A Melman Minute
| By | Leonard Melman |
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NOTE: Leonard is currently at the PDAC convention, the world's largest annual mining gathering, scheduled for March 2-5 in Toronto. We certainly invite all our readers residing in the Greater Toronto Area (GTA) to attend.
Several months ago, I wrote a short piece entitled “Round Trip Caucasus” describing one of Hitler’s misadventures during WWII when he first ordered massive numbers of troops into the Caucasus Mountains to protect oil fields and then, realizing he needed those troops in the attack on Stalingrad, he ordered them back out.
Markets have provided us with their own “Round Trip Caucasus” over the past two days. Yesterday, they sold off sharply on word that Russian troops had moved into the Crimea and it then appeared that odds were growing for some sort of military confrontation with the Ukraine and the West. This morning, Russian Prime Minister Putin announced that it was all a misinterpretation as he had sent those troops in only for humanitarian reasons and he had no intention of any military attacks.
The effect on the various markets was startling and we offer two chars in evidence.
Please note the reversal which has taken place. Yesterday, the Dow Industrials plunged quickly by150-170 points at the opening and then remained sharply lower throughout the day. Today, action has been in precisely the opposite direction.
The lesson to be learned, I believe, is the value of taking short term fluctuations with a proverbial ‘grain of salt’ and concentrating on longer term considerations.
LESSONS FROM THE PAST
One of our principal concepts at “The Melman Report” is that rising international tensions can be an important factor in the progress of important precious metals bull markets – as we saw specifically in the latter portions of the great 1976-80 bull surge when America and the former Soviet Union almost came to blows.
Within that idea, I am growing increasingly concerned about recent actions which I believe could weaken the US military’s ability to respond to potential global problems. I believe those problems could originate in at least three directions; Russia, especially if moves take place which might attempt to recombine the old Soviet Union; a united international Islamic movement; and the growing strength of China which could eventually spill over into the threat of military action in one form or another.
It seems appropriate to reflect on the wisdom expressed by Winston Churchill in the 1930s when the prevailing sentiment in Great Britain was directed toward disarmament despite the evident growing strength of the Nazi menace. Churchill attempted vainly to promote the idea that the only means of truly securing peace was to become sufficiently strong so that no potential enemy would seriously consider an all-out attack. He also believed in strongly supporting treaty obligations.
As we know, Churchill turned out to be right – and the world paid a horrible price for ignoring him. Hitler went from strength to strength, the Allies went from weakness to weakness, and the net result was World War Two with over 60 million dead.
By the way, it is worth noting that no one was pilloried by the conventional press in Great Britain during the 1930s as Churchill, who was variously call a warmonger or with being out of touch with the ‘new reality’.
It may seem remote to make this comparison, but we must ask whether it is indeed possible that the continual reduction in America’s relative military strength might be encouraging America’s – and the Free World’s – enemies to consider increasing levels of military actions or threats of actions.
Any such measures could indeed send the precious metals to higher levels – as they did yesterday.
ANOTHER LESSON FROM THE PAST
Many financial historians have noted that perhaps the single most important reason for the severity of the steep stock market declines of 1929 was the fact that many investors were operating on margin. When markets went up, the leverage allowed by margin permitted over-sized gains, particularly when as little as 10% of the share purchase price had to be put up by the investor.
However, margin worked both ways as investors found out in September-December 1929. As markets began to plunge, numerous investors found the value of their stock holdings had fallen below the level required to maintain their margin-based accounts and the brokerage houses then sold those positions. As this selling mounted, overall securities quotes fell further, bringing about more margin-based selling in an accelerating downward spiral which finally led to a market collapse of epic proportions.
With this in mind, I was somewhat intrigued by an article in the widely-read “Financial Times” newspaper which dealt with the question of margin accounts. While the margin limit is now 50% of the purchase price of a security, that amount is still sufficient to send today’s margin balances to record levels.
According to the FT article, “…margin debt – money borrowed to buy stocks – hit a record level in January according to data from the New York Stock Exchange…Peaks in the use of borrowed money have in the past been a precursor to big bear markets and are viewed as a warning sign.”
I find it very interesting to note that margin debt BOTTOMED in 2009 at $173 billion – compared to the January 2014 figure of $451 billion – and that low level of margin debt in 2009 coincided with the onset of a major securities bull market.
The obvious question is whether the recent high numbers in a contrarian way will coincide with the onset of a major securities bear market.
Historically, precious measures have moved in contrary directions from general securities markets. Therefore, we consider this development to be a potentially credible indicator of the resumption of a precious metals bull market.
ONE MORE WORRY
Perhaps the most potentially volatile piece of the Middle East equation is the relationship between Israel and its strongest supporter, the USA. However, signs are beginning to emerge that cracks in that relationship are increasing and today’s meetings between President Obama and Israel’s leader, Benjamin Netanyahu could result in demands being made by Obama for further accommodations regarding a Palestinian State that Netanyahu might find both historically and politically unacceptable.
If America begins to withhold hits historic support of Israel, particularly from a military pint of view, it could leave Israelis feeling they are on their own and that their enemies are thereby being encouraged to increase tensions and perhaps even attack.
Under those circumstances, it seems to be a possibility that open hostility could break out with difficult-to-predict ultimate social consequences – but which could propel precious metals markets significantly higher.
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As of 8:15 AM PST (11:15 AM EST), financial markets continue to hold their early gains with the Dow Industrials up by almost 200 points while Canada’s TSX Index has gained seventy. Precious metals are lower on the session with gold near $1,337 and silver trading about $21.16 – down by $13 and 26 cents respectively. Base metals are currently trading sharply higher while mining share indexes are very slightly lower.
In other markets, the US Dollar Index has advanced 5 basis points to 80.14; Crude Oil is returning some of yesterday’s strong gains and is now down by $1.56 to $103.36 per barrel and the TYX Index of rates on US Treasury 30-year bonds has also reversed direction and is up by 46 basis points to 3.603%.
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All quotes US Dollars unless otherwise noted.
Next Melman Minute scheduled for Friday, March 7, 2014 – but if market conditions dictate, we are prepared to issue special postings.
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