A Melman Minute — January 28, 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."

The world's press is now filled with the 'good news' that the US government is likely to proceed with the opening of a "bad bank" which will allow American monetary authorities to funnel 'good' money into institutional banking establishments and take as collateral all the filthy, termite-ridden, rotten defaulting loans off the books of those institutions and using them as so-called collateral for the new bank. That is now the preferred solution to restoring believability and confidence in the American banking establishment.

If your editor sounds just a little bit caustic, it is for good reason. For decades, the Federal Reserve maintained some credibility by taking on their books as assets only the highest grade securities, namely those of their own institution and those direct obligations of the U.S. Treasury. They showed determination to retain credibility by adhering to that definition of quality so no one could question their financial integrity. Now, in one fell swoop, they are throwing those guidelines out the window and, somehow, that is supposed to improve the confidence of the American financial community and the integrity of the American currency in international markets.

But, it appears that for this morning at least, many people around the world are rejoicing at this action. As of 9:30 AM PST, the Dow industrial Average was ahead by over 120 points and, in fact, could be tracing out a positive chart pattern as it has established at least a short-term breakout to the upside. Whether this is sustainable is another question which will take time to answer.

There is also another portion to the whole story that could reflect a true 'sea change' in the manner in which the American government relates to the business establishment. Since its formation in 1789, the United States had maintained a clear separation between government and free enterprise markets. The government may have regulated commerce, but the concept of government actually taking over management of the economy was anathema. Until now.

As the Bloomberg news service noted in an article this morning, "The bad-bank initiative may allow the government to rewrite some of the mortgages that underpin banks' bad debt, in the hopes of stemming a crisis that has stripped more than 1.3 million Americans of their homes. Some lenders may be taken over by regulators and some management teams could be ousted as the government seeks to provide a shield to taxpayers." (our emphasis)

There is an old saying in the financial world that "nothing is confirmed until officially denied" and a statement just issued by arch-leftist Barney Frank, House Financial Services Chairman, fits that quote to a tee. Bloomberg quotes him as declaring, "...the government should not take over all the banks." When someone like Frank says it's not going to happen, then, in a contrarian manner, we begin to fear that is precisely the policy now under consideration.

In a similar vein, it is apparent the Obama Administration is seeking the means to 'rescue' homeowners from foreclosure proceedings. As AP has just reported, "Under the program, the Fed has a number of options to provide relief, including lowering the amount the homeowner owes on the mortgage, reducing the interest rate, or lengthening the terms of the loan." (our emphasis)

What we wonder is just how a financial institution will survive if the capital value of their loans is written down, thereby reducing the asset side of their ledgers; if the income side of their portfolio is reduced, thereby negatively impacting their Profit & Loss statements; and if the terms of the loan are lengthened, thereby reducing the monthly incoming flow of payments, thereby leaving them with insufficient incoming funds to satisfy their own debt obligations.

It would appear that under such policies, additional banks, savings & loan associations and other mortgage lenders would be at risk of failure, placing additional pressures on the government to add to the proliferating number of 'bailout' programs.

We can only watch and wait for all of this to 'sort itself out' in the months and years to come - but, as it relates to the monetary precious metals, we are maintaining our belief that all of these new policies and actions are weakening the underpinnings of the economic society, which will gradually diminish faith in unbacked currencies, and will raise the visibility and desirability of gold and silver as monetary options.

In this morning's trading, aside from the higher financial markets, gold and silver are down by $11 and four cents respectively while platinum has held on to a small gain. In the base metals, copper and nickel are higher while both zinc and lead are off slightly. Both major mining share indexes are off between one and two percent.

In other markets, the U.S. Dollar is off by about .33 on the DX Index, crude oil is holding just under $42 and the Canadian Dollar is sharply higher in reaction to the federal budget brought forward yesterday and which includes massive amounts of government stimulation.

One last thought. We are becoming increasingly fearful for the mining industry, particularly those juniors which are already at some high level of risk due to the financial difficulties which have proliferated during the past two years. The last thing such companies need, as it relates to American properties, is a rejuvenated environmental movement which would love nothing more than to place additional and crushing environmental roadblocks in the path of mining ventures. Our fear is that under the new Obama Administration, the environmental movement will believe they have a 'friend' in the White House and will push more strongly than ever before to enact such measures. We are already seeing talk of revising the Mining Law of 1872.

Canadian project owners should take notice as well, for the Canadian government seems to have acquired a propensity during the past few decades for following its southern neighbor in many regulatory matters.

We will take a look at this problem in Friday's MM.

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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