A Melman Minute — August 5, 2011

When we went to sleep last night, it was impossible to avoid wondering what the markets might deliver this morning. After all, Thursdays trading results included the TSX Index down by over 430 points, the Dow Industrials off by more than 500, the S&P 500 Index down by more than 60, NASDQ down by a whopping 136. In addition, all major European exchanges suffered through heavy selling and we must also note that all mining share indexes got clobbered as well, specifically including the mining-sensitive Toronto-Venture exchange which suffered through one of its biggest percentage losses in history.

In other markets, crude oil fell by a huge six dollars per barrel and much of the worlds wealth poured into United States Treasury 10-year and 30-year bonds with those quotes soaring and yields dropping like a stone.

One of the features of yesterdays dramatic selling was that it appeared to indicate a growing concern regarding the worlds productive economies as commodity items took particularly serious hits. Included among those falling prices was that of ultra-important Dr. Copper, the most important of the base metals and a widely-followed indicator of general economic strength. Judging by that metals performance over the past several sessions, major question marks are beginning to form regarding general economic strength.

We also cannot help but note the similarity of action in the Bank Stock Index chart between early to mid 2007 when that average gently rolled over prior to the massive declines which followed and the past several months when the same rolling over action appears to be taking place. The average has now fallen to the 42 level, matching the readings of mid-2009, which means the bank shares have given back virtually all their improvement over the past two years hardly an affirmation that good times and prosperity are likely to develop in the coming months and years.

While I hardly welcome the inevitable advance toward what is euphemistically called old age, there are advantages to having experienced various monetary crises first-hand through the years. One of those learning lessons occurred during the mid to late 1970s when the dollar was collapsing and gold was building momentum toward its great explosion toward the $900 mark in early 1980. It was during that time period that we got used to hearing the term central bank gold sales as it became commonplace for various central banking agencies to sell from their gold hoard in order to improve the balance books of their home nations or agencies.

Those sales became habit forming and, for the most part, the next quarter-century was highlighted by various sales announcements until it was taken for granted that it was a one-way street. In other words, central banks and central financial agencies such as the International Monetary Fund (IMF) were presumed to be steady sellers of gold.

That concept just received a shocking jolt with the revelation that many central banks around the world have reconsidered the entire concept. Several have quite suddenly changed direction and have now becoming net buyers of gold, thereby replacing some of their unbacked fiat paper holdings with monetary reserves dedicated to the yellow metal.

According to a study published in London and released around the world by Reuters news agency, ...Central banks of emerging market countries such as Korea and Thailand have added more than $10 billion of gold to their reserves this year in a sign of waning faith in the Wests benchmark bonds and currencies like the (US) dollar and the Euro. (Our emphasis)

Those two countries are hardly the only nations making such moves as the article lists a host of others including Russia, Mexico, Kazakhstan, Greece (!), Ukraine and Tajikistan as well as China and India which have both taken part on the buy side of recent gold auctions. The total amount of such purchases this year has led to increases in central bank holdings of 200,000 metric tonnes (each tonne is about 67,000 ounces), compared to last years total increase of 76,000 tonnes.

In a separate commentary, the Wall Street Journal noted, ...The demand marks a major shift in central banks thinking about gold. Increasingly, they see bullion as a protection against risks posed by declining paper currencies and global economic upheaval... (Our emphasis)

The concept of buying gold as protection against deteriorating fiat currencies is very real in todays world as most countries do not want strong currencies! Whenever their currencies move strongly higher, they usually take action to bring down the value of their own money. Two primary recent cases are excellent examples. We are referring to both Japan and Switzerland, as the Yen and Swissie rose strongly of late, but were brought down during the past few days by heavy selling initiated by their own central banks.

As long as nations continue this race to the bottom as it has been termed, we believe the influence on gold will be positive over time, particularly as it encourages nations to invest part of their wealth by being buyers of gold on the international scene.

FRANKLY, I PERSONALLY CONSIDER THE FOLLOWING INFORMATION TO BE OF UTMOST IMPORTANCE WHEN IT COMES TO UNDERSTANDING JUST HOW CRITICAL THE WORLDS FINANCIAL SITUATION HAS BECOME.

1 The Bank of New York Mellon Corporation just announced this morning that they would begin charging a fee against those depositors who leave large amounts of cash on deposit in their bank. The net effect of this fee will be that such depositors will actually receive less money back when they redeem their funds than they have turned into the bank!

2 According to Barrons Market Data, the yield on US Government one-month bills has now fallen to, get this, NEGATIVE 0.02%!!! If that wasnt enough to consider, the Fed itself has lowered its target range for short term interest rates to 0.00 - -0.25%.

These events are unprecedented and, in our opinion at The Melman Report, reflect a situation where the important money managers of the world are so concerned about the safety of conventional financial investments that they are willing to accept negative interest in return for the presumed safety of US government or major banking institutions short term debt paper.

As of 9:30 AM PDT, financial markets have been swinging back and forth as they attempt to find a realistic value following yesterdays debacles. The Dow Industrials have varied from +170 points following the announcement of Julys jobs report which showed an increase of slightly over 100,000 jobs to -240 at its lowest point and at present, it is hovering near +50. Canadas TSX Index, reflecting the debacle in commodity values, has plunged by more than 400 points this morning, equaling yesterdays decline. Precious metals are somewhat lower with gold trading near $1,650 while silver is also weaker, trading just below $39.00 per ounce. All base metals including copper, nickel, aluminum, lead and zinc have fallen by 3-6% and mining share indexes are once again being hit hard.

In other markets, crude oil is down once again, this time to below $85.00 per barrel, long term interest rates have steadied and the U.S. Dollar is turning toward the downside.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Monday, August 8 after we spend the weekend attempting to digest the mountains of reports and articles which have accumulated during the past few days.

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