A Melman Minute — May 6, 2009

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NOTE: In order to complete Mr. Melman's forthcoming book on the essential fundamentals of the developing international financial crisis and its relationship to gold and silver, new "Melman Minutes" will be posted only three times per week, each Monday, Wednesday and Friday until about mid-March 2009. The working title of the book will be 'Just a Melman Minute!"

Market history has a habit of repeating itself, and sometimes in a fashion which seems almost eerie. This morning, we have the opportunity to take a good look at one such occurrence. We are referring to the comparison between the securities markets of the past 18 months to the comparable period at the onset of the Great Depression.

First, let's take a look backward. The Dow Industrials peaked in early September 1929 - not just before "Black Tuesday" at the end of October as so many seem to believe. After hitting a high just above the 380 level, the Dow sold off by a sharp 20 percent in just four weeks to the 320 level before rallying back to a second, and lower, peak just above 350. If was from that second and lower peak that the events of the October crash occurred, with the Dow eventually plunging to a low of near 190 by mid-November 1929 - a drop of slightly more than fifty percent from the initial peak.

Now, let's look at the present time frame where we see the Dow Industrials made their historic high of about 14,200 the fall of 2007. A sell-off then ensued down to the 11,500 level before a secondary peak near 13,200 was reached in late spring 2008. The market then went into a steep, protracted sell-off which drove the Dow down to the 6,400 level by early March, 2009 - a drop of slightly more than fifty percent from the initial peak.

From the bottom of November 1929 through early May 1930, the Dow Industrials went on a prolonged, powerful rally lasting six months which drove the Dow back to the 300 level - a recovery of 110 points of the previously lost 190+ - or almost sixty percent. Newspapers of the day trumpeted the 'fact' that matters were not nearly as bad as many had supposed. Unfortunately, that burst of optimism turned out to be ill-founded as from May 1930 through June, 1932 the markets went into a pattern of sharp drops followed by moderate recoveries, eventually reaching their historic low at 41 - or almost ninety percent below their 1929 peak.

And now, let's fast forward to the recent weeks. Starting in early March, the Dow Industrials have rallied from near 6,400 to about 8,500 - a recovery of slightly more than 2,000 points from the previous total decline of 7,800 (from 14,200 to 6,400), or about 24 percent. In other words, so far the recovery from the early March bottom, impressive though it may look, is still far less than half the comparable recovery from November 1929 through early May 1930 - and that one was followed by the most devastating, continual pattern of selling waves in market history up to the present era.

Even the psychological background was similar. In the previous period, the Hoover Administration made aggressive moves to counter the initial effects of the Depression and people had confidence that these measures would improve the country's economic performance. In fact, some of these 'stimulative' measures were so aggressive that in the 1932 campaign, Governor Roosevelt and the Democratic Party adopted a platform calling for "a reduction of federal expenditures and a balanced budget" and "a sound currency." (University of San Francisco study of 1932 election).

Today, we also have governments in power which have adopted perhaps the most aggressive stimulative measures in American history and the public is awaiting the improvements 'certain' to come from infrastructure programs, restoration of the credit systems, etc.; and the result has been a rally similar in tone, if not yet in duration, to the 1929-30 episode.

But there is a dire similarity which, in our opinion, is not yet receiving adequate news coverage. Declines of over fifty percent in securities markets are rare birds indeed. In the last 85 years of market history, there have been only two! While the debacle of 1971 through late 1974 came close, only the 1929-32 episode and the recent declines qualify. We would suggest that they represent something greater than a normal, run-of-the-mill recession and, if history does indeed repeat itself, this would also suggest that the final bottom is not at hand, but rather some time in the future.

At least, that's the way we interpret market history. Therefore, our expectation is that the financial markets may indeed continue the recent rallies, but we believe this is not the beginning of a protracted bull market but rather an important correction within an ongoing bear. We also believe that just as the initial optimism generated by Hoover's initial moves to fight the onrushing Depression eventually faded, so too will the optimism generated by the Obama Administration's massive interventions likewise fade as economic reality bites hard in the future.

As matters stand this morning, while many observers appear to be climbing on board the optimistic train for the future, present news stories continue to have a negative bias.

For example, the number of stock brokers leaving the business has swollen to the highest number on record with a total of 35,000 expected to exit by year-end 2009. During the fifteen year data series on such brokerage exits, the previous high-water mark was only 11,500 in 2002, following the sharp declines of the .com bust. It seems strange to us that if huge numbers of financial analysts are truly expecting improved market conditions; that record numbers of market analysts and brokers would be leaving!

On the subject of the economy's future, we note a recent article written by Michael T. Darda, Chief Economist and director of research for MKM Partners. Mr. Darda believes that the mass of monetary stimulation programs of late will bring about some economic recovery, noting, "...a highly aggressive monetary policy married to fiscal expansion will lead to recovery." However, he then adds these words relating to implications contained in any future tightening of monetary policy to stabilize the Fed, "...there's a real danger that what appears to be a robust expansion will flame out."

One last indication that real estate problems, particularly those relating to commercial real estate, are far from over is an article in the Wall Street Journal relating to a forty-two story premium office building in downtown Los Angeles which is on the market, but where bids have been 'low-balled', to put things mildly. The building was sold in 2006 for slightly above $400,000,000 but now, less than three years later, offers are expected to come in near the $200 to $240 million range, about 50% below the price of 2006. Since many commercial bank loans are collateralized by commercial real estate, this story suggests that bank troubles, particularly smaller, regional banks, are hardly over.

And yet, the markets continue to hold recent gains and add to them. As of 9:15 AM PDT, the Dow Jones Industrials were up by more than 50 points while Canada's TSX Index, propelled by higher petroleum and metals prices, was ahead by nearly 180. Precious metals were indeed higher, led by an exceptionally strong silver market, with the price for the white metal now nearing the $14.00 per ounce level. Base metals were also higher, particularly zinc which saw its price rise above 70 cents per pound for the first time since last fall. Crude was up by about $2.00 per barrel to a new recovery high near $56 while mining share indexes were also strong, up by an average of about three percent this morning. In currency markets, the Canadian dollar moved higher and now exceeds 85 cents US while the Greenback was slightly lower.

(All prices US$ unless otherwise noted.)

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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