Signs are beginning to appear that the inflation dragon might be in the process of re-awakening, despite the fact that many observers might have concluded it had been slain, perhaps forever.  According to yesterday’s U.S. Department of Labour’s September report on U.S. Producer Prices, that figure rose a sharp 0.8% last month and has now risen at an annualized rate of 6.9% for the past year.  At the same time, a report out of the U.K. showed their general annualized inflation rate has jumped to 5.2%.

In each case, these rates are far above central bankers’ target area of about 2% for each nation.  One ‘culprit’ which has been identified by several economists is a renewed surge in the price of Crude Oil which has advanced from a recent low near $75 per barrel to just under the $90 mark this morning.

Historically, fear of inflation has been one of the most important hallmarks of past precious metals bull markets and we believe that should inflation truly begin to escalate to the point where it becomes a visible public concern, history will repeat itself.  Therefore, we will continue to monitor inflation indicators closely..

Aside from all the external risks such as legal, regulatory and aboriginal difficulties associated with evaluating junior and major mining companies, there are also a large number of hazards directly associated with the world of productive mining itself.  This came to mind when we read of the unexpected closure of mining giant Agnico-Eagle’s Goldex Mine near the city of Val d’Or, Quebec.

Agnico recently noticed an increase in the level of ground water in their mine and hired a consulting firm to investigate.  The investigation showed that there had been a weakening in a volcanic unit of the mine’s hanging wall and as that wall began to fail, water flow into the mine commensurately increased.

The company has now decided that production at the Goldex Mine must be shut down for safety reasons and also to protect the integrity of the remaining resource structures.   Company geologists are also downgrading the mine’s remaining ore body from “Proven and Probable” Reserves down to the lower category of ‘resources’.  In the meantime, the company will attempt to provide other employment for the mine’s 233 workers.

We offer this as additional proof, if any were needed, that mining is an inherently difficult proposition at all levels and we wish our law-makers and bureaucrats were more aware of this reality so they might help in mitigating the risks associated with mining rather than continually adding to the industry’s burdens.

One of our continual themes has been the concept that as the world’s financial situation deteriorates, there will likely be an increase in social disorders.  We also hold to the opinion that these disorders have the potential to turn into ugly rioting should the public begin to suspect that their governments will no longer be able to sustain the level of government largesse which has been forthcoming for decades and upon which many individuals, families and business have built their lifestyles.

For this reason, we have been sceptical regarding the ultimate success of the various ‘austerity’ measures which many monetary authorities have insisted upon as a pre-condition for any financial aid to beleaguered governments.  Those governments may have publicly signed on to those austerity measures in order to obtain their fix-of-the-moment, but we note that it is becoming increasingly difficult to obtain support from the general public.

Two nations, Greece and Italy, are showing us just how difficult and fraught with danger the situation has become.  Each country’s population has been riding a gravy train of government support for virtually every welfare scheme that has come down the pike and both countries are now burdened with enormously large and treasury-draining cadres of civil servants.  Both countries are now buried in debt and are faced with the reality that the gravy train is coming to an end.  And in both countries, the population at large is rebelling from that reality.

In the case of Italy, we saw signs of a breakdown of public order during the recent worldwide “Occupy Wall Street” demonstrations.  While the demonstrations were relatively orderly and non-violent in most nations, Italy saw street rioting, burning of autos, smashing of windows and other illegal and violent actions.  As bad as those items were, it is in Greece where the situation is becoming truly perilous.

Unions there have declared a two-day general strike and, according to the Associated Press, over 100,000 people marched through the center of Athens this morning – and the overall scene was not peaceful. The AP article tells that, “...Hundreds of rioting youths smashed and looted stores...Outside parliament, demonstrators hurled chunks of marble and gasoline bombs at riot police.”  We are also told that airline flights have been grounded, public transport has been disrupted, and shops and schools have been shut down while ferries remained tied up in ports.

On the same topic, it is worth noting that Spain is now in danger of following along the same path as their economy continues to be swamped by bad news.  In the latest barrage, Spain’s government debt was down-graded once again by Moody’s bond rating agency and their real estate prices continued to plunge, further endangering the capitalization of Spain’s major banking houses.  In the same announcement from Moody’s it was reported that Italy’s bond rating had been cut once again which surprised virtually no one, but the fact that Belgium saw their debt down-graded as well surprised many and could be an indication that this immense problem is continuing to spread, with no realistic solution in sight.

With all that background news, one might have thought gold would be advancing strongly, but that is not the case.  Short term, gold is trading quietly this morning while over the longer term, gold’s chart performance is beginning to raise doubts.   

Following gold’s drop of almost $400 per ounce to the bottom of about $1,540 in late September, gold snapped back swiftly to near $1,680.  However, since then the recovery rally has weakened and the yellow metals appears to be beginning a reversal to the downside during the past three or four trading sessions.

In our opinion, there is some good chart support near $1,550 with a more important support zone between $1,450 – 1,500 directly below.  Therefore, we believe a breakdown below $1,450 could have important negative implications while it would take a breakout above $1,700 to give the chart a more bullish cast.

(Mr. Melman is a member in good standing of the Canadian Society of Technical Analysts.)

As of 8:20 AM PDT, financial markets in Canada and the USA are moving in opposite directions with the TSX Index off by about 100 points while the Dow Industrials are ahead by around 35.  Precious metals are trading to the downside with gold off by about $5 and silver forty cents lower to near $1,647 and $31.40 per ounce respectively.  Base metals continue trading lower and mining share indexes are off by about 3% on average, continuing to show relative weakness.

In other markets, crude oil is slightly higher; the US Dollar is moderately weaker; and long-term interest rates have moved upward by about 22 basis points to near the 3.2% figure.

All price quotes in US$ unless otherwise noted.

Next Melman Minute will be delayed until Monday, October 24 due to travel scheduled for Thursday and Friday of this week.