A Melman Minute — April 18, 2011

Ever since the reunification of America following their Civil War a period of almost 150 years - one of the bed-rock financial concepts of this planet has been that debt secured by the government of the United States of America was the safest financial instrument on earth. Throughout that century-and-a-half, whenever investors sought the ultimate financial refuge from the vagaries and stupidities of life on Earth, they turned to US government debt instruments.

This morning, just prior to the opening of financial markets on Wall Street, that confidence received a jolt from the blue in the form of a statement from widely-respected financial rating service, Standard & Poors. In its most essential part it read:

Because the U.S. has, relative to its AAA peers, what we consider to be very large budget deficits and rising government indebtedness and the path to addressing these is not clear to us, WE HAVE REVISED OUR OUTLOOK ON THE LONG-TERM RATING TO NEGATIVE FROM STABLE. (our emphasis)

The effects of this statement were immediate and decidedly negative for the financial markets, but positive for gold. As of 6:00 AM PDT, the Dow Jones futures were trading about 70 points lower, but by 6:25, they were 175 points lowerand within the first half-hour of trading, the Dow Industrials were down by over 200 points. In the same time frame, gold leaped from near $1,477 in one rapid bound up to $1,498.80 within $1.20 of the important $1,500 barrier.

While securities market declines and rising gold might be normal expectations resulting from the S&P statement, there has been one unexpected development, namely a sharp rally in the U.S. Dollar. However, there is a credible explanation for that move in the form of a much more immediate crisis that is rapidly developing in both Portugal and, more particularly, in Greece.

Greece is no stranger to monetary problems and last summer, events culminated in a major economic rescue operation enacted by the European Union. The combination of staggering levels of indebtedness relative to their GDP, plus the effects of the Great Recession, caused Greece to edge toward a calamitous failure to pay principal and interest on their debt. Since a default by Greece would have the ripple effects of causing enormous bank losses combined with raising questions regarding the stability and viability of the entire European Economic Community, a major rescue in the form of massive borrowing to roll over Greek debt was arranged.

The world breathed a collective sigh of relief that the crisis had been averted something akin to Neville Chamberlain returning from Munich, clutching in his hands the peace in our time document signed by Adolph Hitler, while the world tottered on the verge of open warfare. The world looked at the Greek rescue and then went about its business, thinking that the crisis had been averted, but all that had taken place was new debt being piled upon old debt. As the Wall Street Journal just noted, ...The 110 billion Euro bailout conceived by the European authorities and the International Monetary Fund doesnt directly shrink that pile indeed, the bailout comprises simply more loans. The EU reckons that Greeces that Greeces government debt will rise to 375 billion Euros in 2013 from 298 billion Euros in 2009.

Unfortunately, borrowing massive sums to repay existing debt has turned out to be nothing more than a band-aid approach, and a remarkably ineffective one, as a new and even more ominous crisis is developing at this moment. Confidence in Greek debt has plunged, indicated by interest rates which have soared to almost twenty percent for Greek government two-year paper. Of course, such rates are having a crippling effect on that governments efforts to balance its books and the perceived level of peril is rising sharply.

In terms of the Eurocurrency, The Greek situation is compounded by a similar problem now becoming evident in Portugal where overnight interest rates are also soaring due to lack of confidence in that government, reaching the ten to eleven percent range, the highest for that nation during the entire Eurocurrency era.

As a result and despite the S&P statement, there has been a flight out of the Euro and an accompanying rush into the dollar this morning, as is clearly shown on charts for both, with the Euro falling sharply while the Dollar Index has made a strong move to the upside.

The short term trend for the Dollar Index has reversed to the upside on the five-day chart and, in a similar but opposite manner, the Euro chart has headed lower, also on a short-term basis.

This strengthening of the US Dollar has also been reflected in sharply falling prices for many tangible commodities from base metals to foodstuffs to softs such as cotton, since it now takes fewer dollars to buy a given quantity of various commodities than it did on Friday. In terms of mining, the effects have been particularly felt in the base metals such as nickel, copper, aluminum, lead and zinc all of which are down anywhere from 1.5 to 4%.

Given the fact that some portion of funds seeking safety are likely heading toward gold, it is not surprising that we are seeing gold make a strong upward move in the face of rising quotes for the Greenback.

Many mining investors are active in the uranium mining field and deep concerns have arisen following the massive earthquake/tsunami in Japan which inflicted serious damage to that nations Fukushima nuclear plants. More importantly for the industry, that damage and the widespread publicity which resulted has caused several nations to announce that they were either suspending or cancelling their plans to construct or expand nuclear power generating facilities. Another effect has been to suggest that any plants built in the future will be required to have more elaborate safety mechanisms and any suggested plants are likely to undergo much more extensive, expensive and time-consuming regulatory reviews.

As a result, the outlook for uranium demand into the future has been brought into question and there has been some significant selling in many uranium-related shares during the past few weeks

Therefore, we find it quite encouraging that at least one nation, the Czech Republic, announced over the weekend that it is putting out bids to build five new nuclear reactors at an estimated cost of $30 billion. Czech Prime Minister Petr Necas told Reuters that he could not imagine closing their nuclear power plants because, ...it would lead to economic problems on the border of an economic catastrophe.

Other countries such as Russia, Turkey and France have also issued statements to the effect that they are going ahead with their nuclear expansion plans.

The situation remains in flux and we will do our best to keep our readers current.

As of 9:45 AM PDT, financial markets continue to sell off with the Dow Industrials down by about 215 points and the TSX Index is lower by 125. Metals are mixed with gold holding on to much of its gain, trading near $1,495, but silver is down 15 cents to just under $43 per ounce while the base metals continue to decline sharply and mining share indexes are off by about 1.5%.

In other markets, the US Dollar Index is trading near its highs for the day, long term interest rates have moved down on the session and crude oil is off by over $2.00 per barrel.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Wednesday, April 20, 2011

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