A Melman Minute — May 16, 2011

We would be remiss in our duties to The Melman Report readers if we did not remain as objective as possible in these columns. Within that thought, although we remain bullish on our long term projections for the metals as well as many mining companies, it is important to point out that an important red warning flag is flying high. That indicator is the relationship between mining shares and the price of the metals themselves, in this case referring to the price of gold.

It is important to realize that profits of producing miners are leveraged to the price received for their output. As an example, if a mining company produces an ounce of gold at a total cost of $800 per ounce and gold is selling for $1,000 per ounce, the company makes a gross production profit of $200 per ounce. However, if the price of gold goes up by 40% to $1,400 and assuming costs remain relatively constant, production profits would approximately TRIPLE to $600 per ounce by calculating $1,400 $800.00.

With that in mind, it can be seen that, all else being equal, share investors who are bullish on the future price movements for gold itself would likely bid up the price of the shares at a faster rate than the metal, expecting a leveraged increase in profits. However, leverage works both ways, and if metals investors were fearful of a future drop in golds price, they would sell their shares at a faster rate.

Now, please note the two-month charts for both the price of gold, as measured by the gold ETF (symbol GLD), and an important mining share index, XAU. About one month ago, on April 11, GLD stood at 141.61 and exactly one month later it stood at 146.59, a gain of 4.98 points or $49.80 in the price of gold. However, the XAU Index (see below), instead of rising rapidly as might have been expected, has instead turned in respective numbers for April 11 and May 11 of 218.74 and 196.59 or a loss of more than ten percent!

Some of the loss in the XAU can be attributed to a larger recent decline in silver than in gold, but we also must assume that for some reason, a substantial number of share investors have become fearful regarding the precious metals future, at least for the time being.

This reality should be regarded as a reason for using an extra degree of caution until the two indexes regain a more bullish confirming stance.

(As always, we remind readers of our caution that no investments should be made without prior consultation with a registered investment professional.)

For many years, the Province of Quebec has been held in high esteem by the mining community. Not only did the province have a generous repayment plan for monies expended by mining companies for exploration and development, but they also had a relatively simplified regulatory structure. Unfortunately, indications are beginning to emerge that this fortunate state of affairs might be in the process of being somewhat compromised.

A weekend article in the Toronto Globe & Mails Report on Business section was headlined, New bill restricts miners in Quebec and details how Quebec is proposing revisions to its mining regulations which include provisions such as, ...new environmental rules in the bill require miners to offer financial guarantees for 100 percent of the cost of rehabilitating and restoring mines slated to be closed. The bill also contains requirements to involve local communities to a greater extent in the mining decision-making process. Quebecs Minister of Mines, Serge Simard, declared, ...Local concerns will have to be taken into account at every step of a mining project.

From our point of view, this could be a real handicap for a mining company whenever quick response to a given problem is essential since, under the new law, companies would be required to set up local consultation procedures before taking such steps.

However and in all fairness, the provincial attitude toward mining in general remains positive, particularly in light of the recent announcement of an C$80 billion plan for development of resources in the northern part of La Belle Provence.

In Fridays (May 13) Melman Minute we cited information regarding the renewed Greek financial crisis contained in an article written by Charles Forelle and datelined from Athens. Mr. Forelle has now written a follow-up piece and it contains information we believe is indicative of a much more rapidly evolving crisis than had been previously contemplated.

We learn that Greece is utterly failing by a wide margin - to accomplish their deficit-reduction goals for this year and 2012. The goals were to reduce the current years deficit to 7.5% of GDP and next years to 6.5%. Now, it appears virtually certain that the budgetary deficit for both years will hover just under ten percent! This means that not only will there be no new moves even aimed at paying off the Greek governments mountain of debt, but rather that Greeces governmental debt will continue to be accumulated at a rapid rate.

When we look at the present level of Greeces total federal debt at near $350 billion Euros; new deficits for the next two years totalling over forty billion Euros and a current borrowing rate of approximately 27 percent on two-year government bonds, it is apparent that Greece has no ability to even approximately meet the terms of its present borrowing agreements.

Forelle also points out that, ...Making things worse, Greeces recession is set to be deeper than expected, the (EU) commission figures show. It projects a decline in GDP of 3.5% this year...

In summary, we have a situation where Greeces economy is contracting and therefore throwing off less taxation revenues; expenditures are rising; debt is escalating; interest rates are soaring and that countrys potential lenders are now truly concerned about making any further commitments. Anyone who believes that is a healthy mix should consider anti-delusional remedies.

The situation becomes even worse when it is realized that, to one extent or another, Portugal, Ireland, Italy, Spain and Iceland all suffer from similar situations.

Since we will be en route very early this morning to Ontario to visit a mining project in Ontario, we will be unable to provide early morning price quotes. Our revised schedule now calls for regular Melman Minutes to resume Thursday and Friday of this week.

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