A Melman Minute — March 18, 2011

One of the curiosities of modern economic life is the manner in which government provides us with information. In the present case, we are referring to the consumer inflation readings provided by the American government and their style has been picked up by many other nations.

If you question most families, the two most important impacts on the family budget from month to month are supplying the family with food and purchasing energy in its various forms such as gasoline, fuel oil, natural gas, etc. Changes in those prices has an immediate and, quite often, dramatic effect on the familys financial status and stability. And yet, by some imaginative use of logic, government economic gurus utterly ignore those two important factors and instead provide us with a core inflation rate, usually of a much smaller magnitude.

According to the U.S. Labor Department, energy prices in America surged by a huge 3.4% in February (an annualized rate of 40.8%!) and food prices gained 0.6% for the month, yet the official rate of inflation came in at a gain of only 0.2%. We can only wonder whether families whose bank account is being rapidly depleted every time they purchase gasoline or visit their local supermarket are finding any real joy in learning that inflation is officially dormant. Somehow, we doubt it.

At The Melman Report we truly believe inflation will become a steadily more visible matter and it will begin to impact the general psychology of consumers worldwide. In fact, an interesting piece of evidence surfaced this morning in the form of a U.K. Telegraph article which informs us that in the U.K., ...consumer confidence crashes to record low, and ...Britons expectations for climbing prices have reached their highest in more than two years.

The article cited the Nationwide Consumer Confidence Index as having fallen to 38 by mid-March, the lowest number since the Index was initially set at 100 in 2004. At the same time, Brits were looking for general inflation to rise by 4% during the coming year. These cannot be welcome numbers for a government still waiting to impose the strictest measures of its announced austerity policies.

All of this confirms our general supposition that it is relatively easy for politicians to announce their various cures. It is much more difficult to make them work over time and we believe the uncertainty created by endless revisions and adjustments is playing a role in the ongoing precious metals bull markets.

One market which is definitely not in a bullish mode presently is the uranium market. As we noted yesterday, thanks to the earthquake/tsunami combination and the resultant difficulties at Japans nuclear generating facilities, the world is assuming that other nations will abort or at least delay their own nuclear power expansion plans and the quotes for uranium have fallen sharply over the past few days and that has negatively impacted many uranium shares which just a short while earlier had been among the markets most stellar performers. According to one source, the quote on uranium fuel has dropped from above $70 just a few days ago to near $50 as of this morning.

However, we would offer one observation learned over 40 years of market experience. During those years, many sudden catastrophes such as earthquakes, floods or tsunamis have occurred periodically. They can and frequently do cause short term abrupt market reactions, but in our experience, those markets frequently return quite quickly to the long term trends which had been in effect prior to the events.

We find sound logic underlying this expectation as all the forces which a nation or the world have available usually fall into place to repair whatever damage has occurred and we expect that will happen in Japans case as well. First, we would expect all humanitarian efforts to save the injured, tend for the displaced and locate and bury the dead will take place. Then, rebuilding of the infrastructure will move forward and finally, industrialization will be restored, followed by a tidal wave of job-creating projects to build new residences and other facilities for those who have been rendered homeless.

That has been the pattern of the past and we can see no reason why it will not be true for Japans current difficulties as well.

In fact, two of our most important charts already illustrate this corrective effect.

Please note that the April Crude Oil contract plunged swiftly from $107 to $96 in the period immediately following the events. However, investors have clearly rushed back in to restore positions and Crude had to over $103 per barrel by early this morning.

The April Gold contract has behaved in a similar manner. In the period immediately following the quake, fears grew that the Japanese economy would contract sharply, perhaps taking down the level of economic activity in other countries as well, leading to diminished commodity price inflation. As a result, gold quickly plunged from near $1,440 to the $1,380 area but then, just as with oil, buyers came in, prices rose and by this morning had reached $1,425 barely $20 from golds historic high.

One of the oldest market adages of all goes something like, The trend is your friend. These charts appear to confirm our opinion that the long term trends in gold, silver, oil and other commodities remains bullish and we would continue to maintain our investment and insurance positions in the precious metals.

We would also offer the opinion that the enormous money creation already announced by Japan to the tune of trillions of Yen will eventually add to the destruction of fiat currency values and increase the long term attractiveness of metals positions.

We wrote recently about the concept of unintended consequences as that idea applies to legislative actions. By coincidence, a thought-provoking editorial commentary based on that same idea appeared in this mornings Wall Street Journal. The article dealt with civil service unions and noted that since early in the 20th Century, ...Progressives championed a rule-based approach to public-sector management...Today, however, the very rules that once enhanced accountability, transparency and efficiency now stifle the creativity of public-sector workers and reduce the ability of public investments to create opportunities for citizens outcomes precisely the opposite of those intended by Progressive Era reformers.

It is our opinion that the battle of general society against civil service unions, over-regulation and the immense power of government bureaucracies is barely underway and ultimately will produce uncertainties and even fear as it progresses. Wisconsin is only the opening salvo of what we believe will be a protracted and brutal struggle.

As of 9:45 AM PDT, metals markets are moving higher with gold trading near $1,420 and silver once again above $35.00 per ounce. Base metals are close to unchanged on balance while mining share indexes are recovering recent lost ground and are ahead by about 2% so far today.

Financial markets are gaining in both Canada and the USA with the TSX Index and the Dow Industrials up by about 95 and 115 points respectively.

In other markets, Crude oil is now close to unchanged on the day, long term interest rates are slightly higher and the US Dollar Index has now fallen down to close to 76, the lowest level in several months.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Monday, March 21, 2011.

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