Gold timing is always tricky because the market is extremely volatile.  The volatility however masks what has been a very consistent bull market for the past five years with an increase of over 100%.

In early April there were several indications that interest in gold may be picking up.

One is that one of the authors received a letter from a friend who is a Merrill Lynch broker who reported that Merrill’s chief economist had met with them and was touting some of the virtues of gold as an investment.

Another is the just released article whose link is below on Marketwatch.com touting “Seven Reasons Why Gold Should Surge.”  Just because there is more interest in gold doesn’t mean that it will immediately go up in price, but clearly it is a part of any future increase.  Plus, the article gives some other very good shorter term reasons gold could move up.

A classic way of making money in a down market is to short stocks.  Like any stock purchase, you have to do your research.  Keep in mind that not all stocks are available to be shorted.  There are two broad ways to short stocks.

Shorting Indexes

One is shorting an index such as the Dow Jones Industrial Average (DIA) or the S&P 500 (SPDR).  This is something like a mutual fund since you are shorting a basket of stocks.

Shorting Individual Stocks

This is like buying stocks expect that you are looking for stocks that are most likely to go down. You just need to do the same research/

Put options are the most powerful and profitable way to bet against the market — and also the most risky.

We are not options traders, although we have traded put options. Hence, we suggest you work with someone who is.  If you would like to know more about options trading, we have listed several books below that are good.

Buying put options can work very well, but volatility and timing can kill you.  We don’t recommend it for the average investor.  In general, we have recommend fundamental investments that aren’t so dependent on timing.  Hence, we will say that the farther in the future the option date is, the safer you are.  But, even then, the risks are very high.

Good books to buy on options are:

“Options Made Easy: Your Guide to Profitable Trading,” (2nd Edition) by Guy Cohen.

The Bible of Options Strategies: “The Definitive Guide for Practical Trading Strategies,” by Guy Cohen

“Options Trading for the Conservative Investor: Increasing Profits Without Increasing Your Risk,” (Financial Times Prentice Hall Books) by Michael C. Thomsett

There are two major investment firms selling bear funds: ProFunds and Rydex.

We have listed the inverse funds available from both of these firms below. More information is available on their web sites.

Bear funds are good because, like any mutual funds, they diversify your risk away from just a few stocks.  They also offer informed, full-time professional management.  Bear funds are also called inverse funds since they are designed to perform in inverse correlation to the stock market.  If the market is going down, they go up.

There are two major investment firms selling bear funds:  ProFunds and Rydex.

We have listed the inverse funds available from both of these firms below.  More information is available on their web sites.

ProFunds

www.profunds.com

Pro Funds Lineup of Inverse Equity Mutual Funds

Rydex

www.rydexfunds.com

As mentioned in the book, there are four main ways to buy gold: Depositories, Personal Holding of Bullion, ETFs, and BullionVault.

Depositories

One of the largest gold deposit companies in the US is Monex Deposit Company Newport Beach, CA. Several of the authors have used Monex and are very satisfied. A depository doesn’t actually own the gold, they just buy and sell it for you. The gold is actually owned by the investor and is stored in a bank. With Monex it is HSBC Bank in New York. You get an actual certificate of deposit from the bank. Monex can also ship you the physical gold if you want to just hold it rather than sell it immediately.

We recommend Alex Collins as a broker. His phone number is (800) 949-4653 x 2356

Their web site is www.monex.com

Bullion

Most major cities have several coin/precious metals dealers that buy and sell gold. They will be a bit more expensive than an ETF or a depository because they have a retails location. But, if you just like buying gold from a person, this works well. In Washington, DC, one of the authors uses Gaithersburg Coin Exchange in Gaithersburg, Maryland. The phone number is (800) 638-4104 Keep in mind that most gold dealers require cash to purchase gold immediately.

Another excellent source is Lexington Coin, Eric Carlson, 781-863-1500.

ETFs

This is a very convenient way to buy gold since you can buy it like any stock through any stock broker. The symbol is GLD and the shares trade at the value of 1/10 ounce of gold.

BullionVault

• It used to be very difficult for private individuals to find a simple, cost effective and secure way of buying, storing, and later selling gold.
• The big problem was that the narrow ‘spreads‘ of the professional bullion markets required settlement in ‘good delivery bars’, so if you couldn’t make delivery in these bars you were excluded from enjoying professional market prices.
• These bars are both very large (usually 400 troy ounces [12.4kg]) and must have been kept continuously in recognized bullion vaults from the date of their original manufacture.
• So just having enough money to buy a bar or two was only half the problem solved. You needed a relationship with a formally recognized bullion vault, and generally they were not accessible to retail customers. The entry level was typically 15 - 20 big bars.
• So the only route for retail used to be small bars without the good delivery status, and this meant high dealing costs. Retail ‘spreads‘ were typically 4-6%, which compared to about 0.4% for main market gold (once physical delivery was included).
• But now people from all over the world can own gold, and keep it in any quantity in officially recognised bullion vaults - in London (UK), New York (USA), or Zurich (Switzerland).
• In these vaults it is held in the form of minimum 99.5% assayed ‘good delivery’ bullion bars, many of which are co-owned by unrelated private individuals who might own anything from 1 gram upwards.
• Although it is privately owned this gold is stored within the vaults of the professional bullion markets, so it retains its full resale value. Unlike privately stored bars a BullionVault bar retains the good delivery status for sales back into the professional bullion markets, where prices are highest. This eliminates one of the biggest costs in private bullion ownership.
• BullionVault customers also save because they deal directly with each other - willing seller to willing buyer - via BullionVault’s public order board. Bid/offer spreads are consistently narrow, and if they are not narrow enough the customer narrows them for himself, and can even earn the market spread - as if he were a market professional.
• Gold is retained in the vaults without trust intermediates as customers’ outright property, in storage facilities reserved exclusively for BullionVault customers and run by Brinks - the largest secure vault operator on Earth. Storage charges are at wholesale rates and insurance is included.
• It is very easy to become a member of BullionVault and most people join simply to buy some gold at a very good price, and to store it safely without having lots of hassle. So that’s what the main features are geared to.
• There are other features of BullionVault which are unique and valuable for you, and which you can start learning about below. We aim to make BullionVault safer, more cost effective and more accessible than any other way of buying gold.

Buy gold online - quickly, safely and at low prices

Five Key Ways to Track Our Bubble Troubles

1. Foreign-owned US Assets:

They stand at $14.7 trillion now, up from $12.5 trillion in 2005.

2. Ratio of Foreign-owned US Assets to the US Money Supply (M1):

Since M1 is about $1.1 trillion, the ratio is 13.3. That is well over the ratio of 3 that we considered manageable by the Federal Reserve.

3. US Government Debt:

It is currently $8.8 trillion.

4. Dollar Purchases by Foreign Central Banks:

For People’s Bank of China, this is difficult to tell on a timely basis. However, reports from the People’s Bank for the first quarter of 2007 (ending March) indicated that China’s reserves were up to $1.2 trillion. That now far surpasses Japan’s $900 billion. More importantly, the Chinese reserves increased in the first quarter of 2007 at twice the rate of first quarter 2006. Reserves are up $136 billion in the first quarter alone. At that rate, they will buy almost $600 billion this year.

The Ministry of Finance of Japan has still not bought any dollars since April of 2004.

5. Falling Asset Values:

Housing is going down slowly now, but is about to take a big fall, in the 10% plus range in hot areas like Florida, Arizona, California and Las Vegas as the effects of the sub-prime fallout and the reduction in available financing and likely increase in interest rates of all mortgages due to greater perceived risk by buyers of mortgage backed securities.

Bucking the falling asset trend temporarily are stocks which are currently rising dramtically — up 1000 points in just over 120 days.  The extreme activity in private equity has affected prices by forcing everyone to take into accoutnt that they might buy a public company.  And, since they never buy at bargain prices, they always pay above the stock market price, all stocks that might fall on their radar screen can easily justify a higher price because private equity firms are willing to pay a higher price, and more, to buy the companies.  This kind of thinking is similar to Internet stocks when eanings and revenues no longer mattered.  What mattered is that someone was often willing to pay a lot of money for those companies with little earnings so they were worth a lot of money.  Of course, this story will turn out badly as well, but it could easily go higher before it goes down.

Coming soon …

In the book we explained why it was important to keep the value of the dollar up, but we did not talk very much about exactly how that is done. The “how” is very important since understanding how also tells us why the support of the dollar cannot continue indefinitely. However, we could not explain this in the book. We had to make many such choices and omissions to keep the book at an easily readable level.

Reviewing briefly what was said in the book, it is important to maintain the price of the dollar because if the dollar price collapsed, it would lead to the consequences explained in the book, such as extraordinarily high rates of inflation, the collapse of asset values, including stock and real restate asset values, and severe pressure on the US and world economies. An important reason the various bubbles can get so high is investors’ faith that the dollar can be supported. To a limited extent, this is certainly true. What we are going to do in the next few paragraphs is explain to what extent the dollar can be supported. In understanding the mechanism of dollar support, we understand why it ultimately cannot be supported.

The key to maintaining the price of the dollar in other currencies is simply to buy dollars using those currencies, such as the euro, yen or yuan. The more demand for dollars, the higher the price of the dollar. So, if central banks are willing to buy enough dollars, they can maintain the existing price of the dollar in terms of other currencies. Or, if they buy even more, they can actually increase the price of the dollar, even if the market would otherwise drive it down.

By timing their buying or selling at key moments, central banks can affect market psychology. For example, if they see the dollar going down a little bit they can step in, buy a lot of dollars and turn what would have been a decline in the dollar price into a significant rally. Even more aggressively, central banks can, by buying enough dollars at the right time, destroy a short or negative position against the dollar held by traders, thereby causing those traders to have huge losses. This discourages traders them from attempting to speculate against the dollar.

However, there are limits to this process. Central banks can easily deal with tens or even hundreds of billions of dollars. Although these are vast sums, they are not large relative to the US and world economy. However, if movements in the trillions of dollars ever took place due to a change in market psychology, central banks would quickly be swamped and there is nothing they could do to stop panic selling and an enormous collapse in the price of the dollar.

Mechanics of Foreign Central Bank Dollar Support

We know that private individuals and corporations can go to a bank or brokerage house and purchase a foreign currency. Central banks use the same basic banks and brokerage houses when they buy currencies for their support operations. A central bank has a trading desk that is responsible for currency support operations. If the bank’s directors decide to support the dollar, they will inform the trading desk manager and the traders will make calls to selected brokers, which are generally large banks or brokerage houses, asking for bids on the purchase of dollars. Those private brokers who make the best bids will have their offers accepted on the spot or will be called back shortly to confirm the central bank’s purchase of “X” amount of dollars from that broker at the agreed upon price. The price is always stated in terms of another currency that will be used to purchase the dollars.

Once the trade has been agreed on, the trade information goes from the central bank’s trading desk to their back office, and from the brokerage firm’s trading desk to their back office. The private brokerage firm then transfers the agreed upon number of dollars from their bank account in the US to the central bank’s bank account in the US. In turn, the central bank’s back office transfers their currency, which could be yen or yuan or euros. Recently it has mostly been yuan. Thus, if the Chinese central bank bought dollars, the Chinese central bank’s bank account in the US, which could be held by the US Federal Reserve or by a large private bank, will receive additional dollars in its account from the broker. China’s central bank will have transferred yuan from its account to the broker’s account held in either the China central bank or a large Chinese bank. In both cases, the cash in those accounts will quickly be transferred to interest bearing assets, such as US treasury bills and the equivalent in China.

Sources of Money for Foreign Central Bank Dollar Support Operations

One of the most important questions in dollar support operations is where does the foreign currency to purchase dollars come from? Where does the foreign central bank actually get the currency to purchase dollars? This is a terribly important question because the source of the currency which is used to purchase the dollars is where the cost of the support operation is felt.

The first step in understanding where the central banks get their money to support these currency operations is to understand that support for the US dollar can either occur by a foreign central bank or by the US Federal Reserve.

Let’s start with foreign central banks such as the Japanese or Chinese central bank. They have three basic options to obtain their own currency for use in supporting the price of the dollar. Two of which are normally used and one of which is never used for reasons that will become obvious later.

“Printing Money”

The first method is to simply “print money.” Central banks have a right to create more of their own currency to engage in support operations for other major currencies, such as the dollar. In the case of China and Japan, their primary motivation for supporting the dollar, as mentioned in the book, is to keep the value of their own currency low so they will have increased exports and hence strong business and job prospects in their own country.

In reality, they never really print money to purchase US dollars. Instead, they simply create a deposit against their currency purchase. The currency they have received in the purchase constitutes an asset and by creating more currency, they have created a liability on behalf of the central bank, which is offset against the asset of the dollars they purchased. The currency they have created initially in their own account will quickly be transferred to the broker who is selling dollars and that broker in turn will rapidly distribute that money to their customers who in turn will spend it however they see fit. The net result is that more yen or yuan are in circulation, which, of course, creates inflation.

On a small scale — tens of billions of dollars — this creates no problem whatsoever. The amount of inflation created is negligible since the support operations are relatively small when measured against the size of the money supply. However, were the scale of support operations to increase into the hundreds of billions or trillions of dollars, this would result eventually in massive inflation.

Borrowing Money

Since that option is not very attractive, central banks have another option which they frequently use, which is to issue bonds. These bonds are denominated in their own currency, such as yen or yuan. The proceeds received from the sale of those bonds can be used by the central bank to buy dollars. The bonds then constitute a liability of the central bank, just as the earlier example of currency issued created a liability for the central bank. In both cases, the offsetting asset is the dollars they are holding in their US bank accounts, most likely in interest bearing assets.

In theory, the central bank can unwind the transaction by selling the dollars they hold for their own currency on the open market. But, in practice, if the dollar has fallen, they will receive less of their currency back then used in the initial transaction, giving them the loss which must be made up either by issuing additional currency or additional bonds.

The major problem, aside from the trading loss, is a problem that has already been discussed in the book, and that is the “crowding out” effect. A central bank’s borrowing can force other borrowers either out of the market entirely or force up interest rates. The bank’s increased demand increases the price of money. Higher interest rates hurt the domestic economy and lower the value of assets such as stocks and bonds. Also, high interest rates in the borrowing country can be well above the risk and tax adjusted interest rates being paid in the US. This can attract investors away from US investment assets and towards Japanese or Chinese investments, which is strictly counterproductive to their attempt to support the dollar and keep the yen or yuan low.

Thus, although this method works very well on a small scale, it would be devastating on a large scale. So, this type of currency support financing works fine for tens of billions of dollars, but has very negative consequences when used in the high hundreds of billions of dollars.

Taxing to Get the Money

The third means of supporting the dollar is through taxation. This is the only method of the three that can be continued indefinitely and there are no major downsides for the economy (other than the negative effect of the taxes). The big problem, and this is a very interesting point, is that it is the one method that is too explicit to work. This method makes it very clear that resources are being taken from the Japanese or Chinese people and given to US consumers for additional spending without any hope of repayment or compensation later. Because it is so explicit it would never work politically. In fact, by making the actions that explicit, it could potentially trigger the world-wide economic collapse without any other factors being necessary.

Mechanics of US Federal Reserve Dollar Support Operations

The US Federal Reserve can also support the dollar. It has strong incentive to do so since the consequences of a major decline in the dollar and the consequential outflow of foreign investment would be devastating to the US economy. We will present below several methods the Federal Reserve can support the dollar. It’s important to note that just as there are costs to foreign central banks for supporting the dollar, there are also costs to the Federal Reserve. However, there is a major additional problem in that a significant amount of activity by the Federal Reserve to support the dollar could actually create the dollar collapse that such intervention is designed to prevent.

Borrowing Foreign Currencies from Foreign Central Banks

The first method for the Federal Reserve to support the dollar would be to borrow foreign currencies from foreign central banks and then use those currencies to buy dollars in the open market. However, such actions will cause substantial inflation in the foreign countries involved since those central banks must create the money necessary to loan to the US. The advantage of this method is that is does protect the lending central bank from a loss due to a falling dollar. The reason is that the Federal Reserve can create additional money that can be used to offset the losses that would occur were the dollar to decline in international markets. Consequently, it would be better for the world for the US to borrow money from foreign central banks and use it to support the dollar rather than having central banks do that directly. Of course, it would also greatly increase our national debt.

Borrowing Money from Foreign Investors

The second method is for the Federal Reserve to borrow money from foreign investors and use that money to support the dollar. Thus, the Federal Reserve, as an agent for the Federal government, would issue US government backed bonds, notes and bills in China or Japan which are repayable in Chinese Yuan or Japanese Yen. Unfortunately, borrowing in this manner would cause the same crowding out effects that domestic borrowing would. The other difference between the Federal Reserve borrowing this way and foreign central banks borrowing is that with the Federal Reserve there is a significantly higher default risk. The reason is that under the extreme economic conditions that are most conducive to a default, there is little incentive to repay the borrowing and there is simply no way to tax or print the money to repay the loan. This is because repayment normally would be expected to be in either a foreign currency such as euros, yen or yuan. Alternatively the US could borrow foreign currency and promise to pay in dollars. This is also risky because the dollar could be drastically devalued.

Since with a drastic fall in the value of the dollar there is no political possibility of taxing or printing money to repay the money borrowed from foreigners, repayment would be not only devastating to the US, but probably fiscally impossible. To make matters worse, repayment under those terms could actually hurt the borrower and lender countries and it would probably be better off for everyone just to ruin the creditors, which is almost certainly what the government would do. For these reasons, this type of borrowing is not likely to be done on the massive scale that would be necessary to help avoid a dollar collapse.

Raise Interest Rates

The third way to support the dollar, and the way that has already been used by the Federal Reserve, is to raise interest rates. The Federal Reserve has a certain level of control over interest rates, primarily through the use of tight monetary policies and to a lesser extent by adjusting various borrowing and lending rates such as the Fed overnight funds rate. This method will definitely support the dollar and will always stop a run on the dollar at some point. For example, even with the drastic plunge in the dollar that is being forecast in the book (more than 60%), a plunge to 0 could be stopped raising interest rates high enough. Of course, those interest rates would be sky high and would absolutely devastate the US and world economy.

Recently, we can see how this works on a very small scale. The Federal Reserve recently raised interest rates dramatically, which has stabilized the dollar without requiring massive Chinese or Japanese intervention. However, we can see on a small scale some of the problems that can be caused by raising interest rates, such as the damage to the housing market and, although we have not seen it yet, we shortly will, damage to home equity values as well. As support operations become more necessary and more vital, the devastation to the US economy would be far worse. The current US economy is highly dependent on low interest rates for its growth and high asset valuations.

Big Issue—Who’s Going to Take the Pain for Supporting the Dollar?

We can see from our foregoing discussion of the methods for supporting the dollar that each method causes substantial problems for the country that is doing the support. As was discussed in the book, Japan and, more recently, China have been doing most of the support operations, with Europe conveniently staying out and not having to suffer the negative consequences that China and Japan have. Recently the Federal Reserve has taken on some the burden of supporting the dollar by raising interest rates. At the same time, it destroyed the housing boom.

So, this brings up the big issue: Who is going to suffer the pain of supporting the dollar and to what extent? Europe certainly considers supporting the dollar important, but they’d much rather have China or Japan do it. And China would rather have Japan do it and vice versa. Obviously all of these countries would prefer the Federal Reserve step up to the plate and support the dollar by raising interest rates more.

When the situation deteriorates enough, a game of Brinksmanship is likely to occur where each nation knows that a collapse in the dollar would be very bad, but on the other hand, would rather someone else take on the burden and consequent financial pain of supporting the dollar. This makes it very hard to act quickly or effectively in supporting the dollar. As the numbers get big enough, it makes it increasingly unlikely that effective support operations can be carried out since the final collapse could occur very quickly — within a matter of weeks or even days giving the central banks very little time to act.

Recent Fall of the Dollar

Since early April, the dollar has been falling consistently—at a measured pace of about ¼ cent a day against the euro. It is now nearing its all time low against the euro of $1.366. The dollar also fell below $2 against the pound, a 15 year low. There is clearly selling pressure on the dollar.

Add to this the fact that the Chinese central bank increased its reserves in the first quarter of 2007 at twice the rate of first quarter 2006 and there is clearly selling pressure on the dollar around the world. Chinese central bank reserves are up $136 billion in the first quarter alone. At that rate, they will buy almost $600 billion this year.

Recent Fall in the US Stock Market

This is clearly an indicator that the stock market is having problems short term. It is not an indicator that the bubble pop is in any way imminent. This slide could stop or reverse fairly easily. However, it is an indication of the pressure which external events and continued sluggishness in housing and manufacturing will put on the stock market. The stock market has performed its best in years when the economy has started to perform its worst in years. The slowdown in the economy will weigh on the stock market for the rest of the year. No collapse, but continued downward pressure.

Perhaps the most interesting indicator in the recent fall of the market was the speed at which it occurred and the relatively small news that kicked it off. In fact, all of the negative news that affected the market on Monday, February 26 was known at the opening—the drop in durable goods orders, the drop in home prices and the drop in the Shanghai market. Accordingly, the Dow dropped 100 points at the opening. Then, on almost no change in the news, the Dow dropped another 400 points in the afternoon.

And the speed with which it dropped was astonishing. Even if you take out the technical glitch that made a 30 or 40 minute drop look like it took two minutes, the overall speed of the drop was breathtaking. It foreshadowed how quickly markets can fall even when cheerleading is very high. It would seem to highlight what is true in every bubble—that people don’t always believe the hype and are ready to run as soon as there’s smoke in the air—just like the Internet bubble collapse.

Third Aircraft Carrier Moving Into the Persian Gulf Area

In our weblink “iranwar” we discussed how a possible attack on Iran could accelerate the popping of the bubbles. In that regard, Newsweek, in its recent cover story on a possible attack on Iran mentioned that they have confirmed that a third aircraft carrier is heading to the Persian Gulf area, in addition to the two that are already there. We were aware that the Truman left Norfolk Naval Base around January 10, but we did not know it was heading for the Persian Gulf. Newsweek seems to think that it is.

As we said in our article, one or two carriers would be enough to make a show of force. When you send three carriers to the Persian Gulf, it is only because you are planning to take action. Whether or not such action is taken remains to be seen, but clearly, with three carriers in the Persian Gulf area, that likelihood has just increased.

Recent Fall in the Chinese Stock Market

That the Shanghai markets recently fell dramatically is no surprise. They were up 130% last year and almost 14% in January. It was a well known bubble market. What was surprising is that other markets fell with it. The normal conventional wisdom you would hear in a finance class is that a fall in well known bubble market such as Shanghai would encourage US and other investors, who have been investing more heavily in such markets, to return their money back to the much safer US markets, which would push up US stock markets. But, just the opposite happened. This doesn’t make sense in a normal world. But, in a bubble world, it makes plenty of sense. If a bubble can pop in one market, maybe it can pop in other markets, so investors get scared and pull their money out of stock markets and into safer cash investments.

So, the fall in the Chinese stock market and the concurrent fall in the US market is an indicator that there is less confidence in the US stock market than it might first appear—a classic sign of a bubble market.

Net Capital Inflow Becomes an Outflow

In December we had the first outflow of foreign capital since 2005. Foreign investors were net sellers of equities, despite the very good stock market. Private investors also bought fewer government bonds and foreign governments bought more government bonds.

Any decrease in private investor interest is a concern. Governments are buyers of last resort. If they have to step up their buying, that means private investors are losing interest.

However, any one month flow is almost irrelevant. The key is whether it continues for several months. If you have a net outflow for 3 or 4 months, that’s a problem for the dollar since we need to bring in at least $70 billion per month to fund our trade deficit.

In the March report on January net capital inflows/outflows, net capital inflow was $70 billion, indicating that December was unusual. However, that is not enough to make up for the $70 billion we didn’t get in December.

New Home Construction Contracts Going Down

A key indicator of future home construction is new home construction contracts as reported by the major home builders. If new contracts are declining, expect that eventually, within 6 – 12 months, new home construction will decline by a similar amount. It appears new contracts are still continuing to decline. Toll Brothers recently reported in February a 33% decline in new contracts from the previous year. Hence, it’s unlikely we are near bottom yet on new home construction.

Housing Vacancy Rates High

One of our authors, who lives in the Washington, DC area, noticed that 8 months ago there were five houses for sale in his neighborhood. Now, there are none. Seems like a big improvement, right? Well, only one home sold, two were taken off the market and two were rented. Housing statistics would show that as a great improvement in home inventory. But, those statistics overlook a “shadow inventory” of homes looking for buyers. On February 5, a statistic was published by the Commerce Department that shed some light on this issue—the housing vacancy rate.

To quote from the Reuters news story:

… a Commerce Department report showing the homeowner vacancy rate rose to 2.7 percent in the fourth quarter, well above the year-earlier level of 2 percent.
That suggests a glut of almost 1 million homes sitting vacant, which will likely pressure selling prices for an extended period…

Foreclosure/Default Rates

Our previous report on January 12, 2007 showed that for Q3’06, California foreclosures were up 111.8% from Q3’05 and 28.3% from the prior quarter. Despite this strong upward trend, most articles invariably followed up this data with a statement such as: Foreclosures are still at historically low levels, and the effect on today’s market is negligible.

The source of these articles is DataQuick. When DataQuick says “historically low levels,” they also disclose that they’ve only been tracking foreclosures since 1992, a key fact that many folks who use DataQuick’s data don’t know is very important. The reason that the start date of comparable foreclosure data for the last cycle is so important is that about two years after the last housing cycle bottom, foreclosures were already declining. If housing were indeed in the process of “bottoming out” now, as many forecast, then foreclosures should be starting to decline. Instead, as we reported last month, they continue to rise rapidly. Note the DataQuick data also show that foreclosures peaked in Q1’96, which correlates reasonable well with the bottom for the housing market. If that pattern of foreclosures repeats, then a bottoming of this housing cycle may not occur before 2010.

February’s data support our theory that DataQuick’s data spans a period of time that began during a period of increased foreclosure levels in the last cycle. As a result, we don’t have a clear picture of comparable foreclosure rates for the housing cycle period we are in currently compared to the last cycle, so no one can say whether current levels are “historically low” or not. Even if they are, that may well be a sign of a market peak rather than a bottom, implying further market volatility rather than market stability as usually inferred from the data.
The number of foreclosures that lenders are taking back in California has increased from an average of 32 a day in August 2006, to 205 a day in February 2007. In dollars that’s an increase from an average of $13.3M per day to $83M per day in seven months. A total of $1.5 billion of loan value was returned lenders in February versus $425 million in Sept. 2006.

These data do not support the idea that the market has “bottomed out.” Rather, the market is in the early stages of decline.

There are three major ways to buy euros:

Euro ETFs

A vey simple way is the euro ETF which can be bought through any stock broker and is trade just like stock.  The symbol is FXE and the price is set at the value of 100 euros.  The downside is that ETFs don’t pay interest.

Euro Government Bond Funds

If you are looking for an interest-bearing method of investing in euros, we recommend the following funds.  They have a mix of foreign government and some corporate bonds, but that can change, so watch their makeup.  We are biased toward government bonds because when the bubbles pop, foreign corporations will be vulnerable to the downturn and may default on their bonds.  However, that won’t happen for a while, so the risk of corporate bonds at least through the next two years is not that significant.

T. Rowe Price International Bond Fund (RPIBX)

American Century International Bond Fund (BEGBX)

Pimco Foreign Bond Fund (PFODX)

European/Asian Stocks

Right now these are doing well and could continue to do well for a while.  However, we don’t think the risk outweighs the potential for profits. However, if you think you can time a bubble, go for it.  There’s always lots of money to be made in a bubble if you time it right.