dollars see this and angle quietly out. Central Bankers from around the world speak of their concerns, from Russia to China, India to the UAE, Kuwait, Iran, Venezuela, and yes, and even Japan speak quietly of the problem. It is the reason stocks are going up, they want to hold anything but dollars. Stock in a company is not dollars.

Of course the virus of Fiat money and credit creation is a worldwide phenomena. With the western governments racing to see who can print currency and issue more fractional credit at a faster and faster pace. The competitive devaluation raceway as Greg Weldon puts it. But the US invented it with the creation of the Federal Reserve, and is the master of it. But around the world they are moving out of the dollar at the margin, which is where long-term trends are born. It can easily be seen in the breakdown of the dollar, the wind has changed direction and it is headed lower. Slowly, inexorably it will decline as people and central banks move out on the margins.

December 12, 2006

I recently read where columnist Jack Kelly stated that President Kennedy once hosted a dinner for Nobel Prize winners. At the dinner he reportedly said: "I think this is the most extraordinary collection of talent, of human knowledge, that has ever been gathered at the White House, with the possible exception of when Thomas Jefferson dined alone." After reviewing the report of the Iraq Study Group, released last Wednesday, New York Post editorial page editor John Podhoretz declared: "The nation's capital hasn't seen such concentrated wisdom in one place since Paris Hilton dined alone at the Hooters on Connecticut Avenue." I have no further comment on the matter - I just assumed you might like the quote as much as I did.

Personally, I believe the Congress and Senate are a group of people who are remarkably capable and have accomplished a great deal. Americans want a health plan for every man, woman and child. Our politicians have made sure that they (the politicians) have an incredible health plan for every man, woman and child directly connected to them. Americans want good jobs that pay a fair wage. Again, our politicians got the message loud and clear. They have continuously raised their own salaries and made allowances where they can obtain further payments from books, media appearances, speaking engagements, etc. Americans want to know they will be safe and cared for in their retirement years. Once again, Congress and the Senate understood your concerns and established retirement programs for themselves that are off the charts. In fact, since many Americans were so concerned with Social Security, they made sure that their deal was not part of Social Security i.e. should Social Security somehow blow up, our politicians have it set up so they will continue to get paid. There is no question these people are highly capable and can get things done - they have proven it! Editor's note: I assume these politicians are just testing these things out for us, so that they will be just right when they allow the rest of us to have them. Do you think our forefathers may have been on to something when the suggestion was made that lawyers not be a part of the new government.

Please forgive my tongue in cheek comments, but it is pretty obvious that this country has come full circle i.e. 200+ years ago we broke away from England on a banner of TAXATION WITHOUT REPRESENTATION. "History repeats itself" .... "Those who fail to study history are doomed to repeat it", etc., etc. We are at a point where a number of qualified cyclical analysts are saying that we are in the process of completing a very major cycle. Without discussing various types of cyclical analysis and boring you with the various terminology, the basic premise is that all cycles have a certain defined sequence of events - clearly, without that, it would be difficult to call them cycles, wouldn't it? At the same point in the cycle, regardless of the length of the cycle, similar things occur. Could we legitimately refer to the current time period as a time period where we have taxation without representation? It would appear that we can. So what's the point?

After long periods of economic expansion in the United States, each such period has always been followed by a severe recession at best or a depression at worst. This current cycle began in 1933 and is the longest economic cycle in the history of the country. At every other similar point in US history, the pundits on Wall Street gave numerous reasons why "it's different this time". It never was. The recent bear market from 2000 to 2002 is merely a sub cycle of the cycle from 1933. At the top in 2000, you could hear endless justifications for the most overpriced market in US history. We were in a new era where the old methods of valuation no longer counted and Warren Buffett was probably 'over the hill'. Of course, neither was the case and an 83.5% correction ensued in the NASDAQ 100. That was a recent mini example of what it means when you end a cycle. Has anyone learned and taken that to heart? It wouldn't appear so.

People who address this point and cite historical examples are considered negative by those who steadfastly refuse to learn from history - much less recent history. I sometimes wonder if warning these people of on-coming traffic would be considered negative by them as well. In reality, it is all a part of the on-going process of human nature - it is what drives the market from one extreme to the next. In all fairness, I do believe on both a personal and a spiritual level that attitude has everything to do with outcome. I have 100% faith that if the vast majority of the US had a positive attitude that the market would soar - and, possibly, be undervalued at the same time. It is interesting to note, however, that high bearish sentiment is bullish for the market. Peter Eliades (www.stockmarketcycles.com) recently pointed out "The sentiment readings over the past two weeks from the American Association of Individual Investors have been surprising, to say the least. As a large number of market indexes and averages were reaching either multi-year highs or all-time highs over that period, there has been a plurality of bears over bulls from that sentiment survey. On November 30th, there were 40.2% bulls vs. 47.5% bears, and this past week, on December 7th, there were 38.9% bulls vs. 41.6% bears. The 10 week moving average of the plurality of bulls over bears moved down to 8.6% this past week .... Notice that almost all market tops over the almost eight year history of that chart occur at readings of 20% or higher on the 10 week moving average of bulls minus bears. The implication from that chart is that the market is probably not near a final high in either magnitude or time. The upside projections remain in effect for both the S&P 500 and the Dow Jones Industrial Average. There is still some leeway for the market to see further sideways action or even a nominal decline without invalidating those upside projections." That pretty much covers it - without an external surprise, this market is destined to go higher for awhile.

We are in a very bullish time period on many levels. The mid term elections just passed and the final two years of a president's term are overwhelmingly bullish. On a seasonality basis, the market is generally up from November to May and the November to December period is usually the most bullish time. It makes little sense to do tax selling in December when you can postpone the pain for 16 months by selling in January. In my last Alert I pointed out a bullish expectation that is likely to carry through year end. I have no change in that outlook. After year end, I would expect a correction. I do not believe we will get past the first couple of weeks of the New Year without the correction beginning. Hopefully, we will see a typical 6 to 8 week correction and then moving into the final thrust higher of this bull market move. At this point, I can't be much more bullish than that.

Please be aware that the above chart is merely a projection. I am attempting to show expected price pattern, not specific price and time targets. It will be clear enough if this is on target as the pattern unfolds. The real question is if we can get this market to rally into year end. A break of that pattern would be cause for concern and would imply a compression of the pattern. In my view, the ideal situation would be a minor correction into mid month or a bit later and then a good rally into year-end.

Gold
As we all know, gold is tied to the US dollar whether it wants to be or not. Currently, the dollar is flirting with a major support zone that would be quite serious for the dollar to penetrate. You can be assured that Mr. Bernanke is intimately familiar with this fact and is also very familiar with the support level for the US dollar. Thursday we have the OPEC meeting in Nigeria where the market is currently assuming that production may be cut. Oil is at $61 per barrel and a production cut would raise prices. If the dollar collapsed through its support level and oil saw meaningful production cuts, gold would obviously experience a nice rally. This is a tough call, but when everyone is leaning in the same direction, it is sometimes worthwhile to entertain the opposing side. News on the dollar has been very bearish lately and there has been a lot of talk about oil prices moving higher. Both are pretty good bets in the intermediate term and they could very well play into the correction I am expecting in the stock market early in the new year. For the moment, however, I believe I am going to assume that the dollar is going to hold support and that OPEC will be reasonable and not move toward any meaningful production cuts. If that is the case, it will allow gold to trade flat to soft into year-end. On the weekly chart below, gold is losing some momentum and could correct down to test the recent lows. In my view, the correction will be minimal and any correction will be an opportunity to buy.

The Great Illusion
America has gained the dubious distinction as the "world's spend-thrift". There is little question that we have earned that distinction. In fact, it has turned into an addiction. There is no question that Americans will have a very difficult time cutting spending - even when their personal economic situation demands such a move. The other unfortunate realization is that the US dollar is the world's reserve currency. At this point in time the benefit of being the world's reserve currency is long gone. There are obvious detriments to being the world's reserve currency, but the one that is the most dangerous to investors in the near term is very subtle. In fact, it is so subtle that even the wealthy and sophisticated are not really aware of it.

What I am referring to is the effect of dollar weakness on US investors. Due to the fact that the dollar has been the world's reserve currency for many decades, the Baby Boomers grew up with phrases such as the dollar is "as good as gold" or "sound as a dollar", etc. This brain-washed us at an early age and was imprinted on our young minds. If we grew up in Brazil, we would be just as brain-washed to be very much aware that our homeland currency could move in large swings that were all too often to the downside. Such an awareness allows one to be very much aware of the fallout from abrupt changes in the value of a currency. Add to this that Brazil was considered a third world country and the US the pinnacle of wealth, education, innovation, etc. This helped to solidify the 'unawareness' and allow it to expand to epidemic proportions.

Times have changed. America's last real surplus occurred in 1969. Our peak in oil production was in 1970. We used to be #1 in education - now we are #22 or so and the scale is probably tipped in our favor. We used to be a manufacturing giant; we used to have an abundance of raw materials; etc. Now PLEASE do me a big favor and don't say something as short sighted as "Gee, that's pretty negative". WAKE UP - stop the labeling and look at the facts. It is not negative or positive; it is merely the statement of facts. All of these facts assist in answering the question "What the heck has happened to the dollar?" Once you observe where we are and how we got here, that question makes sense. When you add in debt, deficits, the derivatives explosion, the costs of war, the costs of terrorism, our addiction to spending and numerous other "negatives" the value (or lack thereof) of the dollar makes sense.

"I don't care if the dollar is going up or down - we live here in America and we spend dollars, not euros, so what the heck difference does it make?" "If I'm concerned about the market, I'll just move my funds into Treasury Bills or money market funds and ride it out until the market bottoms" -- pretty logical comments, right? We have all heard those comments and most of us have said them. Let's assume you are in California in mid 2001 and you are looking at a home that you would love to buy for $1 million. You decide not to buy the house because the stock market is going down and you are concerned that real estate may fall, too. You decide to go into Treasury bills and wait. Now some time has passed and at the end of 2004 you happen to drive by that house you wanted to purchase. You are elated to see a for sale sign and can't believe your good fortune. You get out and anxiously grab one of the flyers and your mouth drops open as you read "A bargain for only $2.1 million".

That is the subtle problem I was referring to. You think that just because you put your money into Treasury bills and got your money back - with some interest - that you were unscathed. The dollar fell almost 35% from mid 2001 to the end of 2004. When a home doubles in price with no improvements, something else is going on! It's the same house, three years older - that is not a prescription for price increase in the real world. What resulted is a major loss in purchasing power - global purchasing power. Another very obvious way to experience this loss is to take a trip overseas. Going to Europe, for example, is remarkably expensive. It used to be just the opposite.

I earlier referred to the wealthy and the sophisticated as being prey to this grand illusion as they are exposed to it much more than the rest of society. Once their real estate and security needs are met, they tend to put the remainder in Treasury bills and money market funds. In many cases, this is the bulk of their net worth - consider the new billionaires of the tech boom. These people have invested serious amounts of money into what they consider to be a "safe money" investments i.e. T-bills, money market funds, etc. That is no longer the case. They are experiencing single currency risk exposure. This may well translate into the new investment epidemic as we continue our move through the current cycle.

In closing, it is important to remember that this market is quite extended and can turn on a dime. Keep that in mind. My very best wishes to all of you for a Happy Holiday Season and a Happy, Healthy and Prosperous New Year!

All the best,

Garrett Jones
garrett111@comcast.net

NOTE: THIS E-MAIL REPRESENTS THE VIEWS OF THE AUTHOR AND IS INTENDED FOR EDUCATIONAL PURPOSES ONLY. THERE IS RISK OF LOSS IN ALL TYPES OF TRADING. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS.

In conclusion, the insanity continues. People and politicians failing to learn from histories lessons, so we are all doomed to repeat them. But as in all previous episodes of this type of insanity there are as many opportunities as pitfalls. Which category you fall into depends on You!! Do you homework and plan carefully and prosper!!!

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