A Melman Minute — December 28, 2010

APOLOGY: Please accept our apology for not posting a "Melman Minute" as had been scheduled for yesterday. We had overlooked the fact that Monday became the official "Boxing Day" holiday and virtually all business activity in Canada ceased.

As the year of 2010 rapidly reaches its conclusion, our attention turns directly toward the

coming new year, 2011. What follows are some of our impressions as the next twelve-month parade approaches and our first consideration is that, in our opinion, the developing economic and social vise we have called "between a rock and a hard place" continues to gather strength. Simply put, we believe that in the long run, it will be impossible to adequately stimulate further growth in worldwide economic activity without unleashing forces of visible price inflation. We believe such visible inflation will drive interest rates higher which will set in motion a parade of uncontrollable forces, fully capable of negatively impacting the world of fiat currencies. Since "hard assets", specifically including the monetary precious metals, are the antithesis of fiat currencies, our opinion going forward remains bullish for the world of gold, silver and platinum prices in particular.

The evidence in support of rising price patterns is becoming steadily more evident and we are including three specific charts to support that thesis. While many focus only on the more prominent commodities such as metals and petroleum, there are other and equally important goods which trade around the world. Two of the most important are coffee and cotton.

If there is a universal beverage on this planet, coffee could occupy such a place of honor. It is served in nation after nation in various forms and it would be difficult to travel to any important location around the globe and NOT be able to obtain a cup. Therefore, when the price of coffee makes an astonishing upward move in world commodity markets, that price action has a direct impact on the lives of many people. Coffee has made just such a move, breaking this past June above a trading range between $1.20 and $1.50 and soaring in swift leaps all the way to almost $2.40 per pound by this morning. In comparative terms, this price in crease is historic in nature.

If the move in coffee has been impressive, the price gains in cotton over the past two years must be rated "spectacular", with the price having more than quadrupled from a low just under 40 cents per pound to a recent high close to $1.60 per pound. Cotton is used in a wide variety of products ranging from medical supplies to clothing to bedding and house wares and cotton's importance to the world's economic development is historic in nature. Much of the economic power of ancient Egypt was built on the production of cotton in the Nile River delta and a more recent example would be the growth of the slave-driven economy in the American South in the 19th century. In fact, from east Texas through the Deep South, cotton continues to be a primary economic force.

When the prices of two vitally important commodity items moves upward at the rate shown by cotton and coffee, then it may indeed be true that inflationary forces are truly 'brewing'.

It is also worth noting that cotton and coffee are not moving in isolation as we could have included the charts of other "softs" items such as orange juice, sugar and lumber - all of which have also headed sharply higher over the past several months.

Another way of looking at the build-up of commodity inflation is to track the value of currencies where the home country is a noted commodity producing nation. One such country is Australia, which ranks high among the countries of the world active in mining of precious metals, base metals and coal as well as wide-spread agricultural production. The situation can be summed up very simply. Australia's Dollar had been a stellar performer among the world's currencies, rising from barely 60 cents US in late 2008 to above parity with the Greenback as of this morning's market activity.

Our interpretation of this activity is this: The American dollar and the American economy have fallen under the forces of currency manipulation, currency creation and artificial economic stimulation. The Australian Dollar and the Australian economy have instead been built on the development and production of important commodity resources such as those noted above.

We are always more impressed with actions rather than words and the world's currency traders are declaring loud and strong - by their actions - that they are much more impressed with genuine productive activities rather than what they apparently regard as artificial manipulation, even if that artificial manipulation is being undertaken by the world's mightiest economy.

To our way of thinking, such preferences appear to augur against currency stability in the coming year and beyond and we believe such instability will eventually find its expression in the troubling form of higher, perhaps much higher, interest rates down the road.

Unfortunately for the public relations factories attached to the U.S. economic powers, the "all is improving and will soon be well" story keeps getting derailed by unfortunate economic data. Two such illustrations have been publicized this morning.

In the first case, instead of glowing in the satisfaction of the anticipation of improving prosperity, Americans seem to still be deeply concerned about their economic future and the latest piece of evidence is a sudden and unexpected decline in consumer sentiment. The Conference Board Index of consumer attitudes dropped from 54.3 in November to 52.5 in December and the "Expectation Index" declined from 73.6 to 71.9 during the same period. Apparently, Americans are finding it hard to ignore the high numbers of their friends and neighbors (or themselves!) who are without jobs and/or losing their homes. They perhaps are also having a hard time wondering how they will pay all their bills in the face of rapidly rising gasoline prices which have now topped the $3.00 per gallon average mark across America.

Another report which could be placed in the negative category is the latest October S&P Case-Shiller index of real estate prices in 20 major metropolitan areas in the USA. The average home price declined by a full 1.0% during October, after having already suffered through a prior similar loss during September. The Reuters article detailing this report indicated that the loss was due to, "...a supply glut, home foreclosures and high unemployment."

Excuse us for our naiveté, but it does not appear likely that these type of sentiments could likely be the basis for strong economic growth going forward. Therefore, we believe that monetary manipulations will continue to proceed during the coming year, with additional distortions followed by more such 'remedies' as the likely result.

Markets this morning are highlighted by powerful action in the precious metals and, as of 9:15 AM PST, gold is ahead by more than $20 per ounce to just above $1,405 and silver has just crossed above the $30 mark - both figures once again approaching their multi-decade or historic peaks. The London Metals Exchange is closed today and therefore base metals action is muted, while mining share indexes are feeding off the precious metals gains and have headed sharply higher. Crude oil is once again nearing the $92 per barrel level, the US Dollar is lower in currency trading and long term interest rates are moving moderately higher.

Financial markets are trading quietly with both the Dow Industrials and the TSX Index showing minor improvement at this time.

All quotes US$ unless otherwise noted.

Next "Melman Minutes" scheduled for tomorrow when we will take a further look at inflationary and monetary pressures and Thursday when we will offer our annual forecast.

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