A Melman Minute — February 21, 2008

Gold near $950

Platinum close to $2,200

Crude Oil above $101

Soybeans above $14 per bushel

Others, including wheat, corn, heating oil, unleaded gasoline, zinc, lead, copper and nickel are ‘merely’ trading near or at multi-year highs. It is our opinion that these explosions in commodity prices are sowing the seeds of rampant inflation in the future, particularly when combined with an American government policy that seems to be a version of, “Open the monetary floodgates as widely as needed to avoid recession.”

Historically, rampant inflationary expectations have been the single most important components of previous golden bull markets, since that would represent a diminishment of the purchasing power of unbacked, fiat currencies. Therefore, it is worth a very close look at one of the chief ingredients behind the expectation of rising prices. We are referring to Crude Oil. As can be seen from the multi-year chart, this great upward surge in prices has been sustained and has been able to overcome all predictions of imminent collapse - and there have been many!. Our belief is that it will continue to do so for several years as new record high levels, far beyond the present new high of $101, are attained.

Crude oil and its derivative products have so many applications in our modern social and productive society that any increases in the price of petroleum are inevitably passed on to wide sectors of major economic activities. These applications include gasoline, heating oil, fertilizers, lubricants, plastics, medicines, detergents, explosives, synthetic fibers, synthetic rubber, tar and asphalt - plus many, many others.

In our opinion, the fundamental case for higher petroleum prices is quite convincing. According to most authoritative bodies, current total demand for petroleum products is in the neighborhood of 87 million barrels per day (mbpd). At the same time, all-out production combined with refinery capacity is about the same figure. Therefore, and most importantly, there is virtually no margin for unexpected supply shocks such as the failure of a producing oil field, a refinery malfunction, etc.

For the future, the picture seems to darken quickly. Demand is expected to grow by about four percent per year over the next seven years to about 110 mbpd - but production seems likely to lag far below that number, opening up an ever-widening demand/supply shortage gap - and it is this growing gap that we believe will be the prime driver toward MUCH higher crude oil prices in the decade ahead - and these higher prices should then impact inflationary predictions.

Some observers blame the new record high prices on speculative money entering the commodity markets, but that explanation does not appear to be sound. Were that the case, crude prices would have spiked higher, and then retreated immediately when those positions were unwound. However, one look at the price chart of Crude Oil over the past seven years shows that an ongoing, powerful and relentless bull market is underway - an unlikely event if markets were driven primarily by speculative activity.

Rising crude prices have recently driven gasoline prices back above US$3.00 per gallon in America and well above C$1.00 per liter in Canada - and they have been just one factor driving consumer confidence to its lowest levels in many years. That loss of consumer confidence, combined with an ever-worsening American residential real estate market, is placing the entire consumer-driven economies of the Western World at risk.

That is what the Federal Reserve Board is fighting so desperately, but we believe that there is a distinct possibility that their actions to stimulate the economy may be the wrong medicine at the wrong time as the American government is already awash in debt and creating more debt obligations on such a massive scale could place confidence in the stability of the U.S. Dollar itself in severe jeopardy.

The U.S. Dollar Index has once again fallen below the 76 level and is within a hair-breath of crashing to a new historic low. Should that occur, the precious metals in general and gold in particular could rise spectacularly.

If one agrees with this analysis, then the acquisition of quality junior mining shares of those companies with high proven reserves of gold and a solid track toward production could turn out to be a very sound decision in this time frame.

This morning’s markets are relatively quiet with gold holding in the mid $940s, silver just under $18 and both platinum and palladium once again moving sharply higher. Securities markets opened higher, but have returned to close to unchanged after 90 minutes of trading. Oil futures have fallen back slightly to near $99 per barrel.

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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