A Melman Minute — August 19, 2009

6

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. The working title of the book will be 'Just a Melman Minute!"

As noted in our MM of this past Monday, questions are now being raised regarding the "certainty" of strong economic expansion in China going forward. This growing uncertainty is one reason being proffered to explain the weak performance of the Shanghai Stock Exchange Index which has suffered its worst spate of selling since the beginning of the year during the past few sessions.

Alan Abelson of Barron's Magazine recently quoted John Makin, economist with the American Enterprise Institute regarding the current situation in China. Makin stated that Beijing, "...routinely dresses up its accounts to give the impression of exceptional growth." He believes that the recent report by the Chinese government that their economy continues to grow at an annualized rate of 7.9% must be considered as suspect, particularly in light of the fact that their exports - which have been the major basis of their astonishing growth over the past decade - have been declining this year at a 21.2% rate!

One of the more interesting statistics Makin writes about is the report by the government that washing machine production is on the rise; but what the government failed to point out is that many of these machines are simply being dumped into areas which have no running water or electricity! As he puts it, "...but those 'sales' were dutifully included in GDP growth."

More questions about just how strong is economic growth in China were raised by a sudden drop in quotes for their domestic steel prices. As the Wall Street Journal points out, "...Economic data for the month showed signs of a slowdown in infrastructure spending and real-estate development, two areas that between them account for more than 50% of China's annual steel consumption." In a separate statement, they noted that, "New project starts, which include infrastructure, dropped in July for the first time since October, according to China's National Bureau of Statistics."

Yet another factor in question was whether China could continue its stimulative monetary policies of late indefinitely into the future. Presumably, any tightening would slow down economic growth, placing further doubt on expansion. As WSJ observed, "Liquidity infused by bank lending and government stimulus into the economy this year has helped boost stocks, as well as housing and other assets, probably at a faster pace than made financial sense. In recent days, Beijing has sent clear signals that these flows will be curtailed in the second half." (Our emphasis)

We would also ask another question. If China's growth was spurred and driven by huge exports of their low-priced goods to consumers around the world, exactly how is their economy to continue growing at the same kind of rates when those exports are plunging? Where will the orders come from to justify the production of goods on such a monumental scale as has occurred during the past few years?

That type of question regarding China dovetails quite nicely with a report published in the Telegraph newspaper in the U.K. regarding the excess capacity now plaguing many industrialized nations. as Ambrose Evans-Pritchard declared, "...Too many steel mills have been built; too many plants making cars, computer chips or solar panels; too many ships and too many houses. They have outstripped the spending power of those supposed to buy those products."

He cites a report from John Lin, World Bank's Chief Economist, that half-empty factories risk setting off a 'deflationary spiral' and perhaps we are even moving into, "...a phase where the real economy crisis bites deeper - meaning mass layoffs and drastic falls in investment as firms retrench."

Capacity Utilization, meaning the percentage of manufacturing capacity actually in current use, has plunged dramatically in recent years and, for many nations, now stands at the lowest point since WWII. Among the figures Lin quotes are: Germany - 72%; Japan - 65%; USA - 65.4%; and near 50% in some poorer countries.

With figures such as these, in our opinion, there is little to no impetus for manufacturers to invest in new plant capacity, which has been one of the primary ingredients in past economic recoveries.

Many of the positive predictions for base metals price improvement have been based on an assumption of rapid demand growth in China and other industrialized nations. In our opinion, perhaps it would be wise to double-check the accuracy of such assumptions.

We could not help but be particularly concerned about an article relating to the horrifyingly poor academic scores of the average American high school graduate when taking college or university entrance examinations. According to an article by Robert Tomsho, which cites data provided by the ACT admission testing agency, "Only about one-quarter of the 2009 high school graduates have the skills to succeed in college." The tests cover skills in English, reading, math and science.

As it relates to our economic concerns, it is worth pointing out that, "...the level of preparedness was worst in science...and another problem was math."

While these numbers indeed reflect a growing social problem, they also indicate potential problems for the American economy at large, for if youngsters are unprepared to read, write and calculate at any acceptable levels, the economic impact on America in coming decades could be especially severe. There is huge competition among nations to capture as large a portion of world trade as possible, and if huge numbers of American students are unprepared to compete at high levels for technical and industrial positions, then it is likely that America's primary industries will continue to contract, jobs in manufacturing and data dissemination will continue to be shipped overseas, and, as it concerns the monetary precious metals, the American government will be forced to continue huge increments of deficit spending in order to prop up whatever remains of its once-robust consumer economy.

Huge increments of government spending and debt have been historic plusses for the monetary precious metals.

Speaking of same, gold's chart has resolved itself into a narrowing triangle with a declining trendline drawn by connecting the tops near 990 and 970 and a rising trendline drawn by connecting the bottoms at 870, 910 and recently near 930. We believe the direction of the breakout from this narrowing pattern could be a valuable indication of future price moves in the yellow metal.

As of 9:20 AM PDT, several markets this morning have had sharp reversals from their earlier numbers. The Dow Industrials opened down nearly 100 points, but are now up by over 70 and the TSX Index in Canada has followed a similar pattern. Gold opened down by about $5.00 but is now up by more than $6.00 and silver has rallied from a morning low of $13.49 back to the $14.00 area. Platinum and the base metals have also swung from early losses to positive gains.

Perhaps the strongest single 'driver' in these reversals has been the price of crude which has soared to almost $72 per barrel after opening just above $68. Among other things, this has resulted in a lower US$ and strength in the Canadian currency.

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.

← All A Melman Minute