A Melman Minute — March 23, 2011

Perhaps the most difficult task of all for the objective analyst is to separate those influences which are short term and shift with day to day emotions and those which are of longer duration and therefore can be acted upon with a higher degree of assurance. Within that overall concept, it is worth determining if price changes in the marketplace are merely commonplace fluctuations or are consistent with powerful and long-lasting trading forces. Charts can indeed be of some assistance in these evaluations.

For example, please note the above chart of Regular Gasoline for the past five years. Despite all the negative predictions, gasoline prices have been on a generally rising trend for the past two years and appear to be headed even higher, perhaps approaching the previous chart peak area of near $3.55 per gallon, an era when gasoline pump prices rose to well above $4.00 per gallon and caused so much consternation. Recent web site filings are telling us that pump prices are now approaching that same $4.00 per gallon zone in several American states and in Canada, pump prices have surpassed C$5.00 per US gallon equivalent in most provinces.

The trend-following concept is even more evident in the price of gold, which is once again surging toward the highest (non-inflation-adjusted) prices ever recorded, rallying to just over the $1,440 mark in early trading this AM. It is worth noting on the five-year chart of gold that not only has the price of gold been able to overcome every sell-off attempt, but the magnitude of those attempts has been diminishing over time, from the major set-back from $1,030 to $670 during most of 2008 to the much lesser decline from $1,430 in late 2010 to the relative low near $1,300 in early 2011.

As noted previously, one of market lores oldest adages is the trend is your friend and both gasoline and gold seem to be confirming that message at present.

By the way, there would appear to be an evident contradiction between the two trends. After all, gasolines powerful rally would seem to be saying that economic activity is growing, demand is rising and upward price pressures are intact, while golds message would, in a contrary manner, seem to be informing us that deep difficulties remain for the world to resolve.

One of those areas of difficulty would appear to be a repeating pattern which has indicated trouble for the European Economic Community in the cases of both Greece and Ireland, both nations eventually requiring massive rescue packages at the EECs expense. In each case, prior to the activation of the rescue deals, both of those nations spent months assuring the world that they had the situation well under control, no outside help would be required and, by the way, please, keep buying our bonds at low interest rates.

That pattern has once again repeated itself in Portugal as the world was first assured that all was well; then that Portugal could handle what appeared to be serious problems, but now the financial condition of the country is unravelling quickly and, once again, a rescue program is being considered.

The proximate cause of Portugals current dilemma is the reality that they face payment of over $6 billion in principal and interest next month, but they dont have the money and there is no evident way to raise it before default stares them in the face. Portugals debt already carries a high risk premium which has driven their five-year bond rate to over eight percent; their nation is incurring a horrendous current budgetary deficit; and they are bleeding new debt rather than repaying old ones.

The countrys Prime Minister, Jose Socrates, has offered a new austerity program to the legislature, but it appears likely to go down to defeat as being too severe and new elections will probably be called for within eight weeks, meaning harsh austerity measures are unlikely to be enacted, but without them, we believe theres not a hope in hell Portugal can pay its debts. It is amazing to us how matters have unfolded in Portugal in a manner eerily similar to Ireland.

Could Spain and Italy be far behind?

All is not well in two of the worlds largest economies as well, as stories out of both the U.K. and America would indicate.

In Her Majestys realm, the Bank of England is growing increasingly concerned with rising inflation which that body now believes could reach a 5% annualized rate in coming months. With short term rates presently near 0.5%, should inflation reach those levels, it is probable that many investors will cease buying British government debt paper unless interest rates rise at least to a level where they would compensate for loss of purchasing power over time. However, should short term rates rise to five percent or higher, all economic growth strategies could be tossed out the window.

Of even greater concern is the reality that interest rates may be forced higher at exactly the same time the U.K. is reporting weakness on several fronts, specifically including retail trade where Britains major food shopping center chain just reported declining year-over-year same-store sales. Justin King, Sainsburys CEO, found it hard to be optimistic, telling the U.K. Telegraph, ...We expect the consumer environment to remain tough, with our customers facing fuel price inflation, uncertain employment prospects and government spending cuts.

Serious problems continue in America as well, problems which appear capable of negatively affecting that countrys investor psyche. Their housing market fell deeper into the tank last month with reported sales of existing homes falling by a huge 9.6% in February and home prices are continuing their decline, now having fallen back to 2002 levels meaning virtually all home equity which was built up during housings halcyon days has now vanished.

Yet another problem suddenly lurks on the horizon for many cash-strapped states and municipalities. Many public servants (to use the term loosely!) are taking a look at the increasingly hostile public relations environment, particularly as it relates to massive pensions, and are opting for a strategy of retire now while the retiring is still good and retirement applications from state and local employees are soaring, presenting huge problems for those bodies, as they can ill afford to take on massive new retirement expenditures while being required to bring on many new-hires at the same time.

Despite assurances to the contrary, it is apparent that all the Keynesian solutions to the worlds problems are not working. In fact, we would offer the comment that major problems are now accelerating and will soon burst out in the form of attention-gathering festering sores, a process we believe will propel gold and silver to new record highs. At least, thats the way we see things.

Speaking of new record highs, gold is once again flirting with such an accomplishment, now trading close to $1,440 as of 9:45 AM PDT, with silver also rising sharply, once again trading near $37.00 per ounce. Base metals are particularly strong today and mining shares, not surprisingly, are moving higher as well.

Financial markets opened slightly weaker, but are now on the plus side with the Dow Industrials up by about 20 points and the TSX has gained close to 40.

In other markets, long term interest rates are little changed, the petroleum complex pas posted major gains and the US Dollar is a little stronger in currency markets. As noted, the petroleum complex is gaining strongly so far today.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Friday, March 25, 2011

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