A Melman Minute — February 25, 2008

Financial markets opened to the upside this morning, building on the powerful rally of last Friday which saw enormous reversals to the upside in the last two hours of trading. As of 8:00 AM PST, the Dow was up by over 100 points, rising once again to the upper limits of its recent trading range, while the TSX was up about 60. Both crude and gold were trading close to Friday’s closes, near US$99 and US$950 respectively.

The biggest factor in Friday’s closing rally and in today’s opening strength in the financial markets appears to be a new ‘rescue’ plan for the major bond issuing companies, a plan which would allow them to retain their “AAA” ratings and which would also permit the same ratings to be carried over onto the bonds they insure. As of this moment, there appears to be confidence that this rescue can indeed be completed successfully.

However, we must admit to having our own doubts.

One of the reasons is the continued weakness in the American housing market, which is the underlying proximate cause of the entire debacle which has unraveled during the past 18 months. Figures from the American housing market continue to deteriorate and this morning is no exception.

According to the National Association of Realtors (NAR), sales of single-family homes and condominiums dropped by 0.4 percent in January to an annual rate of 4.89 million units, the slowest pace this century. In addition, the median price of those homes fell to US$201,100, a drop of 4.6% from one year ago. The report also noted that sales were weak in all regions except the Midwest, being particularly slow in the Northwest which had previously been the region most immune to residential real estate weaknesses.

This report continues a trend which has seen sales of both existing and new home tumble relentlessly during 2007 and the early part of 2008. In our opinion, there is very little likelihood that there will be a meaningful reversal to these trends, at least in the near future, for several reasons.

First, with prices continuing to decline, there is no immediately compelling reason for buyers to rush into the market.

Second, even if they wanted to purchase a single-family home, given the new and tighter lending standards abounding, less than 30% of American households qualify for a conventional home mortgage, thereby severely diminishing the pool of potential buyers.

Third, many of the foreclosure proceedings now underway are nearing their final stages when homes are returned to the mortgage holders and put back on the markets. This virtually insures additions to an already monumental inventory of unsold homes, which is likely to put even further pressure on home prices as this year unfolds.

There is no question that the government is doing everything it can to stimulate the economy in general and the housing industry in particular. Among their favored remedies are dropping interest rates, flooding the financial markets with liquidity and supporting favored industries that appear to be in jeopardy, such as mortgage insurance corporations.

The great question is whether these measures will succeed in restoring the economy and the real estate industry to good health. We have our serious doubts - and, therefore, look to even greater stimulation via monetary creation over the next weeks and months - which historically should be positive for the precious metals in particular.

Base metals demand got another ‘shot in the arm’ with the announcement by China that they were beginning a program which would allow China’s 740 million rural residents to receive assistance when it came to the purchase of modern appliances and entertainment units for their homes. Given the lower incomes in rural areas versus urban area comparisons, apparently the government felt it was necessary to come to their assistance via programs such as this.

The specific appliances which will be subsidized by the government include up to two refrigerators, two television sets and two mobile telephone handsets.

It is interesting to note that the Chinese government has foreign and domestic cash reserve assets of approximately US$2 trillion - which would allow it to sustain a program of rural assistance for some time into the future, should it choose to utilize its enormous cash reserves for domestic purposes.

Our own note is that this is a powerful example of what a government can do when it has enormous freely-owned ASSETS rather than being burdened with staggering levels of DEBTS.

In any case, there is no question that the base metals have been showing strong relative strength of late, as exemplified by the commodity price of copper (see chart). After undergoing a rather severe price correction, copper is once again approaching its historic highs.

Important data has recently been released regarding the potential for the American economy to descend into an immediate recession, perhaps a severe one. We plan to examine this information tomorrow - barring any last-minute spectacular financial or political developments.

NOTICE: Just as this report was being completed, fears of an imminent central bank sale sent gold down by about $10.00 to the upper US$930s - and the rest of the metals group fell along with gold. It is our opinion that this type of selling is temporary and will likely be overcome by future rallies.

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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