A Melman Minute — September 26, 2011

It always amazes us just how quickly market sentiment can change, both negatively and positively and, in the case of last week’s volatile markets, it took only one word from the Fed to send markets reeling around the world. That word was “significant” as in ‘significant problems for the American economy’.

Based on that one word, financial markets plunged in anticipation of a slowing economy, base metals markets – and many other commodities – plunged in anticipation of slowing demand, the US Dollar soared as panic spread, many interest rates reached their lowest levels in history and all the precious metals went into steep decline, to put things mildly.

The Fed statement was hardly the only negative factor weighing on mass market psychology, but it was a sufficient trigger event to bring about major market moves. Other serious problems which markets were forced to content included the European debt crisis; possible slowing economic growth in China; USA political paralysis as yet another government shutdown crisis loomed; warnings from the IMF chief, Christine Lagarde, that “The world was entering a dangerous phase”; Greece falling into an unanswerable financial abyss; economic growth forecasts being reduced around the world, all combined with a growing belief that the Fed has run out of effective (if it ever truly was) ammunition.

Results of this unique assembly of events included the worst week in the general securities markets since 2008 and, from the particular point of view of this newsletter, dramatic declines in gold, silver, platinum, palladium and copper – just to mention a few. Not surprisingly, mining share indexes also declined sharply, although at times they did not decline quite as severely as the metals themselves.

Let’s look at three very illustrative charts:

Please note the most recent week on the chart which shows a high above 11,400 and a low down to below 10,500. Virtually all of this decline took place within 48 hours of the Fed marking their “significant problems’ comment. The Dow Industrials now stands near the bottom of their recent trading range and it will bear close watching to see whether the average falls into a new and lower range or whether it gains temporary strength and moves back up toward the mid 11,500 area.

The chart of copper clearly shows a breakdown from the topping formation which saw “Dr. Copper” rally into the $4.60s. In fact, the chart now shows similarities to the deep declines which occurred throughout 2008 and which saw copper decline into the $1.25 area before embarking on powerful rallies throughout 2009 and 210. We believe that copper’s recent declines reflect a fundamental weakening of demand, perhaps brought about by lowering worldwide economic expectations as noted earlier with particular emphasis on questions regarding China’s future rate of economic advancement.

The chart of gold is of particular interest, not just because the yellow metals are the focus of much of our analytical work. The most important question relates to the long-term perspective of gold’s performance, which is why we chose the 25 year chart of gold for this morning.

Please note the prolonged period of relatively quiet trading and the gradual breakout from that quiet era which began in the very early part of the new century. Gold gradually rose to the $770 area before encountering its first serious decline which began in April 2006, one which saw gold fall back to about $560 before ultimately breaking to a new high by September 2007.

The next serious break in gold was the sharp decline which began in March 2008 and which saw gold fall from a relative high of $1,030 to near $660 before resuming its upward journey and rallying to new record levels in September 2009 a journey which saw two consecutive peaks in July and August 2011 just above the $1,900 level, before encountering the most recent round of serious selling.

There is clearly no question at all regarding the short term trend which we believe now to be negative and perhaps the intermediate term can be called into question. However, at least for the present, we believe nothing has occurred to suggest tan end to the long term bullish trend for gold.

As far as a target area where gold might encounter support is concerned, we would note that the 2006 decline fell 28% from peak to trough while the 2008 selling wave declined by 35%. Using 32% as an average and a peak number of $1,920, we can project a possible general bottom of about $1,320 as an area where gold might expect strong support. Of course, there is no guarantee gold will continue to fall and robust buying this morning, which saw gold rally from about $1,520 to over $1,600 is a sign that gold buyers are still active – and it is also true that there is no guarantee that gold will not ultimately crash through to low levels which will indeed signal a reversal of the entire bull market – but we do not believe this will take place.

There is one last comment to offer and it relates to our Melman Minute several weeks ago when we discussed a vision of the world’s economies which compared market activity and psychology to the impact of the giant tsunamis of late 2004. In that commentary, we compared the relief felt by what appeared to be a much-less-than-expected impact of an early wave to the relief felt around the world when the economies did not collapse en masse in 2009 as had been expected.

Our point was that just as the first moderate waves of 2004 were followed by the massive inundations which took 240,000 lives, we believe it is quite possible that a much greater economic tidal wave could be waiting just out of sight beyond the horizon. One of the clues of the greater tsunamis was water withdrawing back into the ocean, exposing areas of sand which would normally be covered by water, when such exposure was followed almost immediately by the mammoth waves.

In a similar vein, we cannot help but note that interest rates at every interval from one-day through ten years has now pulled back to the lowest levels in history – and we cannot wonder if that ‘rate exposure’ is a preliminary to the profoundly negative economic event that we truly believe is somewhere ‘out there’.

All we suggest is that a high degree of caution in investments might be a worthwhile strategy until the situation clarifies itself.

Markets are mixed this morning as of 9:45 AM PDT with financial markets rallying on yet another European rescue program with the Dow Industrials presently ahead by about 100 points and Canada’s TSX Index ahead by around 40. Precious metals are trading near ‘round numbers’ with gold near $1,600 and silver close to $30.00. Base metals have stabilized somewhat this morning, but copper, nickel, zinc and lead still show large losses over the last few trading sessions while mining share averages are close to unchanged so far today.

In other markets, crude oil is trading near $79 per barrel, interest rates are advancing slightly after their recent declines and the US Dollar is giving back a bit of its recent strength.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Friday, September 30, 2011

← All A Melman Minute