A Melman Minute — May 15, 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!"

Perhaps the most important question facing economists and investors at the present time can be placed in the form, "Will the massive stimulative measures now being enacted and implemented by many nations bring about the desired results?" Another way of formatting the question is to wonder whether the combined effect of these interventionist activities of the past eighteen months is a better form of remedy than letting free markets 'sort out' matters.

Clearly, one of the best eras to study in order to gain perspective is the United States of America during the time known as "The Great Depression" and thankfully, we have an excellent series of statistics available thanks to a document entitled, "Historical Statistics of the United States."

It is also clearly important that the time span under study contains information from a time when free markets combined with limited government intervention formed the dominant philosophy, as well as a time frame when government intervention became the rule. Fortunately, the available data series covers the years from 1900 to immediately following WWII.

As we have noted in other writings, and using Grover Cleveland's 1893 Second Inaugural Address as an example, prior to the Great Depression the former philosophy was dominant, but once the Depression began to bite hard and the cry of the time was for government to "Do Something!", the latter philosophy took hold. It is most interesting to compare the contrasting results by simply looking at the numbers.

There were other serious Depressions in America prior to the 1930s and, for our purposes, we have data available for those of 1907-8 and 1921, which were painful in the extreme and occurred with frightening rapidity. Here is what we have learned about those two episodes.

The Unemployment Rate in 1906 was just 1.7%, rose to 2.8% in 1907 and exploded upward, almost tripling to 8.0% by 1908. It then began to decline rapidly, falling to 5.1% the very next year. Workers' wages averaged $502 in 1907, fell sharply in 1908 to $446, but rebounded to new highs in 1910, reaching $517. From these statistics, we can surmise that the depression came suddenly, but the economy began to recover quickly by historic terms.

When we turn to 1921, a similar picture emerges. Unemployment skyrocketed from 5.1% in 1920 to 11.7% in 1921, but fell back to 6.7% for 1922 and only 2.4% in 1923. Average earnings declined from $1,236 in 1920 to $1,009 in 1921, but then rallied back to $1,231 by 1923. Again, the economy quickly from that Depression as well.

When we turn to the Depression which began in late 1929, a completely different picture emerges. At the onset of the Depression, unemployment rose from 3.2% in 1929, to 8.9% in 1930, to 16.3% for 1931 and the peak area of 24-25% in 1932-3. However, even as late at 1939, the unemployment rate remained above 17%, and still held above 14% in 1940 before the wartime economy began to take hold.

In terms of average earnings, the data shows a similar picture. Average earnings fell from $1,356 in 1929 to $1,207 in 1930, $995 in 1931 and eventually, a low of $678 in 1933. However, as late as 1939, ten years into that Depression, the figure remained under $1,000.

What had changed? In our opinion, the great change was that the recovery from the two earlier examples occurred during times of minimal government intervention, while during the last case, massive government intervention was the rule with measures such as the elimination of gold from their domestic currency, the formation of an enormous number of government agencies, passing new banking laws, artificially manipulating interest rates, creating Social Security, etc.

As we have noted several times during the pat two weeks, the question at hand is whether the rally from March's lows is the real thing, or whether it is simply a strong rally inside an overall Bear market. Given the fact that the Obama Administration is following the same path as that of FDR's Administrations, namely that of massive intervention, can we really expect a different result than a dragging-on of negative results lasting many years?

One look at the current chart of the Dow Industrials tells us that we are near a critical time, with the average looking like it is 'rolling over' to the downside. In our analysis, the 8,000 level is taking on a rising level of importance as a drop below 8,000 could serve to discourage many who have only recently returned to active investing.

In our interpretation, if the markets resume their rallies and achieve relative new highs, that could tell us that economic performance will improve and the demand for all materials, specifically including base metals, should rise. However, if the recent rallies roll over and new and powerful declines set in, then the potential for fear and panic could become widespread, benefiting the precious metals, but not the base metals.

Very interesting times indeed - and it appears next week's market actions could go a long way toward providing some clarity.

In the meantime, gold continues its recent rally which is beginning to gather strength. From a low of barely $875 at the beginning of May, the yellow metal has added almost $60 and now sits just below the mid-$930s. We believe the next resistance on the chart is near $950-960, and if gold succeeds in rising through that level, then we have the all-important $1,000 to 1,030 zone to overcome - and area which has beaten back all rallies since March, 2008.

Markets this morning show financial indexes opening higher, but then trading lower. As of 9:50 AM PDT, both the Dow Industrials and Canada's TSX were down about 50 points, near their low levels of the day. After touching a high of $934, gold was holding on to a $6 gain near $932 while silver and platinum were close to unchanged. Base metals were moderately lower on average, crude oil was down about $2.00 per barrel and the U.S. Dollar was slightly higher in currency markets.

(All currency quotes in 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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