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Melman Minutes - By Leonard Melman
MELMAN MINUTE March 21, 2012



Anyone who believes that it doesn't really matter which political party wins elections might want to take a second look.  If they do so, they might realize that there is a genuine difference in emphasis between political parties and the policies they advocate.  Two headlines from yesterday's Wall Street Journal illustrate the point.


In one headline relating to the Obama Administration we read, "Top 1% Would See $90,000 Tax Rise, Report Says", while in another headline relating to Britain's Conservative Party we read, "U.K. Cuts Taxes on Rich, Business."  There is indeed a reason why we at "The Melman Report" consider such differences to be an important factor in our analysis of the precious metals markets in particular.


There once was a time when gold and silver responded to a form of quantitative analysis which strongly considered fundamental supply and demand coming from identifiable sources such as industrial demand, scientific applications, electronic devices and so forth, but there has also been the variable factor of ''metals as money' to be considered.  However, except for times of presumed high levels of imminent crises, that factor was of lesser importance. 


The period from 1979 through 2002 offers us an excellent example of this premise.  During the latter part of 1979 and early into 1980, several crises hit simultaneously including powerful rises in both visible inflation and towering interest rates; the Soviet invasion of Afghanistan; the US retaliation by withdrawing from the 1980 Moscow Olympics; the revolution in Iran and subsequent taking of huge numbers of American hostages.  It seemed that at one and the same time the economic structure of the world was at risk while the US and the USSR seemed headed toward direct armed conflict.  As can be seen on the accompanying chart, gold exploded upward, quadrupling from near $200 per ounce to over $800 per ounce in just a few months.



It is our opinion that the explosion in gold's price during that period had little to do with fundamental supply-demand considerations, but a lot to do with panic and hedge buying.


Then, quite suddenly, by the end of 1980 the regimen of visible crises seemed to decline.  Interest rates and inflation began to subside; war between the USA and USSR never occurred; the hostages were released and processes which appeared to lead toward economic stability were instituted.  In fact, a 'non-crisis' mentality took hold and during the ensuing twenty years, evaluations of the precious metals began to turn more toward the fundamental and away from hedge buying as insurance against economic, currency and social disorders.


However, one look at that long-term chart of gold will show that a material change began to develop with the advent of the new century and millennium.  Gold began to gather strength and eventually developed a powerful momentum which saw the price increase almost eight-fold from barely $250 in 2001 per ounce to almost $2,000 by 2011.


After due consideration, it is our opinion that much of this gain was the result of monetary factors rather than fundamental supply-demand considerations and we place particular blame on a growing international concern regarding the long-term stability of the new world of what we choose to term "economic expansion through massive fiat currency creation."


Therefore, it behooves us to periodically take a good, hard look to determine whether the factors leading to such fiat currency growth are diminishing, are sustained at present levels or are continuing to increase over time.  If monetary expectations have indeed become the dominant factor in precious metals price movements - as we believe to be the case - then this evaluation, we would hope, could point us in the right direction regarding precious metals price expectations over time.  Presumably, if such considerations are diminishing, gold and silver would likely see some price retrenchment; if conditions are likely to continue at current levels, we might see a quiet 'trading range' period, but if conditions appear to be trending toward even greater future crises, then the outlook for the precious metals could indeed be toward higher, perhaps much higher prices.


I believe the most important factor in creating the ongoing crisis is a strong tendency among many governments of the world to buy loyalty from the voting public by creating programs which they believe would be regarded with favour.  As a result of this tendency, such programs - and the hordes of bureaucrats to micro-manage them - have proliferated during the past several decades to the point where government operating deficits have become commonplace and have reached a scale which is literally beyond comparison with past ages.


These deficits have then been financed by governments using debt markets to float loans, until the point has been reached where a combination of two factors has been 'achieved'.  In the first case, governments such as those in Greece, Spain, Italy, Portugal, Ireland, Hungary and Slovakia - as well as others - can no longer effectively manage their existing debt or market new debt to finance their new deficit-ridden budgets.


As a result, their existing debt has come to be regarded as shaky and to be avoided and, most recently in Greece, we have seen an actual default take place which had to be covered by both losses by private holders and papering over the problem by various international agencies - with overt currency creation being the mechanism to accomplish such financial legerdemain.


This over-spending by governments has become so evident that finally, many governments and supra-national agencies are now demanding some form of austerity measures be imposed in order to rein in spending and we have witnessed such measures being imposed in several nations.


Our question, then, becomes this:  "Will these measures be sustainable in the long run and will they allow for the ultimate restoration of prosperity on a reliable and sustainable scale?"


What makes the question even more intriguing is that many of the advocates of the new austerity policies are the same economists who have been preaching Keynesian economic philosophies of stimulation and currency creation for decades and it is almost amusing to see them change their tune.


However, they may have been right to a certain extent in one particular sense.  Aside from angering the domestic populations who are now frequently resorting to social disorders and street rioting, the new austerity measures are having the effect of putting the brakes on economic development, thereby reducing government taxation revenues and increasing the very deficits they were designed to reduce or eliminate.  In addition, it appears likely that the ability of several governments to honour their debts is being compromised by the very economic difficulties that the austerity measures appear to be inflicting.


However, we believe it is also true that if austerity measures are not imposed, if economies are not allowed to contract and if wild expenditures far beyond the ability of government to finance with current revenues continue into the future, than the fires of inflation and perhaps hyperinflation will be ignited.


It is a dilemma without easy resolution.  Therefore, it is our expectation at TMR that uncertainty and a substantial degree of fear will continue and over time will accrue to the benefit of the precious metals prices.


Accordingly, we continue to hold to our published forecast of highs of $2,400 per ounce for gold and $55 per ounce for silver before year-end 2012.


As of 9:00 AM something has lit a fire under the prices of gold and silver as they have rallied sharply so far this morning with gold ahead by more than $20 per ounce to $1,665 and silver has rallied by about $0.70 per ounce to just over the $32.00 level.  Financial markets have also turned higher with the Dow Industrials ahead by 40 points and Canada's TSX, boosted by higher metals and petroleum prices, is up by 80.  Base metals are moderately higher and mining share indexes have gained about 2% on average.


In other markets, the US Dollar is down quite sharply, Crude Oil is once again above $107 per barrel and long-term interest rates are headed lower.



All quotes US$ unless otherwise indicated.


Next Melman Minute scheduled for Monday, March 26, 2012




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