A Melman Minute
By: Leonard Melman
July 28, 2008
If the goal of the financial markets was to create
uncertainty, they should be congratulating themselves at the moment, as based on
the past week's action, it is difficult indeed to form conclusive projections
about near-term performance. What many regard as powerful rallies which are
indicative of a reversal of the negative trends which have so dominated the news
(falling financials, rising petroleum prices, etc.), others hold to the position
that they are simply corrections within powerful and ongoing major trends.
For example, two weeks ago, the outlook for American securities was surrounded
by 'gloom and doom', but, with sudden swiftness, the Dow Industrials rose by 800
points from near 10,900 up to 11,700. However, with equal swiftness, they have
just given back one-half that advance by declining 400 points to the 11,300
level. Similar patterns exist in gold (all prices US$) from a low this year of
near $850, back to about $990 and now a decline to the low $920s.
This same pattern of major moves followed by sharp reversals is apparent in many
commodities and securities, as the recent rally in the banks stocks has shown
where we have observed a massive decline followed by a sharp rally which
recovered a small portion (in most cases) of the previous great decline.
In today's early trading, as of about 8:15 AM PDT, financial markets are split
with the Dow Industrials down by over 100 points while the TSX is up by close to
the same amount. Precious metals are higher with gold back to $930, silver up
four cents and platinum, recovering from recent weakness, is up about $30 so far
today. Base metals are higher with zinc and lead showing particular strength, up
3.5 and 4.1 cents respectively. Crude is about unchanged near $123 per barrel
and the U.S. Dollar is somewhat weaker so far this morning.
One mining acquisition which just hit the news media caught our attention and we
are referring to the proposed acquisition of Aurelian Resources Inc. by Kinross
Gold Corp. What makes the story so interesting is the level of political risk
that Kinross is apparently willing to assume.
For those not familiar with the background, Aurelian has made a major discovery
in the South American country of Ecuador and has published figures which a
Reuters article notes would, "...With an inferred resource of 13.7 million
ounces of gold and 22 million ounces of silver, Fruta Del Norte is considered
one of the world's largest gold deposits."
As news of the project hit the media, the stock soared, as the chart clearly
indicates, rising from just a few pennies (adjusted for splits) to over $10.00
between late 2005 and late 2006. After trading sideways for 18 months, the stock
got a severe jolt when the Ecuadorian government announced a cessation of their
mining law, bringing operations at Fruta Del Norte to a halt and causing the
stock to lose almost 70 percent of its value with stunning swiftness.
Apparently, one must assume Kinross believes that mining law conditions in
Ecuador will improve and the deposit can be placed into production, because they
have just announced an offer to purchase the outstanding shares of Aurelian at a
63% premium to their market price's 20 day moving average.
In our opinion, this is a high-stakes gamble which could turn out poorly if (a)
no new mining law is enacted in the reasonable future, or (b) a law is written,
but it is of an unfavorable nature.
The hits just keep on coming for the American economy and two recent articles
point to continued difficulties.
First, the housing debacle continues on its ever-expanding path as it was just
reported that the damage already inflicted to real estate values in America now
totals one trillion dollars! Just to put that number into context, it represents
almost one-third of the total operating costs of the American government for a
year!
Noted analyst Bill Gross, chief execut6ive officer of Pacific Investment
Management Co. in America offered this analysis in an article written by
financial reporter John Perry for a recent Reuters story. In our opinion, it is
well worth studying...
"The problem with writing off ($1 trillion) from the finance industry's
cumulative balance sheet is that if not matched by capital raising, it
necessitates a sale of assets, a reduction in lending, or both that in turn
begins to affect economic growth, creating what (economist) Mohamed El-Erian
fears is a 'negative feedback loop.' "
In other words, we believe the situation could get a LOT WORSE before it gets
better.
Second, it is difficult to imagine a more negative news background than the one
which has emerged regarding the major American auto manufacturers, known
collectively as the "Big Three." Not only have sales dropped to levels not seen
since 1993, but a new and potentially massive problem has emerged.
As a result of the recent sharp increases in the price of gasoline, the
desirability and value of used large vehicles such as big pickup's and SUV's has
collapsed, in many cases dropping by one-half. Given that a major portion of
vehicle sales are leased through financing arranged by the manufacturer's own
financial arms such as Ford Credit or GMAC, huge problems are developing as the
re-sale value of the vehicles being returned at the expiration of the leases is
far below the residual values originally calculated when the leases were
written, with the net result being that huge losses could accrue in the future
as these losses are written off against income.
As a consequence, Chrysler and GM just announced they were getting out of the
vehicle leasing business, but this would leave them facing the difficulty of
attracting buyers seeking lower payments and lower capital outlays - forcing
dealerships to now offer huge cash discounts and "zero-percent-financing", both
of which are eating into their revenues and making it difficult, if not
impossible, to carry on profitable operations.
And the beat goes on......
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