A Melman Minute — January 11, 2008

Anyone who believes that there is no inter-connection between events and various financial markets got a genuine object lesson yesterday. The occasion was a closely-watched speech given by Fed Chairman Ben Bernanke, he of the ‘dropping-dollars-from-helicopters” comment fame. He began speaking at 9:00 AM PST with the Dow virtually unchanged.

(By the way, Bernanke earned that nickname thanks to his years-earlier comment that, should a true credit crisis develop, the Federal Reserve Board would drop dollars from helicopters, if necessary to re-stimulate economic activity.)

Within five minutes - during which time he declared that the Federal Reserve Board was likely to cut interest rates further - the Dow soared by 150 points, from 12,720 to 12,870 as investors took heart that the Fed was going to ‘hypo’ the economy. At the same time, gold investors surged into the market, interpreting the Fed’s actions as a virtual guarantee of further ballooning of the money supply figures which would likely be accompanied by higher inflationary expectations, and drove the price of the yellow metal to US$896 spot.

At the very same time, the U.S. Dollar went into a sinking spell on currency markets, with the DX Index falling once again to reading of just below 76, near the lowest level in the index’s history.

At the end of yesterday’s wild session, the Dow closed up about 117, gold retreated to near US$890 and the currency markets stabilized

What followed next was quite unexpected. The rest of the world looked at Bernanke’s speech and voted ‘no thanks!’ Markets in Japan and Australia tumbled sharply, to be followed by European exchanges which also moved lower. By the time trading resumed in North America this morning, market sentiment had once again turned negative and both the Dow and TSX opened lower, by 180 and 60 points respectively. After 90 minutes of trading, the Dow was still sharply lower, but the TSX had recovered to be slightly ahead.

In the meantime, gold continues to perform strongly. In overnight trading, the nearby February 2008 Futures contract - which many traders regard as a proxy for the spot price - reached US$899.90 in overnight trading. After falling back to the low US$890s shortly after the opening, buyers came in once again and, just before 8:00 AM PST, the contract traded at its highest level in history, a remarkable US$900.10. Silver surged as well, reaching above US$16.25 spot but the base metals, perhaps reacting to fears of a looming recession, traded flat to slightly lower on balance.

Speaking of the word “RECESSION”, that topic has been the focus of an enormous amount of conjecture in recent weeks as analysts speculate on whether the USA is already in a recession, is about to enter one shortly, or will be able to avoid such an eventuality if only the Fed will act promptly and with assurance. There is also a great deal of ongoing speculation regarding how the rest of the world will be affected should the US economy descend into that particular pit.

Perhaps the single most negative blow was the recent report by the U.S. Department of Labor that the Unemployment Rate in America had surged by three-tenths of a percent in December, the largest such one-month gain on record. This appeared to confirm the downtrend in housing, finance, insurance and retail share prices and also served to further dampen the already-depressed level of consumer confidence. One measure of such confidence, the RBC Cash Index, fell to the lowest level in its six-year history in early January, plunging to 56.3, down from 65.9 in December and well below the level of 95.3 one year earlier.

Commenting on the figure, economist Richard Yamarone of Argus Research noted that, “Consumers are gloomy. The confidence reading suggests that people believe bad times are upon us.”

Pessimism seems to be spreading. In England, ”The Times” newspaper wrote about the sudden decline in consumer spending during the recent Christmas season as the famous retail firm of Marks & Spencer just reported an actual decline in year-over-year sales comparisons for the period. One commentator attributed the sales decline to the, “…chill wind of the credit squeeze.”

In Geneva, Switzerland, economists gathered there for the World Economic Forum voiced fears of a recession in the US during the next twelve months and also expressed doubts over whether the rest of the world was capable of taking up the slack such an event would cause. They also issued statements expressing concerns about the vulnerability of the current model of financial markets as well as the risks implied in the rise of food prices. Meanwhile, here in Canada, markets were startled by news that the Canadian economy had lost jobs in the manufacturing sector this past month and there was also concern that the housing boom may be reversing itself - and the C$ plunged by over one full cent versus the Greenback on the news.

Our own opinion is that an American recession is imminent, and that it will be deeper and more prolonged than generally anticipated. We also are of the opinion that the Fed will continue to use every weapon at its disposal to fight an economic contraction, but ‘this time is different’ in that the American consumer, the American industrialist and the American retailers are already carrying overwhelming levels of debt and will not be induced to expand their operations simply because of the anticipation of lower interest rates. The visual representation of such a condition is known as ‘pushing on a string.’

One of the critical indicators we will be watching is none other than the most widely followed financial number on earth, the “Dow Jones Industrial Average.” One look at the chart identifies clear support in the 12,400 to 12,800 zone. Should that level be decisively breached, our interpretation would be that such a breach would serve as confirmation that difficult times were indeed on the way.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

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