A Melman Minute — October 9, 2007

Markets this morning have opened relatively unchanged, with the Dow up about 20 points and the TSX down 40 after one hour’s trading. Metals have moved to the upside with gold ahead by $4, silver by 23 cents and both platinum and palladium little changed. Base metals are strong with copper, nickel, lead and zinc all showing good gains.

Speaking of the base metals, for many years they were regarded as ‘poor sisters’ when it came to market analysis. During prior metals bull markets, most metals gurus chose to focus primarily on gold and silver with some ink devoted to the Platinum Group Metals (PGMs). But that is no longer the case as the base metals have enjoyed truly spectacular price gains over the past five years. During that span, we have seen:

Copper rise five-fold

Zinc rise five-fold

Nickel rise six-fold, and

Lead soar by a multiple of seven or eight from its 2002 lows.

These enormous gains have prompted a rush of exploration and development expenditures and efforts around the globe to locate, develop and bring to production sizeable quantities of these metals. However, the results have been relatively unsuccessful as warehouse stocks, as measured by the London Metals Exchange (LME), have fallen dramatically over the past few years for copper, zinc and lead with nickel remaining little changed. We offer the 5 year chart of LME warehouse supplies in Zinc as an example of how reserve supplies are diminishing.

Normal economic law would suggest that the huge increases in price we have witnessed would have led to rapid increases in production, all else being equal. After all, if the selling price of automobiles rises, one would expect manufacturers to increase production. If an item in supermarkets is a hot seller, the supplier would bring every additional unit to store shelves as soon as possible. And yet, although the base metals have risen sharply in price, production has been insufficient to restore warehouse stocks to anything resembling their levels of five years ago, with the exception of nickel.

The question is of major importance. If prices remain high and particularly if actual supply/demand imbalances continue to grow, then we can expect prices to remain near present levels or move even higher, impacting future price inflation and also causing disruptions in the manufacturing supply chains. Both of these eventualities would likely be positive for the precious metals as well as the base metals.

It is our belief that this scenario will actually take place, that prices are unlikely to fall sharply for two reasons. First, demand from expanding markets such as China, India, Indonesia and other economically advancing nations continues to grow rapidly. The Chinese economy is expanding at an 11% rate with India growing at 9% and both nations’ demands for base metals are becoming voracious. Given the growth in their huge domestic economies plus continuing heavy metals demands from the rest of the industrialized world, it is unlikely we will see anything resembling a sharp drop-off in the demand side of the economic equation.

On the other side, the supply side, it is becoming ever more difficult to bring new projects into production. The world frenzy over “Global Warming” has sharply raised awareness of a potential project’s environmental impact and this is causing permitting complications and delays, which are both discouraging and expensive. In addition, political opposition to development from the radical political left have become stronger in South America, Latin America, parts of Africa and even in Europe, putting additional roadblocks in the path of mineral development.

At the same time, heavy current production is depleting reserves at existing projects and many of them are nearing the end of their useful lives.

This continuing combination of rising demand, depleting current production and the ongoing new supply difficulties could be presenting the mining industry with the ‘win-win’ situation of strong demand combined with higher prices - thereby presenting opportunities for the investor to do some strong due-diligence investigations to uncover potentially profitable opportunities.

DISCLAIMER

The information presented above is based on data which we believe to be from reliable sources, but the accuracy of which cannot be guaranteed. Any opinions or predictions contained herein are those of the editor and are likewise offered also for information purposes only.

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