A Melman Minute — February 13, 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."

What we prefer to look at are hard facts, and we cannot help but note that one of our most reliable and interesting indicators is telling us that something of great significance is taking place within the world of gold in relation to the rest of the financial community. We are referring to the Gold/Dow Industrials ratio.

As we have noted previously, this ratio, which measures the Dow Industrials divided by the price of gold, has varied enormously through the past eight decades. Twice, in 1933 and again in 1980, the ratio approached a reading of "one-to-one". In the earlier case, the Dow bottomed at 40 and the price of gold was fixed at $35 per ounce. In the later case, the Dow and the price of gold traded at almost exactly 850 in January, 1980. At the other extreme, in early 2000, the Dow Industrials traded just above 12,200 while the price of gold was near $270, for a ratio of just over forty-five to one!

Since that time, the general trend in the Dow Industrials has been down, with the most recent quotes in the 7,800 area, while the general trend for gold has been higher, with the price of gold now approaching the $1,000 level. As of 10:00 AM PST this morning the two actual quotes were 7,847 and $940, for a current ratio of 8.35 to one.

What this means is that if an investor had transferred his holdings out of the Dow Industrial stocks in early 2000 and into physical holdings of gold, he would have improved his relative investment performance five times over! Naturally, dividend payments and the variances of individual stocks must be considered, but, in general, the movements of this ratio point to gold outperforming the financial stocks by a wide margin.

We also note that the rate of change in the ratio is accelerating to the downside; that is the Industrials continue to trend flat to down while the long-term price chart of gold is in a generally rising curve. One may question whether the ratio will ever return all the way to 1:1 (or even lower!), but the change which has taken place from the historic high of 45:1 to this morning's figure of roughly 8:1 bears note.

One of our goals is to observe important occurrences within the economic structure and then use those observations to reflect on the economic condition as a whole. Several months ago, we noted the price erosion of one of the western world's most historic names, Lloyd's of London, as an illustration of just how severe has been the international economic contraction. Well, in the intervening time, matters relating to Lloyd's have descended even further.

As can be readily observed, for almost two years the stock of Lloyd's Bank has been an unmitigated disaster to long term investors, falling from over $45 (all quotes US Dollars), to the present level of under $4.00 - or a wipeout of over ninety percent of investor equity - and information just released regarding their financial situation shows that in the last quarter, the Bank lost an astonishing $12.3 billion. Most of the loss was attributed to write-offs of bad loans, clearly illustrating the point that there remain mountains of bad debt within the U.K. banking system.

The British government already owns 43% of Lloyd's and we can only wonder if this latest negative report will be an excuse for the government to take total control of one of England's most historic free enterprise corporations.

As another illustration of just how parlous has become the international financial situation, the Wall Street Journal just published an article this morning which would have been literally unthinkable just a few months ago.

Virtually from the beginning of the U.S. Treasury more than two centuries ago, debt obligations of the Treasury have been the byword for gilt-edged, highest-quality, ultra safe-and-secure investments. No one ever seriously questioned whether full interest payments would be made on time or whether 100% of capital would be safely returned upon expiration of the life of any direct Treasury obligation. But questions are now being raised, and not by some flim-flam radical group, but by one of the world's leading financial rating services and published in the most widely read financial publication on earth!

In an article entitled "Rescue Efforts Ding U.S.'s Triple-A Rating", the story leads out with, "The creditworthiness of the United States is deteriorating more rapidly than most of its triple-A rated brethren." After noting the potential effects of the U.S. government's massive stimulative legislation which is now wending its way through Congress, Moody"s Rating Service commented regarding U.S. debt, in relation to its foreign competition, "...By the end of a two-year period, the U.S. debt ratios will be higher and moving the country's metrics to the lower end of the pack...this triple-A rating isn't assured forever." (Our emphases.)

It is apparent that the world is beginning to take note of just how potentially damaging this recent relentless money creation could be to the basic American financial structure. It also indicates that we at TMR are hardly alone in believing that much higher long-term rates for American debt instruments will develop in the coming 12 to 24 months.

This morning's financial and metals markets have trended lower and, as of 10:30 AM PST, the Dow Industrials and Canada's TSX Index were down by 60 and 80 points respectively. Gold and platinum were each about ten dollars lower while silver and platinum remained close to unchanged and the base metals were moderately stronger on balance. Crude oil was rallying sharply to the $38 level, up about $4 on the day while the US$ was little changed in currency trading.

NOTE: Because of the President's Day holiday in the US, their markets will be closed this coming Monday. Accordingly, we will publish 'Melman Minutes' on Tuesday, Wednesday and Friday next week.

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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