A Melman Minute — January 8, 2008

Gold bugs rejoice! Today, action in the world’s metals markets drove the price of the yellow metal to the highest US$-denominated price ever recorded, just above the $880 level, exceeding every reading established during the famous bull run of January, 1980. And, while gold made its stunning move, the rest of the financial world continued to reflect a growing level of anxiety

Once again, we have seen the same pattern emerge in securities trading, namely a burst of selling after a positive opening. For this morning, the Dow Jones Industrials followed up an eighty-point early gain with a barrage of selling which brought it to minus fifty-five points on the day about two hours into the trading session. Seemingly, the release of nominally positive information overnight was again insufficient to stem the effect of a crush of negative news the marketplace must deal with.

Today’s worst blow came in the form of a dismal report from housing construction giant KB Homes (formerly Kaufman Broad) which reported a horrendous loss of $772 million for the fourth quarter 2007. In addition, as reported by the Associated Press, they also predicted that the year 2008 would be, “…another tough year for the homebuilding industry.” (All figures US$)

What was even more significant was the nature of the loss reported by KBH. A substantial amount, $403.4 million, represented an accounting transaction called a ‘pretax charge’ due to a reduction in the estimated value of homes already constructed and held in KBH’s ‘unsold inventory’ category. In simple terms, construction companies carry the value of their unsold homes at estimated market value. Unfortunately for KB Homes, the present market value of their inventory has been falling rapidly and must now be recalculated to a lower amount. The net result of this recalculation was the reported charge to earnings.

According to AP, “The average price of the company’s homes also slipped, down 12% to $247,000 from $280,000 in the fourth quarter of 2006.”

Another telling note, and one which indicated just how bad conditions in real estate have become, was that the company reported the cancellation rate of orders on which customers had paid deposits rose to 58%, up from 50% in the third quarter 2007.

All in all, it was not the kind of news that the market in general or KBH shareholders in particular wanted to hear. As a result, KBH stock has plunged almost eight percent today alone and now stands at less than one-fifth of its peak value set less than two years ago. An examination of the ten-year chart of the stock shows just how dramatic has been the devastation in real estate construction, as the gains earned in ten years of hard work have evaporated in just eighteen months.

While the housing construction debacle is an important component of the overall picture, it is hardly the only negative category for the market to contend with as the Balance of Trade Deficit in America is once again expanding, the price of petroleum products is squeezing the already-diminished level of consumer discretionary activity, budgetary deficits are on the rise, the Unemployment Rate is on the rise and a massive credit crunch has been building for months.

The combination of a record price for gold and a declining price for the Dow Industrials (this morning’s low at 12,760) has resulted in a major move in gold’s favor in one of our most important long-term indicators, the DJIA/GOLD ratio. As long time readers might note, that ratio has varied from a historic low of one-to-one in 1980 (with both figures in the mid-800s) to a high of close to forty-six-to-one in early 2000 with the relevant numbers being near 12,000 for the Dow and $260 for gold.

Since that time, the ratio has been contracting and fell into the upper teens, where it sat for many months. However, it is once again moving in gold’s favor - that is, declining - quite rapidly, and with the recent strong trends toward a higher price for gold and a lower Dow number, this morning the ratio reached the lowest number in almost one decade, at only 14.5 to one! (12,760/880)

This ratio is well worth watching, and may, in fact, be one of the most important indicators of the direction of the world’s economic and social well-being.

At 9:00 AM PST, gold smashed through to a new peak at US$880.80, up almost twenty dollars on the session and appears ready to challenge the US$900 level in the near future and, as might be expected, gold share indexes are soaring with the AU and HUI making important new highs. Silver is once again above $15.50 while platinum and palladium, along with all the important base metals, are up solidly. Crude has recovered to near US$97 and the Canadian and American Dollars are virtually at par with each other.

Given the importance of the KB Homes report and action in gold, we chose to feature that information today. We still plan to look at the growing impetus to higher food prices tomorrow morning.

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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