A Melman Minute — July 27, 2011

Quite recently, we wrote about the seeming non-conformity of gold and the US Dollar rising in tandem, rather than moving in the opposite direction as had been the normal case for most of the past several decades. As readers might recall, we offered the explanation that both gold and the Greenback were benefitting from the monetary turmoil in Europe and each may well have been the beneficiary of funds seeking a safe haven. We also added the caveat that:

...when the U.S. financial background weakens dramatically, which we continue to believe is a high likelihood, then the inflow will cease and eventually reverse itself. It is our belief that when that trend takes hold, a truly powerful bull move in gold relative to the Greenback will take place.

Frankly, we had expected that this counter-move to restore the normal alignment between the Greenback and gold might take up to several months to arrive, but matters appear now to be moving much more swiftly. Since that quote was published on July 11, barely two weeks ago, the following has taken place:

The Dollar Index has fallen steeply from just above 76 to an early morning low today near 73.6, a sharp drop of well over 3% in just two weeks.

At the same time, gold has soared from about $1,540 to just under $1,630 at its peak early today.

Our most likely explanation is that the monetary markets are beginning to distrust the American Congress regarding its ability to solve the growing financial crises in America including both the current Debt Limitation deadline of August 2 as well as the longer-term imbalances between spending and revenue which are causing the US national debt to explode upward at the rate of a trillion dollars per year or more.

There is another chart which illustrates the growing lack of confidence in the Greenback and that is the once-powerful Swiss Franc. Old-timers might easily recall the days of the 1978-81 financial crisis in America when interest rates were nearing a destructive 20% while the rate of visible inflation was approaching the same figure. Faith in the US Dollar was collapsing and the alternative currency of choice was the Swissie - or Swiss Franc - which rallied strongly in that time frame.

With the creation of the Eurocurrency about one decade ago, that unit became the alternative currency to the US Dollar, but with the recent collapse of confidence in the entire European economic structure, we have noted a sudden resurgence in Swiss Franc investments as monetary hedgers are now re-discovering Switzerland as a historic haven.

When the current budgetary fiascos are added to the inability to hammer out a rational Debt Limit extension and those are combined with the open threat of a first-ever reduction in Americas AAA rating for government debt, it may indeed be the case that we are witnessing an unprecedented move toward reducing the Greenback to the status of just another currency and away from its present role as the worlds reserve currency.

Should that change develop legs, it is our opinion that the impact on the world of precious metals could become immensely positive.

In the meantime, the Debt Limitation debate clock continues to tick down toward the highly-publicized deadline of August 2 and, even at this late date, no resolution is in sight. The Democrats under President Obama continue to strongly oppose any severe governmental cutbacks while the Republicans, presumably led by House Speaker Boehner, are just as vehemently opposed to the tax increases demanded by the Democrats. And so, days pass by, the world becomes more anxious, and financial markets are beginning to show signs of strain.

At The Melman Report, we believe there are other much more powerful, much more potent factors underlying the entire debate, factors which have so far been kept hidden out of sight as much as possible.

The first is a gradual deterioration in the status of the US Dollar from its historic stature of a currency of gold which had absolutely unassailable value over time. Its role became so reputable that two sayings prevailed for decade after decade. In one case, we knew that the US Dollar was as good as gold and, in the other case, if something was to be described in the most positive terms, it could be said to be as sound as a dollar.

When have you heard either expression of late?

The second problem is even more severe in our opinion and actually raises the question of whether the entire structure of the debt-ridden American economy is savable. We are referring to the fact that over the past eight decades or more, the expansion of government into the social and economic lives of the nation has been virtually absolute. Even worse, this expansion has obliterated virtually every alternative, meaning that if government was ever removed from any important function, there is no other body ready to step in and take its place.

We believe, therefore, that there is no clear answer to the problem of just how the enormous functions and costs of government are ever to be reduced without collapsing important segments of American life, but at the same time, it is abundantly clear that the American economy simply cannot collect sufficient taxation revenues to finance the present costs of government programs.

It is our opinion that this irresolvable situation is what truly lies at the heart of the rating agencies recent threats to downgrade American debt, not just the inability of Congress to promptly resolve the crisis-of-the-moment. The situation appears to be much more dangerous down the road that just the Debt Limitation question.

As if to emphasize the magnitude of the difficulties facing the American, and therefore the worlds economic structure, is the question of whether that nations economy is already headed into a period of difficulty and any cutting back of government largesse could immediately exacerbate such problems.

In short order, we have just received news that Home Sales prices continue to decline; Durable Goods Orders an important measure of future economic activity are once again falling sharply; and profits of major auto manufacturers are again slowing down and perhaps even reverting back into losses.

Many problems abound while believable solutions are notable only by their scarcity. However, while that may spell potential trouble for society, we believe that it simultaneously opens the doors for profits in our world of precious and base metals mining.

As of 9:00 AM PDT, precious metals are retreating somewhat from powerful openings. Gold traded to just under $1,630 overnight before retreating to about $1,618 while silver rose to well over $41 per ounce before falling back slightly. Base metals are evenly balanced with copper and lead slightly lower while nickel and zinc are trading a bit higher. What is very surprising is the fact that with gold and silver both achieving new historic or multi-month highs and the base metals trading quietly, mining share indexes are trading sharply to the downside (see below).

Financial markets in both Canada and the USA are continuing their recent declines with the Dow Industrials off by another 125 points while the TSX Index is down by a steeper 150+. In other markets, crude oil is down by about $1.25 per barrel, long term interest rates are slightly higher and the US Dollar Index is rallying following recent declines.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Friday, July 29, 2011

We also cannot help but note the relatively weak performance of mining shares in general, despite robust-appearing metals markets. We plan to address this question at length in a special Melmania report to be published on this site in the near future.

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