A Melman Minute — August 15, 2011

One of the subjects dealt with in a recent Melman Minute was the concept of trading volume relating to the direction of a major market move. Unfortunately, at that time we had only a few minutes to deal with this difficult subject but market action is presently muted so far today, so we have a bit more time to explore the subject more thoroughly.

One of the reasons we consider it so important is that during the past few weeks, it is becoming apparent that the historic contra-relationship between general stock markets and gold markets seems to have been re-established. This relationship states that when general financial markets are rising, gold tends to decline and the opposite, that when general stock markets are in decline, gold tends to rise.

Therefore, if we can confidently establish the primary direction of financial markets, we can also obtain a very useful bit of information about the direction of gold and, perhaps to a lesser extent, silver, platinum and palladium as well – and one of the useful tools we use to determine that primary direction is the concept of overall trading volume in relation to actual market direction. With that in mind, please take a second look at the comparison of daily trading volume with direction of movement for the Dow Jones Industrial Average. For ease of interpretation, we are using a relatively short-term chart, that of three months’ trading. The chart is most illustrative.

During the period of mid-May through about July 20, both market moves and trading volume were indecisive, moving mostly sideways. There was some minor non-confirmation when the DJIA fell slightly during June and volume expanded modestly, but nothing of a dynamic nature took place. That all changed from July 20 forward.

During that time, the markets have made two decisive moves. First we note the rapidly accelerating DECLINE which saw DJIA plunge from about 12,700 to 10,600, almost without let-up. As the rate of DECINE increased, there was a commensurate and clearly identifiable INCREASE in trading volume – thereby CONFIRMING the downward direction of the Dow.

During the past five trading days, the Dow has INCREASED from a low of near 10,600 to almost 11,500 – a gain of close to 900 Dow points. During that same period of time, trading volume in Dow stocks DECLINED dramatically, thereby offering a non-confirmation of the upward Dow trend and reaffirming that the real direction of the market is to the downside.

In his well-known charting text, “How Charts Can Help You in the Stock Market”, author William Jiler had this to say about such confirmations and non-confirmations: “(when) volume subsides on the rallies and increases on the reactions, it may be a signal of a pending price reversal.” That appears to be our present case.

We will soon learn if this technique is valid for the present time frame. If it is, the suggestion of such action is that the present rally is invalid and selling in the Dow stocks will soon resume, driving the Average downward and, therefore by our prior assumption, driving precious metals higher.

Being a somewhat quiet day, we can turn our attention to topics which might be ignored when we have more vigorous market action taking place. One of those areas is the Republican contest for that party’s Presidential nomination which will be contested throughout the first half of 2012. It is already showing signs of becoming most interesting indeed.

First, we had the assumption that Mitt Romney was the front-runner and Sarah Palin might also take a position of importance in the race. Then came the entry of both Minnesota Senator Michelle Bachmann and former governor Tim Pawlenty with each one staking out territory on the ‘far right’ of the Republican Party. Most recently, we have seen the entry of the race by a candidate with a particularly wide following, Texas governor Rick Perry whose philosophical leanings are somewhat more to the ‘center’ and we have also failed to see the official entry of Palin.

All of this came to a boil so to speak, at the first polling event of the long election season, the Iowa State preferential straw poll held over the previous weekend. There were several surprises, most notably the weak showing of Pawlenty and his subsequent withdrawal from the race. Perry polled well, Romney did terribly (although he said he wasn’t really interested) and Bachmann won first place - but there was someone else deeply involved and therein lays a most interesting tale. While Bachmann did win, the second place finisher was Libertarian-leaning Representative Ron Paul, who was in a virtual dead-heat with Bachmann at the top of the polls, losing by the tiniest of margins.

What we have found most interesting at The Melman Report is the almost universal dismissal of Paul as a serious candidate. In its evaluation of the straw poll results, the Wall Street Journal dismissed Paul with this offhand comment: “Libertarian Ron Paul, who has no chance of winning the nomination, finished a close second.”

We believe there is an important concept underlying the nominally conservative Wall Street Journal’s dismissing the Paul candidacy so blatantly.

Paul has been crystal clear in his basic platform stands. He is against government spending money it does not have. He is opposed to intrusive and ultra-powerful central government. He is FOR a currency of gold. He is deeply suspicious of the activities of the Federal Reserve Board and is demanding a full audit of that organization. He is against involvement in foreign entanglements unless the security of the United States is directly threatened.

Strangely enough, these stands are similar to editorial positions the WSJ has taken through the years and it is undeniable that they resonate with huge numbers of conservative Republicans. Yet, the WSJ and other Republican leaning publications dismiss his candidacy as a meaningless exercise with no prospect of success and they refuse to provide Paul’s candidacy with anything near the attention it deserves.

Could the real truth be that Ron Paul represents the true solutions to America’s problems, but those solutions are a direct threat to the style of government which has become the norm in Washington for decade after decade, the politics of buying favours and using political influence to hand out money or regulatory advantages to favoured contributors and vilifying one’s opponents at the same time?

The relevance is simply this: if a powerful publication of the right is still supportive of the present political power structure, then what real hope is there for revolutionary and dynamic change toward smaller, less expensive and less intrusive government? And, if that is so, then can we not expect a continuation of the bloat and excessive spending that has created the mess in the first place, a mess which has required ballooning of the money supply and the creation of uncountable units of fiat currency?

These are ideas to think about and follow closely as this contest unfolds over the next year.

As of 10:15 AM PDT, financial markets seem determined to continue their recent advances with the Dow Industrials up by about 140 points and the TSX Index ahead by about 110. Gold has begun to surge, rising from an early morning low of $1,733 to near $1,755 while silver has advanced from near $38.75 to $39.30. Base metals are trading close to unchanged on average while mining share indexes are ahead by about 1.5%.

In other markets, the US$ has dropped sharply with the DX Index now under 74; crude oil is ahead by almost two dollars; and long-term interest rates have moved moderately higher.

All quotes US$ unless otherwise indicated.

There will be a slight change in our Melman Minute schedule this week as I will be traveling most of Wednesday, so will plan for Melman Minutes on Thursday and Friday.

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