A Melman Minute — April 29, 2011

We were studying the long term (25-year) chart of gold recently when several observations seemed to pop right off the screen.

First, the staying power of this bull market has been remarkable. As can be observed, the original bottoming formation was put in during the period 1998-2002 when gold traded between $250 and $300 for the majority of those four years. According to several charting textbooks, that kind of lengthy base can support a genuine, long-term bull market.

However, it is the action between 2007 and the present that we find most intriguing. As the financial crisis began to unfold in a serious manner, gold suffered through its worst correction of the entire bull market, from $1,030 to $680, as deflationary fears began to run rampant. However, starting in late 2008, gold began a strong, almost continuous advance, which has seen the yellow metal gain more than $750 per ounce in less than three years.

In our interpretation, the strength of this rally has been built upon rising expectations that the underlying economy was transitioning from deflationary to inflationary expectations, and this would help explain another anomaly, namely that the rally in gold over the past two years has been accompanied, almost step by step since early 2009, by a similarly relentless rally in financial securities, as indicated by the three-year chart in the Dow Jones Industrial Average.

As noted in previous Melman Minutes, financial and precious metals markets normally move in opposite directions, since financial markets have historically prospered during periods of business expansion combined with stable prosperity while precious metals markets usually move strongly higher during periods of troubles and fears. By this reasoning, the period from March 2009 onward has been atypical and we would expect a resolution of this anomaly, perhaps a truly dramatic resolution, to take place. This could be accomplished by gold falling back in relation to the Dow if business conditions improve dramatically or by the Dow falling back in relation to gold if conditions worsen.

One of our measures to identify such relative movements is the Gold/Dow ratio. Historically, that ratio has spanned wide distances such as in 2000 when the Dow exceeded 12,000 while gold languished near $260 for a ratio above forty-five to one all the way down to one-to-one when both gold and the Dow stood close to 850 in January, 1980.

As of this time period, the Dow stands near 12,800 while gold is trading just under $1,450 for a ratio of 8.8 to one we plan to monitor that figure closely and report to our readers on a regular basis.

SILVER

When we look at the 25-year chart of silver, one important difference between the white and yellow metals becomes apparent. While the gold chart takes on the appearance of a gradually accelerating bull run, the silver chart now indeed has taken on an appearance somewhat like a vertical blow-off and we believe this conclusion has prompted several analysts to write that they expect at least a sizeable correction in silvers price. Given that many of our readers and sponsoring companies are deeply involved with silver, it is worth taking note of comments that silver is indeed vulnerable to a sizeable correction.

One of the more prominent analysts who are now calling for such a break is, somewhat ironically, named Howard Gold. Mr. Gold has been reporting on the precious metals for some time now and he has just authored a report, published on the Yahoo.Finance site entitled, Silver Fever is About to Break and Break Badly.

His primary short-term theme is that silver has moved into a mania phase, noting, ...Since then (last summer) it has rocketed more than 150% and has soared 50% in 2011 alone...In recent weeks, silver fever has reached, well, fever pitch. He also points to a sharp increase in trading volume for silver commodity contracts as yet another sign that the public is pouring in, another indication that shows, ...just how zany things have gotten.

As far as specific predictions are concerned, Gold points to another analyst, Eric Roseman of Montreal, stating ...silver will be a good buy again after falling to $30 an ounce in coming months... Golds final comment is that ...silver may keep rising for a few days or weeks, but then it will come crashing down quicker than you can unwind a call option...

With respect, we at The Melman Report humbly disagree and would point toward a historic difference between silvers performance in this precious metals market compared to previous circumstances.

The great difference we believe relates to the entire economic background which is strikingly different from that which took place in early 1980. In the former case, inflation was roaring ahead, interest rates were skyrocketing and a clearly identified attempt was being made to corner the entire silver market. Today, none of those circumstances is true.

Inflation is not roaring ahead, but appears to be in the early stages of a forthcoming acceleration. Interest rates, both short-term and long-term, are at historically low levels. Finally, there is no evident effort to corner the silver market as took place previously.

Due to these differences, it is our opinion that gold and silver may, in fact, still be in the building stages of a future move to much higher levels as inflation heats up and interest rates begin a sustained rise to perhaps some frightening level which could disrupt economic activity.

We would also point out that much of silvers move could be due to concentrated buying by people who are fearful of economic trauma but who cannot afford the price of gold in dollar terms and who are therefore turning to the lower-priced white metals.

While some corrections are always possible, at this time we do not agree with either the nature or scope of the kind of correction Mr. Gold and his associates are indicating.

We shall see.

As of 10:00 AM PDT, gold continues to set historic highs, having touched the $1,550 mark just a few minutes ago, while silver is trading more quietly near $48.40. Base metals are trading little changed on balance while mining share indexes are moving higher, but only moderately so despite the major move in gold. Financial markets in both Canada and the USA are mixed with the TSX Index down slightly while the Dow Industrial Average has gained 63 points.

In other markets, crude oil is trading quietly near $113 per barrel, the US Dollar Index continues to decline, just having reached the 73 level, and long term interest rates are moving slightly to the downside.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Monday, May 2 Canadas Election Day.

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