A Melman Minute
By: Leonard Melman
August 5, 2008
One of the great advantages of price charts is that
they simply present facts about price movements, without opinion, without bias,
without any attempt to put a 'spin' on anything. We can now state that the
facts that some of these charts are presenting are indicating significant
changes are underway, changes that could indeed have a pronounced affect on our
world of mining investments.
First, the base metals, where something unexpected
and out of the ordinary is taking place. The declines which have hit nickel,
lead and zinc are far beyond what might have been expected just a few short
months ago. The chart of nickel clearly shows the extent of the damage, falling
from the area of (all prices US$) $25 to just under $8 per pound at present!
Copper also merits a close look. While the other
three prominent base metals, including nickel, lead and zinc, were plunging,
copper held close to the area of its all-time high above $4.00, but that is
suddenly changing. As can be clearly seen, copper has now descended to the area
of $3.50 per pound and threatens to head sharply lower.
Another chart which concerns us greatly is platinum,
because it reflects health in the international automobile market. Very
suddenly, platinum's price has begun to give way, and the rate of decline has
been accelerating. Once support between $1,850 and $1,800 was breached, the
decline has been swift and remorseless. Our concern is that this decline is
indicative of a more severe economic slowdown worldwide, particularly as it
affects auto manufacturing, than had been previously anticipated.
At the same time as we note these declines, we also
have observed substantial weakness in the resource-based Canadian Dollar which
has just broken decisively to the $0.96 level vs. the U.S. Dollar, representing
a new low for the past several months. The obvious question we must ask is
this: "If the world's economies outside of the USA are going to continue to
grow as vigorously as has been r4ecently anticipated, why are the markets for
the raw materials, which would be required in such expansions, declining in
their recent manner?"
This leads us to our last chart, one which is
directly reflective of the mining industry itself, and that is the
closely-watched chart of the XAU mining share index - which now is breaking
sharply below previous support levels. Please note that the strong support near
170 which had contained previous declines, but has now been violated, as have
lesser support areas at 165 and 160. It must also be noted that the XAU index
primarily reflects the performance of major mines which, in general, have fared
better than the smaller junior mines.
In our opinion, several important factors may be at
play here including the depth of the credit contraction which has been taking
place, putting a damper on the ability of many mines to raise capital without
ruinous share dilution, and also slowing the general level of economic activity
which is putting future metals demand into question. In addition, the continued
upward spiral of costs - combined with the sharp declines in the prices of the
metals themselves - has put the potential profitability of many new projects
into some degree of jeopardy.
In fact, when compared to the economy at large,
mining appears to be confronting a similar situation, namely slowing economic
activity and tighter credit conditions combined with rapidly escalating price
pressures - a condition commonly called "Stagflation" - and it does not appear
to be easing.
Signs of economic contraction continue to accrue on
an almost relentless basis. We note a Reuters article which forecasts a hike in
the projected rate of U.S. bankruptcies and corporate bond defaults; the recent
report showing the Unemployment Rate in America at a four year high; airline
earnings continuing their fall with even the largest carriers such as British
Airways no longer immune; a Financial Times article headlined "Factory activity
slows across Eurozone"; General Motors' and Ford's well-publicized difficulties
accompanied by huge lay-off projections; the decline in building activity
spreading from America to Canada, Spain, the U.K. and other nations; etc.
The list of actual and projected economic woes seems
virtually endless and does not appear likely to vanish at any early date.
Therefore, in our opinion, the watchword should be 'caution' until matters
become clearer. There are still many optimistic forecasts for mining companies
'out there', but until actual improvement takes place regarding projections for
steady increases in natural resource demand combined with some easing of credit
conditions, we would prefer to err on the side of that cautious stance.
There is an important point to consider which we
believe augurs well for the future of the precious metals. Many of the factors
noted above clearly indicate the rising possibility of some form of deflation,
or falling prices. However, given the high level of government spending, the
relentless nature of growth in that spending and the high levels of government
debt now extant which must be serviced, governments around the world simply
cannot afford a period of delation. Such an event would reduce government
tax revenues just when huge extra expenditures were required and the specter of
actual defaults on government debt could become terrifyingly real - and event
which would likely diminish or even destroy the various governments' abilities
to raise capital.
The only answer, therefore, appears to be that
governments at all levels must take whatever measures they need in order to
restore business activity to a high level - and if that means flooding the world
with mountains of fiat currency, then so be it.
As of 8:30 AM PDT, today's markets show natural
resources declining once again, with gold down to the $885 level, silver at
$16.73 and platinum near $1,550 while the base metals continue to encounter
selling. In addition, the price of crude oil has hit a three month low near
$118 per barrel. However the financial markets are split, with the Dow
Industrials in America ahead by more than 170 points, thanks to those raw
material declines, while the TSX, which more closely reflects the fortunes of
companies involved in those materials, is off sharply by about 300 points.
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