A Melman Minute — March 21, 2011

Anyone who believes in the inherent logic of markets had better take a step back this morning. At one and the same time, financial markets are telling us that international actions to contain the Libyan situation are right by rising sharply, with the Dow Industrials and Canadas TSX Index sharply higher in early trading. On the other hand, gold and silver are rising once again and the only reason offered by leading media analysts is along the note of Gold Prices Gain on Rising Uncertainty, presumably brought about by the Libyan situation.

There is also the apparent contradiction that markets are moving forward on the basis of the Allies gathering strength to oppose Moammar Gaddafi in Libya, thereby adding to the prospects for peace in that troubled country, but at the same time, oil prices are headed sharply higher on those heightened interventions, raising the specter of rising inflation and driving long term interest rates higher instead of lower.

In our opinion, these opposing forces indicate that there are suddenly no over-riding forces-of-the-moment to drive markets.

In fact, in some ways, a market psychology similar to early 2007 appears to be growing. Readers may recall that for some time a Goldilocks feeling took over, that the markets were just right with proper growth, proper interest rates, proper improvements in technology and proper advances in the consumer-driven economy all combined with a general feeling that there were no problems sufficiently severe to drive economic growth into the tank. And so, financial markets in America, Canada and elsewhere soared to the highest levels ever recorded.

Unfortunately, the world soon learned that all was not truly well, the real estate market collapsed, taking with it the credit markets and the debacle of 2007-10 was under way.

Consider the similarities with today when it comes to a rose-colored outlook. Investors have been warned for some time that unlimited fiat money creation would lead to inflation, but rampant inflation has not yet appeared. They have been warned that the various governments rescue and stimulation plans would destroy the value of fiat currencies, but no such widespread destruction has yet occurred. They have been told that the European Economic Union was fragmenting and headed toward insolvency, but that has not taken place. They have been told that Chinese growth was unsustainable and would surely reverse into contraction, but that has not taken place either.

Recently, it appeared that several Arab and Middle East nations were on the verge of self-immolation and chaos would be the result, but, other than Gaddafis tragic assaults against rebels in Libya, such wide-spread destruction has not developed and that instance appears now to be on the wane.

And, most recently, Japan has had to cope with horrendous tragedy, specifically including dire threats to their entire nuclear power apparatus, but even under such circumstances, that most resilient nation seems to be moving toward coping with their severe difficulties and may even be starting the re-building process.

And so, the general feeling that problems have been exaggerated and solutions are continually achievable is growing, sustained by the remarkable improvement in securities markets over the past two years (see Dow Industrials chart) which have recovered the majority of losses sustained during the previous debacle.

It seems that each day we continue to see a parade of market experts on the TV networks in Canada and the USA who utter their optimistic projections and attempt to convince those who remain on the sidelines to aggressively take new positions to take advantage of the new reality.

At times like these, we at TMR believe it is an excellent time to take a step back and look at some good, hard facts which might temper some or all of that renewed bubbly feeling.

First, while it remains true that visible, official inflation numbers remain moderate, the impact of three years of government currency licentiousness is beginning to tell. We recently reviewed prices for some of the most common commodity items and were able to construct the following table:

There are many other items we might include such as food greases, commercial lubricants, base metals, grains and so forth but the observation is clear. Under the surface, the costs of manufacturing and distributing the worlds goods and services have been rising. Much of the increase has managed to remain invisible, but we do not believe such legerdemain can be long sustained.

Next, Americas Social Security system is headed toward bankruptcy under present laws. There is simply not enough money likely to pour into the system to sustain benefits at their current levels meaning either of two alternatives, neither of which is politically palatable. Either benefits must be reduced by raising the retirement age or reducing benefit payment checks - or taxation contributions must be increased.

While some Senators from both parties appear willing to discuss the issue in principle, not one has stood forward and declared they realized the implications of the onrushing reality and were prepared to deal with that reality. Most have been following the pattern of influential Democratic Senators Harry Reid of Nevada and Charles Schumer of New York, who refuse to even consider adding Social Security revisions to present discussions on deficit reduction as if the problem will simply go away if they ignore it long enough. We have news for them. It wont and, like many other important problems which are growing in severity, it will only get worse over time unless genuine corrective measures are adopted.

The facts are simple. The number of Social Security recipients is slated to grow significantly over the next few years under present law. The number of active workers entering the labor marketplace will not keep pace. All the political hot air in the world will not change those two realities.

The third fact of life which must be dealt with and quickly is the onrushing US government debt level. This past Friday it reached $14.233 trillion. The current authorized debt limit is $14.294 trillion or a difference of only $61billion and at the rate debt is presently being accumulated, that limit will be reached in about TEN DAYS. Positions are hardening on both sides with fiscal conservatives demanding that the authorized debt level remain constant while fiscal Liberals are demanding the authorized debt level be increased. It should be quite a show in the days ahead.

As of 9:30 AM PDT financial markets remain higher with both the Dow Industrials and the TSX Index up by over 180 points. Precious metals are strong as well with gold up by almost $20 to about $1,433 while silver has gained almost $1.00 and is above the $36 level once again. Base metals are little changed on balance while mining share indexes are about two percent to the upside.

In other markets, long term interest rates are moving higher, Crude oil is up by over $2.00 per barrel to nearly $103, and the US Dollar is showing renewed weakness with the Dollar Index once again under the 76 level.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Wednesday, March 23, 2011.

← All A Melman Minute