A Melman Minute — August 10, 2011

One of the most interesting divergences we have noticed of late is the enormous difference in the performance of gold compared to the other ‘semi-monetary’ metals such as silver, platinum and palladium. While gold has been moving powerfully from one record high to another – it rallied to just above $1,780 this morning – the other three have been mired in patterns of mediocre performance as their price charts trace out sideways patterns.

The differing performance levels have been startling. While gold has powered through $1,500, $1,600, $1,700 and is now approaching $1,800 silver has traded quietly just under the $40 level; platinum has moved sideways in the middle $1,700’s (now trading UNDER the price of gold for the first time in years) and palladium has struggled to gain any ground, trading in a relatively narrow range near $750 per ounce.

Our interpretation is that there is a growing, possibly calamitous currency debacle forming around us to which gold is positively responding, as might have been predicted, but the world’s economies are in the doldrums and may possibly have entered a renewed period of actual decline. Therefore, gold, as the primary monetary metal, is prospering, while the others, which have much more of an industrial commodity aspect to their prices, have been floundering at best.

Few charts illustrate the growing danger of a genuine economic slowdown as cotton. As can be observed, cotton was in a spectacular bull market not too many months ago, but in the recent past, the price of cotton has undergone a spectacular reversal, plunging rapidly to barely half its bull market high. Chart watchers cannot help but note that is has traced out an almost perfect “Head-and-shoulders top” formation in the process, with a clearly identifiable neckline which has been broken decisively to the downside.

Cotton has an enormous number of uses in clothing, bedding, industrial fabrics, etc. – and for the priced to have undergone as spectacular a reversal as the chart indicates is likely telling us something about falling demand on a significant scale.

Speaking of charts, there is another pattern we have observed which we believe has negative implications for the general financial markets, and, therefore, positive implications for gold, particularly now that it seems the ‘normal’ relationship between gold and financial markets has been re-established. We are referring to the trading volume pattern relative to price movement for the Dow Jones Industrial Average.

Please note that during the relatively long advance from the lows of March, 2009, trading volume remained mostly constant at a somewhat diminished level. Compare that to the surge of volume which has accompanied recent declines. Charting textbooks are consistent in the interpretation that volume either confirms a move or is a contra-indicator. In the case of the Dow’s sharp drop, we interpret the surge in volume coincident with the decline to be a confirming indicator of such declines.

One of the most distressing features of the prelude to the financial crisis of 2008-09 was the early collapse in the quotes of many banking establishments, particularly in the USA, but also in much of the industrialized world as well. Therefore, it is no small concern that we are now observing a somewhat similar collapse in the price quotes for major French banks, several of which have lost more than HALF their value in just a few months! This manner of decline is of even greater concern when it must be realized that investors are bailing out of these shares precisely at the same time that the European Central Bank is assuring the public that is it taking ‘decisive’ action to correct any problems. The chart of Credit Agricole is appended below, but we could also have used the charts of other major French banks such as Societe General or BNP Paribas to illustrate the same point.

It has never been the intent of “The Melman Report” to become involved in partisan politics, either in Canada or the USA, as we believe firmly that such matters are for individuals to decide for themselves. However, actions of the office of the President of the United States are of such vital consideration to overall economic sentiment that it sometimes deserves commentary – and this is one such time.

It is our opinion that in order to plan economic activity such as the construction of new plants or the hiring of additional employees, an industrial corporation must have confidence in the future. One factor in building such confidence is consistency of policy among political and economic leaders. It can be almost irrelevant what the specifics of such policies happen to be; what matters is that they be consistent – and consistency is what, in our opinion, we have NOT been seeing in statements issued from the Oval Office during the past months.

One statement tells us that government must regulate society and new laws are issued for the creation of a Consumer Financial Protection Agency, for example, with hundreds of pages of complex regulations. Almost immediately afterward, the President announces he is going to do everything possible to cut back on regulations! One day we learn that the new policy is to be one of austerity involving government cutbacks, but the next day we learn that the immediate focus is to be on job creation accomplished through government spending!

That is the case presently at hand. The White House has just presented a plan calling for improving the labor market by a combination of policies including a cut in payroll taxes for employers; a cut in employee payroll taxes; extended unemployment benefits and financing a new program of infrastructure improvements. What the White House, in our opinion, seems to be overlooking is that each of these measures would either reduce revenues or increase expenditures which seems to us to be a strange ‘recipe’ for attacking deficits.

There is also the academic question of whether, in fact, government can “create jobs” in the first place. Without going into text book specifics, two obvious questions can be posed.

First, if it is so easy to “create” jobs, why is America faced with an Unemployment Rate consistently near 9% or higher, despite the spending of trillions by government in order to ‘hypo’ the economy?

Second, if simply taking money from group ‘A’ and using those funds to employ group ‘B’ is a valid technique, that poses a simple question. How does the economy in general improve if the overall benefits to group ‘A’ are clearly offset by the reduction in economic activity imposed on group ‘B’? There is also the further point, in our opinion, that by removing funds from group ‘B’, you are taking that money out of the hands of those most capable of financing new plant construction, hiring of workers and so forth, and handing it over to the least productive segments of society.

Gold is telling America and the world that consistent economic policy based on sound financial history is needed – and that is not being served up at present.

As of 9:15 AM PDT, markets have once again entered a period of turmoil as financial markets have returned virtually all of yesterday’s late gains with the Dow Industrials currently off by about 350 points while the TSX Index, helped considerably by surging gold and petroleum prices, remains close to unchanged. Gold is clearly the star of the day, rising to just below the $1,800 mark before retreating to near $1,785 while silver, platinum and palladium are up slightly on balance. Base metals are trading in relatively narrow ranges and mining share indexes are moderately higher.

In other markets, crude is once again above $81.00 per barrel; the US$ is slightly stronger in currency markets and long term interest rates remain near multi-month lows.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Friday, August 12, 2011. Among other subjects, we plan to discuss the recent spate of positive recommendations for gold from sources who traditionally have hated the yellow metal.

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