A Melman Minute — January 5, 2009

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NOTE: In order to complete Mr. Melman's forthcoming book on the essential fundamentals of gold and silver, new "Melman Minutes" will be posted only three times per week, each Monday, Wednesday and Friday until about mid-January 2009. The working title of the book will be 'Eight Pillars of Gold."

When we look out at the landscape of shattered dreams; falling asset values; failed banks and other companies; huge worries about pensions; and a genuine fear that the worst is yet to come for the world's economic structure, one cannot help but look into the just-arrived year and wonder in which direction events will move. Will a growing consensus be accurate, that the general economies have now bottomed and various levels of recovery - including securities markets - are about to take place; or will the general situation deteriorate much further, perhaps even exceeding the woes and trauma of the Great Depression?

In the first case, a multitude of analysts are indeed optimistic. In a recent story headlined "Equity Markets Optimistic", Canwest News Service quotes Union Bank of Switzerland (UBS) analysts as declaring, "...equity markets are starting out on a positive note in anticipation that fiscal measures will provide a spur to economic activity." We are also informed that, "...investors are reportedly staking their hopes on the potentially massive fiscal policies which were expected to be rolled out during the first half of the (new) year."

Indeed, it has not been difficult to find numerous expert economic commentators from banks, the real estate professions, government and mutual funds who are radiating optimism. However, their predictions must be regarded with some skepticism since many of those optimists were dead wrong at the beginning of 2008 when they assured everyone that any economic contraction would be minor and short-lived. As Barron's columnist Alan Abelson wittily noted this week in referring to those seemingly perpetual optimists, "...We especially admire their refusal to be cowed by their abject failure in the year that has now skulked into history."

Abelson also makes this telling point about when he might change his current stance of dire pessimism into a somewhat more hopeful viewpoint, "...we stand ready to honor that theme in our view of the markets and the economy, but only when the facts on the ground warrant the switch...Our skepticism reflects our fear that we haven't felt anywhere near the full brunt of the financial and economic collapse." (our emphasis)

One of the questions being debated is whether the current structural problems have the potential to cast the world's economies into the depth of a new Great Depression and, in fact, should that eventuality actually take place, whether the new occurrence could be even worse than the trauma of 1929 through 1939. Your editor has asked the same question and found the answer to be positive, that yes, the negative impact of this growing calamity does indeed have the potential to be worse.

We are not alone. Noted analyst, Robert Prechter, publisher of the Elliot Wave Theorist newsletter, was recently interviewed by Globe and Mail financial columnist Boyd Erman. Prechter told Erman that, "...the debt implosion should accelerate. We have yet to enter the strongest portion of the declining wave pattern in the stock market." On the question of whether this decline could rival or exceed the Great Depression, Erman quotes Prechter as declaring this time around could be much worse for the following reasons, "...This time, the engines of debt are much bigger; the debt balloon is far larger; the pool of speculators among society is far larger; overvaluations among investment went far higher; U.S. banks on average are flat broke; the manufacturing sector in the U.S. has become aged; government is far more stifling. I can't think of a single aspect of the situation that is less bearish than in 1929."

Prechter does note that there could be rallies from time to time, but for most people, his advice is to, "...stay safe, stay safe, stay safe."

We believe there is yet another profoundly negative factor, and a vitally important one that Prechter failed to mention and that is the potential for the destruction of fiat currency values which could be brought about by the relentless (and reckless!) stimulation of the financial marketplace now being undertaken by governments around this Earth. The quantities of (so-called) money being created are unprecedented and are resulting in enormous distortions of the financial systems.

Two examples will suffice to make the point. First, the Federal Reserve Bank of the United States, perhaps the greatest single influence on international monetary policy, has had policies, since its inception in 1913, that it would only hold the highest grade securities as assets. Suddenly, in the past few months, it has stated a willingness to buy up worthless, junk-ridden, failed mortgage and other debt portfolios in order to restore liquidity to banks and mortgage lenders. As Peter Hodgson just wrote in the Financial Post today, "...The long-held rule that the Fed is only to deal in the highest-quality and most liquid securities has been tossed out the window...The rules have been there for a reason; namely; to maintain a sound and stable currency that people can trust.

Secondly, the ongoing failure of the United States to finance their expenditures with valid revenues is reaching critical mass. American budgetary deficits are now forecast to reach one trillion U.S. dollars during fiscal 2009, which would be, by far, the highest on record. In order to finance such monumental deficits, the U.S. Treasury will be forced to market wave after wave of government securities and this also cannot help but weaken faith in the long-term stability of the economic structure.

Therefore, we believe that trust in the value of many important currencies, without which economies cannot function, is at risk around the world. We also believe that as perception of that risk rises throughout 2009, many holders of fiat monetary wealth will increasingly turn toward gold and silver. This has already been seen in the physical metals markets where sellers of gold and silver coins have run out of stock. In our opinion, the financial markets will soon get the message as well.

Markets this morning are reflecting some early strength in the U.S. Dollar, clearly bolstered by optimism that the incoming Obama Administration can indeed set things right. The U.S. Dollar Index (DX) is up by a sharp 0.93 and, as can be seen on the DXY chart, that Index now stands in the middle of a trading range, with support near 78 and strong resistance near 88. Gold, as might be expected in the face of this morning's dollar rally, is down substantially, off by about $25 (all quotes US$) to just above $850 while silver is down more than 50 cents to just under $11.00. Industrial and base metals are faring somewhat better with platinum holding steady while the base metals are also little changed on balance.

As of 9:30 AM PST, crude oil is continuing its recent rally, up about $1.00 to just over $47 per barrel and securities markets in Canada and the USA are mixed, with the Dow Industrials off by about 50 points but the TSX Index is ahead by about 40 on the higher crude price.

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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