A Melman Minute — February 23, 2011

Yesterday we noted some of the important developments which have been driving markets and today, we will continue to list several others.

However, there is one very important matter to discuss and that is the relationship between crises, the US Dollar and gold. For decades, we have noticed that when various crises arise in the world, one of the knee-jerk reactions among the general public has been to turn to the US Dollar for safety, but this time around, things may be different.

We have just put a pair of interesting numbers together and they may be telling us a story of an important shift in future investor focus. Assuming the worst of the Middle East crisis has developed over the past two weeks, it is most interesting to note that the US Dollar Index has DECLINED from 78.00 on February 10 to 77.40 this morning while gold has RALLIED from $1,360 to $1,415 during the same period of time.

In fact, while watching the financial coverage on CNBC this morning, we noted a famous commodity trader recommending that commodity investors short the Greenback and go long gold. This type of projection has been almost unprecedented during the past several years.

One important item of late has been the continued deterioration in America's housing markets. The widely-watched Case/Shiller Index shows that home prices have declined to new low levels since the real estate collapse began in no less than 11 metropolitan areas during December, raising real fears of a genuine "double-dip" decline in housing. From a wider viewpoint, home prices across America have declined on balance for the past five months and have now erased virtually all the gains which have been previously recorded since the initial bottom in real estate prices was reached during March, 2009.

Along with the release of raw data, index founder Robert Shiller noted, "...there remains a substantial risk of another 15% or 20% decline in home prices." Among the reasons offered, Capital Economics stated that there were at least 850,000 too many homes presently on the market in excess of demand.

One city which is an example of just how devastating the real estate collapse has become is Las Vegas, Nevada. At the height of the real estate frenzy in 2007, average homes in gambling's Mecca averaged near $400,000, but the Wall Street Journal just reported, "...In Las Vegas, the median price of previously-owned homes fell to $109,000 in January..."

The situation is bad and shows little signs of any near-term improvement, putting yet additional strain on the consumer-driven economy and perhaps forcing the government into further aggressive attempts at stimulation.

Speaking of stimulation, George Melloan, former editor of the WSJ just authored a study entitled, "The Federal Reserve is Causing Turmoil Abroad." His thesis is that the abundant stimulative measures by the Fed, including QE1 and QE2 and creating bubbles of inflation abroad, particularly affecting the prices of food and fuel and these price increases have been a factor in creating the unrest and rioting of the past few weeks. He informs us that the consumer price index in Egypt has risen by about 30% during the past two years, driving the price of essential items above the income levels of many citizens.

His specific explanation of the tie-in between the Fed and basic price indexes reads as follows: "When the Fed floods the world with dollars, the dollar price of commodities goes up, and this affects market prices generally, particularly in poor countries which are heavily import-dependent."

Well, it appears that present market action leads us to the assumption that there will be more of the same as the price of gasoline has just shot up by 12 cents per gallon this morning while the quote on the widely-watched Crude Oil contract is now approaching the $100 mark.

Melloan also predicts that Fed actions will soon produce domestic inflation, advising readers that, "...The fed is financing a vast and rising federal deficit, following a practice that has been a surefire prescription for domestic inflation from time immemorial."

One last thought about the growing conflict between government labor unions and the general public: The conflict is spreading, and spreading fast. After gaining initial momentum in Wisconsin, direct conflict has now spread to Ohio and Indiana and California is now discussing some sort of remedial action regarding civil service pensions which, in our opinion, have reached levels that are borderline insane.

Markets this morning are in some degree of turmoil, to put things mildly. As of 10:15 AM PST, financial markets in the USA are lower with the Dow Industrials down by about 115 points but Canada's TSX is up about 40 on higher precious metals. Both gold and silver are up sharply with gold trading near $1,415 and silver up to about $33.50 per ounce. Base metals are sharply lower on fears of an industrial slowdown due to high petroleum costs Mining share indexes are up by about 2%, crude oil remains just under $100 per barrel, the US Dollar is lower on the day and interest rates are close to unchanged so far this morning.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Monday, November 28 as I will be traveling tomorrow en route back home to "Beautiful British Columbia.".

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