A Melman Minute — December 6, 2010

(NOTE: Please accept my apologies for today's late posting. I simply was

pre-occupied with completing projects with a hard deadline of noon today. LMM)

There are times when I truly wish that somehow an open line to Ben Bernanke could be magically established in order to pose some direct questions to this eminent leader of the world's economic policies. In short, I would tell him that in my humble opinion, he had lost his mind! To us here at TMR, that is how strange his recent actions appear.

From what we believe would be a logical point of view, when a policy does not work, you change it. Yet, month after month, even year after year, the Fed Chief deviates not to the right or left when it comes to his answer for virtually everything, an answer we believe tells the world to "stimulate, drive interest rates low and use public relations techniques to tell the world that all is well so they won't panic." Somehow, massive growth in government debt levels; continued deterioration of the housing situation; confusion in the mortgage industry which is preventing new lending; and continuing staggeringly high levels of real unemployment which seem immune to conventional solutions do not seem to bother this august individual at all, nor have they caused him to openly question his own policies and actions.

This all came to light once again thanks to a lengthy televised statement issued by Bernanke over the weekend. As reported by Bloomberg News Service, Bernanke did sort of acknowledge that all was not well on the economic front, but he never questioned whether the continuing problems were actually being exacerbated by his own policies. Instead, he declared that, "...it's possible the Fed may expand bond purchases beyond the $600 billion announced last month to spur growth."

All we can declare is an exasperated, "Ye Gods!" If government stimulation, government buying of bonds, government rescues, government ballooning of the money supply and government debt were the truly valid pathways to prosperity, then between the Bush and Obama Administrations' actions of the past three years, we should be enjoying the greatest economic utopia in the history of the world. But we are not, as is evident for all to see.

Of course, part of the problem may be that Congress, in its varying degrees of wisdom, has confronted the Fed with an apparently irresolvable set of directives. In one case, namely the Humphrey-Hawkins act of 1978, since that statute recognizes that everyone has a right to a job, the Fed it is directed to engage in policies which will ensure full employment. However, at the same time, the Fed has been given the responsibility by Congress to maintain a stable currency and control inflation. We would only query as to how it can consistently accomplish both goals over time.

Perhaps this continuing confusion is responsible for what is happening in the precious metals markets, but for whatever reason, they have been putting on a spectacular show during the past week or so and gold is now within just a few dollars of breaking through to a new historic high while silver is within a few pennies of rising above the $30 barrier, a price not achieved since the Hunt Brothers bubble of early 1980 - almost 31 years ago.

One of our favourite market 'saws' is that bull markets traditionally 'climb a wall of worry'. This appears logical since if everybody agreed on the fact that the particular market under consideration had nowhere to go but up, that would infer that virtually every participant had already established 'long' positions and then, where would new buying come from? However, if there is great doubt combined with predictions of imminent 'bubble collapses', then it becomes obvious that there would still be many who have remained on the sidelines and others who have aggressively 'shorted' the market, meaning those people must eventually cover their positions with 'buy' orders, potentially driving the bull market ever-higher.

What brought this to mind was an item in the Globe & Mail financial pages, namely a listing of those companies with the greatest 'short positions', meaning the largest number of investors who are putting their money on the side of those shares falling.

Since registering a profit on a trade only requires an action where the selling price is higher than the buying price, it really makes no difference which trade comes first. In other words, if a person buys a stock and $40 and sells it at $50, then clearly a $10 per share profit has been made, discounting trading costs. The same result may be obtained if he sells the stock at $50 via a 'short sale' and then buys it back later at $40 in a covering trade.

With that in mind, it is clear that substantial numbers of investors expect mining shares to fall as no less than nine out of the top twenty largest short positions on the Toronto Stock Exchange are to be found in mining corporations. Not only that, but seven of the top twenty increases in the amount of shorting also belong to mining corporations. Of course, everyone is entitled to their opinion, including those who believe that the gold and silver markets in particular are in some sort of 'bubble' and are likely to fall sharply, but we believe in the opposite manner. One look at the XAU Mining Share Index suggests that this major bull market is no short-term bubble, but rather a gradually accelerating bull based on powerful trends in the world's monetary situation vis a vis the mountainous growth in fiat currencies worldwide and the instability generated by that growth - and, in our opinion, that situation cannot be resolved easily, quickly or without major trauma.

Let's take a look at one last word regarding the sense of illogic that appears to pervade the law-making bodies of this planet. The USA is suffering from huge budgetary deficits where spending is dramatically in excess of revenue. Presumably, the long-lasting solution would come from the direction of increasing revenues and decreasing expenditures. But the collection of geniuses in Washington, DC appear to believe otherwise.

In a story headlined "Tax Deal Within Reach", the Wall Street Journal reports that the coming deal would involve both extending all the Bush-era tax cuts while at the same time extending the payment of special unemployment benefits which are presently set to expire.

So, let's see. In the first case, you reduce anticipated government revenues by extending tax cuts while at the same time you increase anticipated government expenditures by extending the period of benefit payments. Could that really be the way to resolve budgetary deficits?

Of course, we are told that only in this manner might prosperity be restored so that, down the road a fair bit, the economy will become so prosperous that it will throw off incredibly enlarged government tax receipts so that the budget might not only be truly balanced, but a genuine reduction in the level of the national debt might be achieved.

To our ears, that sounds somewhat similar to stories about the Tooth Fairy, Santa Claus, etc. But then, we acknowledge an inherently high degree of skepticism when it comes to the utterances of the political establishment of any major party in the USA, Canada, Europe or elsewhere.

As noted, precious metals are moving strongly higher and, as of 11:30 AM PDT, gold had traded as high as $1,422 before falling back slightly and silver had hit $30.10 before retreating to about $29.95. Financial markets were mixed with the Dow Industrials close to unchanged and Canada's TSX Index was up by about 30 points. Base metals were little changed while mining share indexes gained about 1.5% on higher precious metals. Crude oil is now close to $89.50 per barrel, the U.S. Dollar is slightly stronger in currency markets and long-term interest rates have declined so far today.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Wednesday, December 8, 2010.

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