A Melman Minute
By: Leonard Melman
Mid-Year summary and outlook (Part
One)
What a half-year this has been! We have seen the
securities market buckle and then head sharply lower. We have seen one form of
credit trauma after another. We have seen the Federal Reserve Board and other
central banks bang their heads against monetary walls, but with limited and
often futile results. We have seen unemployment soar, America's housing crisis
worsen, gold fall then begin to recover, and, by far most noticed, we have seen
the price of the entire petroleum complex leap toward the figurative
stratosphere. Perhaps most threatening of all, we have begun to see the first
glimmerings of true troubles in the most fundamental areas of all as the world
struggles to satisfy its hunger and slake its thirst for clean water.
And, in our opinion regarding the rest of this
pivotal year, we will turn to Al Jolson's most famous line, "You ain't seen
nothing yet!" For, in our opinion, what we are beginning to see is the true
beginning of the repudiation of Franklin Roosevelt's awesomely wrong 1933
decision to break America's official monetary ties to gold and silver.
The world is awash in artificially created currency,
the tidal waves relating to the movements of those oceans of liquidity are
edging out of control, and the consequences relating to inflation and financial
instability are beginning to become evident to the general public. We foresee
that by the end of 2008, with the American election over and a new incoming
President McCain or Obama ready to be inaugurated, the desperation of the
situation will become more evident to millions and events will begin to
deteriorate with a speed and power that will be startling.
And if that sounds like so much hyperbole, then so
be it, but it is what we believe.
But, as is usually the case, while damage is being
inflicted in some directions, tremendous opportunities will be advancing in
others and it is our goal to suggest where investors' attention might best be
directed.
We are not alone in arriving at such negative
conclusions looking forward. For example, Bloomberg News Service reports that
Ryan Atkinson of Balestra Capital Ltd. noted that we had entered a, "...secular
bear market that may last 10 to 15 years (our emphasis) as home prices fall,
consumers default and tighter credit slows economic growth...History shows we
have bull markets and bear markets and this is a bear market."
Goldman Sachs Group Inc. remains one of America's
most prestigious investment banking organizations and what they have to say
about the world's largest bank, CitiBank, is particularly ominous. As it added
the bank's parent company, Citigroup, to its "conviction sell" list, GSG stated
that, "...losses in the industry will be far worse than it originally
anticipated." (our emphasis)
One important bank that illustrates the
difficulties banks have been facing is Ohio-based Key Bank, situated deep in the
industrial heartland of America. The chart of KeyCorp, Key Bank's parent,
clearly reflects the depth of troubles that are afflicting both banking and the
manufacturing sectors. Fully three-quarters of the value of this huge company
has been erased in the past year and losses in stock-holders' equity have
amounted to almost $15 billion during the steep decline from the stock's peak at
$40 to its recent low at $10. all quotes US$).
The list of serious problems afflicting the world's
economies in general and America's giant economy in particular continues to grow
and one area has increasingly perilous implications. We are referring to the
growing difficulties being encountered by state and municipal governments as
their tax base is being eroded by both falling real estate values and rising
levels of unemployment while their expenditures continue to escalate.
Highest on that list is the giant state-nation of
California, whose economy ranks as the eighth largest in the world. As their
economic fundamentals have begun to deteriorate, their budgetary deficits have
been escalating sharply and the estimate for the current year amounts to $17
billion. Unfortunately, their only ready recourse to raise those funds is the
short-term money market and California's borrowing rate has increased by 85
basis points - or .85 of one percent - during the past year. The consequences
of that increase are shown by the realization that it now costs the state an
extra $8.5 million per year for every billion dollars it must borrow.
As California Treasurer, Democrat Bill Lockyer,
noted in a recent e-mail statement, "...every additional dollar we shell out to
Wall Street is a dollar we can't spend on educating our kids, providing health
care for our families and keeping our communities clean and safe."
Long term rates for new California-issued municipal
now exceed five percent, meaning the state must rely on volatile short-term
borrowing, leaving them increasingly vulnerable to rising general interest
rates. The dangers keep compounding as real estate sales fall, taxable values
fall, unemployment rises and infrastructure requirements continue to grow.
There are no easy answers to California's growing
list of difficulties. In fact, the situation is so perilous that Bloomberg New
Service reported that as a result of Governor Schwarzenegger declaring late last
year that California was in a state of 'fiscal emergency', "...California may
need letters of credit or other backing for its short-term loans.", and the cost
of obtaining those documents could add another full percent to the cost of
raising needed funds.
We also note two important areas of rising suspicion
and uncertainty which could have a great impact on future financial
developments. Those include the sense that the Federal Reserve Board has used
up the most important arrows in its financial 'quiver' including flooding the
marketplace with cheap money, forcing interest rates down, aiding client banks
with diminishing regulatory capital requirements and supporting the mortgage
insurance industry - all to virtually no positive effect. It appears to us that
confidence in the Fed is dropping like a stone and is not likely to improve for
some time.
At the same time, confidence in the quality of
financial data being published by America's governmental economic authorities
has become highly suspect. While Americans groan under skyrocketing energy,
food and medical costs - among others - the government maintains that price
inflation is modest to non-existent, citing their own self-created 'core
inflation' index, as if the population lives energy, food and medical cost-free
lives. Analysts also note that the employment numbers issued by the Department
of Labor are so altered with seasonal and technical adjustments that the figures
are becoming almost meaningless.
In our opinion, this state of affairs means that
many members of the financial community are operating without confidence and
without reliable data on which to make important choices.
In short, we see a sea of difficulties to overcome
before genuine, solid prosperity can be restored and plan to report on another
few problems tomorrow morning in 'Part Two" of this summary and outlook..
However, on a positive note, we believe that gold
will move sharply higher going forward. Once the $1,000 barrier is overcome,
which we expect will occur later this year; the growing list of apparently
insoluble problems could ultimately create a powerful movement among the general
community at large into the 'protection' of precious metals investments.
Markets this morning have been relatively quiet with
gold and the other precious metals slightly higher, base metals weaker on
balance, crude oil reaching new highs above $143 before retreating to the $141
level, currency markets generally quiet and security markets in Canada and the
USA higher, with the TSX and the Dow Industrials ahead by about 70 and 50 points
respectively as of 9:00 AM PDT.
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