A Melman Minute
By: Leonard Melman
So far this morning, as of about 9:00 AM PDT, the
one most notable feature of several markets has been the quick reversal. We have
seen gold drop to (all prices US$) near $876 before heading up to about $886,
silver is ahead by 45 cents after a weak opening, platinum has recovered from
its sharp early sell-off to return to near unchanged and the petroleum market
has recovered from down about $2.00 per barrel to a slight gain to just above
$126.
Financial markets, on the other hand, have moved from strength to strength with
the Dow now up over 80 points and the TSX up by over 150. No major news has
appeared to explain these strong rallies which have served to reverse, at least
temporarily, the weakness demonstrated late last week.
Two news events caught our eye this morning. First, additional information has
been provided which shows that the financial crisis is far from over.
Once-powerful mortgage insurance giant MBIA just reported their First Quarter
2008 earnings and they were, in a word, awful, as they showed a staggering loss
of $2.41 billion, reflecting continuing deterioration in the home mortgage
markets along with the effect of write-downs of corporate assets. Premiums
earned on new policies fell by almost half to $97.3 million from $171.3 million
in the year-earlier period and the value of its insured derivative holdings
plunged by a horrendous $3.58 billion.
In fact, the situation in MBIA has become so serious that the “Fitch” rating
agency just dropped the rating on MBIA from “AAA” to “AA”. The significance of
this move is that sellers of asset-backed packages which have been insured by
MBIA can no longer claim that they are insured by a “AAA” rated insurer, which
will serve to diminish the value of those new packages, which will then provide
yet another difficulty for the already-strained home mortgage industry to
overcome.
The other story, and one with perhaps even more serious potential consequences
for economic stability, is the report out of China that their domestic inflation
rate is now rising rapidly. According to an Associated Press report out of
Beijing, “China’s inflation rose in April to near decade-high levels…April’s
consumer prices rose 8.5% compared with the same month last year…That was up
from March’s 8.3% and just short of February’s 8.7%, the highest inflation in 12
years.”
That means China’s inflation rate has now exceeded 8% for three consecutive
months and can no longer be considered just a one-shot statistical aberration.
In fact, the article also informs us that Beijing is now becoming concerned
about avoiding price-driven unrest just prior to the all-important Summer
Olympics.
As is true for much of the world of late, one of the most dramatic areas of
price increases in China has been in their foods index as the cost of foodstuffs
in China has now risen by 22.1 percent year-over-year. The situation is
sufficiently threatening that the government is beginning to implement price
controls. Our own observation is that price controls seldom work and usually
lead to supply shortages as merchants withdraw supply when future sales become
unprofitable.
There are two other consequences of recent Chinese inflation which, in our
opinion, could severely impact the fight against inflation in America, Canada
and other Western nations. If the cost of Chinese goods escalates, that is bound
to show up as higher prices in domestic markets, thereby affecting the published
rates of inflation here at home. One of the controlling factors in domestic
inflation rates over the past two decades has been the importation of huge
quantities of low-priced goods. If those goods begin to rise sharply in price,
general cost-of-living indexes are bound to reflect that new reality.
Second, it appears likely to us that as China becomes less competitive in price,
the demand for their products could begin to diminish, and that would represent
a genuine threat to the continued rapid expansion of their manufacturing-based
economy, which, in turn, could put somewhat of a damper in the Chinese demand
for raw materials, particularly those provided by our precious and base metals
mining industries.
China’s global trade surplus is already beginning to show signs of contraction -
and that is a trend which bears close watching.
As long-term readers know, perhaps the two most important charts we follow are
the “TYX”, which reflects long-term interest rates, and the “DX” Index, which
reflects strength or weakness in the U.S. Dollar. Recent action in the TYX
appears to be of particular interest.
As can be seen, the TYX failed once again to break through to the upside above
the 4.70 level and has returned to the 4.40 to 4.50 zone, an area which has
considerable chart support. It is our opinion that the breakout from this
trading range will have considerable importance, perhaps even historic
importance. Our reasoning is based on the almost fanatical desire by the Fed to
drive interest rates lower and all its recent actions have been geared in
support of that policy. If rates rise in spite of such pervasive and dramatic
actions, we believe that would be an indication that the financial world was
beginning to lose confidence in the efficacy of Fed actions. We also believe
that a breakout to the upside in long rates would tell us that fear of rising
inflation was increasing.
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