A Melman Minute — May 2, 2011

While there is much rejoicing within the mining community concerning the rapid rise in prices for the precious metals group, there has been some questioning and wondering why the moves in many mining shares have been less than inspiring. In fact, as measured by the XAU mining share index, the shares have been lagging the price of gold by an enormous margin.

In early 2008, the price of gold peaked at $1,030 with the XAU standing near 210. As of this morning, gold is trading close to $1,550 fully 50% higher than the early 2008 peak and, therefore, one might normally expect the XAU to have also gained by about 50%, or to about 315 - but that is far from the case as this mornings quote for the XAU is in the low 220s.

One of the most important pieces of the puzzle in explaining this apparent anomaly is the role played by relative currency values and we are including two fiver-year charts to illustrate the point; the Australian Dollar and the chart of gold itself.

If we go back, for example, to mid-2007 when gold was priced near $700, the A$ was valued at about 76 cents. Since miners must pay their expenses in their home currency, the most important question for Australian miners as is also true for Canadians, Russians and so forth is what quantity of home currency they receive for their gold. In the 2007 example, Australians were receiving 700 divided by .76 or just over A$910 for each ounce. Now, four years later and with the A$ standing near US$1.09, they are receiving $1,550 divided by 1.09 or about A$1,450 per ounce.

That represents a gain in Australian Dollars received per ounce of gold of about 10% per year since 2007, barely enough to keep up with the general increase in costs and it can be seen that the mighty move in gold has been of limited benefit to mining companies located in those countries where the home currencies have made strong moves against the Greenback.

Just as we began preparing this Melman Minute last night, word broke that Osama Bin Laden, long the leading light of the Islamic group al Qaeda, has been killed by American forces in a lightening raid carried out in Pakistan. Very little specific knowledge was contained in a speech by President Obama, but it was clearly asserted that Obama was indeed dead, that his body was in American custody and the 2001 9-11 terrorist raid on America had been avenged.

However, this news had barely been digested when, quite suddenly, it was announced that Bin Ladens body had been buried at sea and, for ourselves at least, this has immediately raised two questions. First, why was such haste necessary when open viewing of the body would have removed any questions regarding the finality of his death while the present circumstance allows his followers and there are multitudes to hope that he is indeed alive? Second, there is no Islamic tradition of burying the dead at sea and taking such action would appear to raise the risk of major and perhaps violent protests across the Islamic community.

The initial assumption making the rounds is that Bin Ladens death will ease tensions in the Islamic world, but we would raise the possibility that, if he is indeed dead, there is a true possibility of his becoming an inspirational martyr to the Islamic terrorist cause and thereby actually adding to the terrorist equation.

One of the most relevant questions in our evaluations of the precious metals markets is the degree of future stimulation by American authorities with the assumption being that increasing levels of stimulation will result in additional dollar weakness and rising inflationary pressures, thereby adding to the future value of gold, silver and platinum in terms of American dollars.

With that in mind, we were quite interested to learn that there has been an unexpected and yet potentially significant factor which has come about as a result of decimation in American real estate values. That factor, strangely enough, has been a dramatic change in American bail bond procedures.

During past times, the most common means of raising funds to post bail bonds was to put up residential real estate as collateral for such bonds, with the equity in the real estate providing a guarantee of payment for the bondsmen. However, with the collapse in home values, for many recently-imprisoned persons, their families and friends no longer have equity to put up and, therefore, huge numbers of arrested persons who might formally have been released and returned to their families and jobs are now languishing away in jails, awaiting their legal fates.

Although it may be less dramatic than the national unemployment rate or the collapse of major banking or finance establishments, three measurable results from this development can already be noted, and they each augur for increasing pressures on government to stimulate. First, by being unable to return to their jobs, the at-risk prisoners no longer earn wages and their participation in the consumer economy is thereby reduced. Second, the flow of business into bail bondsmens books is similarly reduced, leading to diminished incomes and rising unemployment in that field. Third, many families of such prisoners now find themselves without a primary wage-earner and are now finding their way onto state and national welfare rolls.

The impacts of the housing price decline and the failure of any meaningful rally to materialize continue to be felt in ever-widening circles and, in our opinion, the final effects are yet to be witnessed.

Another portion of the over-all price equation for commodities in general is relative supply and demand. Simply put, when demand factors rise without a corresponding increase in supply, that equation alters toward increasing pressure for higher prices.

It appears that a surprising new demand factor for energy, metals and food commodities must now be considered and that is a rapid rise in the number of middle-class persons in Africa. According to financial writer Peter Wonacott in a story datelined out of Johannesburg, the number of middle-class Africans is growing rapidly and has now increased by 60% during the past decade alone. Wonacott informs us that, ...These new consumers are credited with cushioning Africa from the recent global economic crisis. The International Monetary Fund projects that sub-Saharan Africa, a collection of 47 countries, will grow 5.5% this year and 6.0% in 2012.

With a population of over one billion persons, any dramatic increase in Africas standard of living could have an important upward impact on commodity prices and, in our opinion; this would translate to important increases in the value of precious and base metals.

As of 8:00 AM PDT, financial markets are rallying moderately with the Dow Industrials ahead by about 50 points while Canadas TSX Index has gained more than 80. Precious metals sold off sharply overnight in Asia, but are recovering very sharply at this hour with gold having rallied from an inter-day low of 1,540 to a present quote just under 1,570 and silver has recovered from a sharp selloff which drove the price below $43 per ounce, but is currently trading at just under $47. Mining share indexes sold off earlier but have been responding to the improving gold and silver quotes. Base metals are little changed as several primary metals markets are closed for the international May Day holiday.

In other markets, the US Dollar is little changed, long term interest rates are slightly lower and the petroleum markets are joining gold and silver by spiking higher and are now approaching the $115 per barrel mark.

Given the volatile nature of trading over the past hour, we would strongly advise readers to keep a close watch on markets for the remainder of today.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for Wednesday, May 4, 2011

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