A Melman Minute — August 3, 2011

The gold market has clearly given its verdict on the recent United States Congress concept of a solution to the American debt crisis. We believe gold is saying, as succinctly as possible, ...This was the wrong action to take. You had a chance to make a real impact on indebtedness for generations to come but you opted instead for the easy path of business as close to usual as possible. For shame!

Since the moment President Obama made his dramatic Friday evening announcement that a settlement had been agreed upon, gold has moved solidly to the upside and in overnight trading Tuesday night, it reached yet another record high, this time trading up to the $1,675 level.

Some observers are becoming worried that gold is going through some kind of blow-off stage and are therefore calling for a major correction, but we would advise them to take a good look at golds five-year chart. They will see a remarkable example of a sustainable bull market, the latest phase of which is now almost three year old and which has moved in a consistent manner without either a major downward correction or a major upward blow-off and the recent rally keeps gold well within the channel which has held since late 2008.

A matter of particular interest to gold advocates is the sudden return to normalcy in the gold/Dow Industrials relationship. Since this monetary crisis reached a head, we have seen the securities markets and gold move in opposite directions, which is the historic norm and recent action in the Dow suggests that the securities markets are making a particularly severe breakout to the downside just as gold is making new historic highs.

Our conclusion is simple: both gold and the securities markets are voting thumbs down on the plan just approved by both Republicans and Democrats. It will be most interesting to see where we go from here.

Now that the US crisis has been resolved, at least for the moment anyway, there is an equally powerful and dangerous threat emerging for the worlds economic leaders to deal with. Both Italy and Spain may be in a period of simultaneous collapse; at least economically if not socially. Here at The Melman Report, we believe collapse is the exactly correct term to be using.

In point of fact, both countries may have passed the mythical point of no return in their governmental financial matters and the proof lies in what bond traders active in both Italys and Spains debt markets have been doing of late. Many of them have been bailing out of each nations debt paper like rats on a hot tin roof. As a result of this selling, brought about by fears that both countries can no longer properly service their mountains of debt, interest rates which both Italy and Spain are being forced to pay are rising steeply, which, of course, is exacerbating the very problem they are facing.

In simple terms, Italys bonds are being sold down so fast that the rate they must pay for ten-year paper has soared from barely 3.5% late last year to 6.217% as of Mondays bond market close and Spain is in an even worse situation with their ten-year rate now standing at 6.367%.

As existing debt is coming due for re-writing to say nothing of additional debt required to finance new deficits - the calculation of interest rates being offered on this new debt have staggering implications as old debt, perhaps carrying a rate of less than 3%, is being re-written at the current rates. The interest which must be paid by these already-strapped nations is more than doubling, which means they likely cannot repay those amounts. As traders recalculate Italy and Spains interest rate problems, they are selling more of those bonds which is driving rates even higher, which then is scaring more bond traders, which is causing them to sell more bonds, which is driving interest rates yet higher, etc. etc. in a downward spiral which has truly ominous implications.

Spains level of debt is higher than the combined debts of already-defaulted Portugal, Greece and Ireland and Italys debt is TRIPLE that of Spain. Therefore, any plan of rescuing the situation by providing even more borrowing power for Spain and Italy appears to be beyond the capacity of the European Community.

European stock markets are beginning to crumble with Italys Milan Exchange average off by about 25% during the past two months while Belgium is down by about 20%, France by about 17% and even Germany, with its highly-regarded economy, is off by nearly 10%.

The Times of London newspaper informed us this morning that, ...A crisis in confidence around the periphery of the Eurozone accelerated last night as alarm over the fiscal health of Italy prompted a scramble for safe havens beginning with gold, German bonds and the Swiss Franc. We find it very interesting that the Times put gold at the top of their list of havens.

The Times quoted James Nixon, chief European economist at Societe General banking house as stating, ...There is a feeling that Italys day of reckoning is coming it has lost competitiveness, its productivity is shot to pieces and it is an economy that really is going to struggle to grow. We would then ask just how a country in such a sad state is going to continue to service its debt, particularly when the interest rate it must pay has doubled in recent months.

In yet another article, they summarized matters for the entire European economy with this simple paragraph: The consequences are now obvious in the economies of southern Europe. Greece has a huge budget deficit. Portugal has high levels of private debt. Spain has both of these elements. Italy has a mountain of government debt amounting to some 120% of GDP...There is no good news in this. A debt crisis first crushed the western banking system. It is now devastating sovereign borrowers. Italys plight is one more facet under which the West is buckling.

Our only comment relating gold is this: It appears to be fulfilling its role as the negative thermometer of the worlds financial stability.

Meanwhile, in America, economic data continues to slant toward the negative. Recent reports now tell us that the American consumer has actually reduced his spending for the first time in 20 months, just when the economy needs a jolt of additional spending. Service firms such as hotels, restaurants, retailers and financial companies experienced the slowest growth in 17 months during July. New Factory Orders, a key indicator of future economic activity, fell by a large 0.8% during the month of June and we would remind readers that these new releases are coming on top of a stream of negative data received during the past several weeks.

We would suggest that if the American economy begins to seriously contract into a new recession or worse the likelihood of all the austerity measures now being bandied about ever actually taking place would appear to be minimal at best and non-existent at worst meaning full-scale ahead for the growth of government indebtedness and government monetary creation.

We would simply ask this question: With all of that going on, is it any wonder that the precious metals are moving ahead strongly?

As of 9:15 AM PDT, markets continue to reflect economic uncertainty as financial exchanges in Canada and the USA are losing more ground with the TSX Index off by 85 points and the Dow Industrials down by 125 points, bringing the latter average down more than 1,000 points from its recent high above 12,800. Precious metals continue to rally with gold now trading at $1,671; up by more than $20 today while silver is ahead by $2.00 this morning to the $41 level. Base metals are down across the board thanks to fears about a weakening economy and mining share indexes are up by one to two percent.

In other markets, crude oil continues to head lower and is now nearing the $90 per barrel mark, the US Dollar is slightly weaker in currency trading and long term interest rates are rebounding moderately following several days of steep decline.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Friday, August 5, 2011 when we plan to discuss an important new development, namely the accelerating rate of gold accumulation among several central banks.

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