A Melman Minute — May 19, 2011

It always amazes us just how automatically the general media can accept concepts without examining relevant facts which might contradict the very argument they are presenting. The collapse of commodity prices is a case in point. If the media is to be believed, we are witnessing nothing less than the complete reversal of the frenzy toward higher commodity prices which has been prevalent for the past year or so.

However, one look at the CRB Index chart, an index which measures general commodity price levels, shows us that by historic terms, the much-ballyhooed collapse looks, so far at least, like nothing more than a garden-variety correction of an overbought situation, the kind of correction which normally occurs on a periodic basis with virtually every traded item. As can be seen from the chart, after rallying almost non-stop from 450 to near 680, the index has declined to about 630. However, on that basis of this modest decline alone, television, newspaper and radio pundits have assured the public that lower prices are a sure bet.

We happen to disagree and would note the price of wheat as an example of a major food price item that is not only failing to collapse, but appears likely to advance sharply in price, to the detriment of stability in several nations with marginal economies.

One such region is the Middle East where wheat is an important staple in the daily diet of the citizenry. In fact, the price for wheat is heavily subsidized by governments and is thereby provided to the consumer at very low prices. The public has come to accept these low prices as a right and woe betide the government that fails in that particular responsibility, which brings us to the most populous North African Arab nation, Egypt.

Despite recent revolutions and regime changes, the people remain dependent on wheat subsidies as part of their daily dietary routine and, with wheat prices remaining almost double those registered last year, the cost of providing the subsidy is enormous. According to a World Bank study, the system of subsidies is becoming unstable and Egypt just announced that it would need $10 billion in aid over the next 13 months.

The situation is becoming perilous as the cost of importing a metric tonne (MT) of wheat has risen from just $172 per MT last fall to about $360 per MT at the moment. Their problems are exacerbated by the fact thatEgypts tourism industry has virtually collapsed due to civil unrest which took place earlier this year.

The bottom line is simply this: despite their own financial difficulties, Western nations must be prepared to continue or even accelerate foreign aid to the Middle East region or risk complete civil disorders all because commodity inflation in the form of high grain prices has NOT collapsed, despite various arguments to the contrary we hear on a regular basis.

Somehow, the mining industry continues to receive troubling news on a regular basis, whether it is in the form of massive earthquakes and tsunamis in Japan which have resulted in major setbacks to uranium demand, or criminal elements seemingly running wild in several Mexican states, or proposals by several governments to raise taxes or demand proportionate ownership of mining projects. And now, we find two additional items which also serve to raise troubling issues for mining, most particularly in foreign nations.

The first story relates to mining giant, Barrick Gold Corp. Barrick decided that their African holdings could be better developed is they were spun off from the parent company into a new entity, African Barrick Gold PLC, and that was accomplished in March of last year. The new company encountered several problems, including such items as a mill failure, the theft of fuel and unplanned power shortages, but the worst episode yet has just taken place at their North Mara Mine located in Tanzania near the border with Kenya.

As described by an article in the Financial Post, we learn that, ...about 800 criminal intruders armed with machetes, rocks and hammers broke into the mine site and tried to steal gold ore. The Tanzanian police were called in and were forced to open fire after being attacked by the intruders. Seven people were killed and another 12 injured.

This incident clearly highlighted the security risks now becoming evident in several foreign nations while the second episode (see below) demonstrates the political and legal risks mining companies might encounter.

These have been difficult recent months for Canadian junior, Khan Resources, who have been working to develop a uranium project in Mongolia. First, shares of the uranium mining group were sold heavily following the Japanese calamity of March and, in addition, Khan has encountered legal difficulties when the government of Mongolia arbitrarily revoked Khans mining license and set up a joint venture with a Russian state-owned entity, Atomredmetzoloto JSC, to develop the Khan project known as the Dornod.

Khan had spent more than $40 million since 2005 at Dornod and they are now suing the Mongolian government in Ontario and Mongolian courts and legal questions relating to the matter are now expected to spill over into international courts.

(This commentary in no way suggests any form of opinion regarding the investment merits of Khan Resources. The information is presented to help our readers remain informed regarding some of the difficulties which might be encountered relating to foreign mining investments.)

During our recent visit to a mining operation near Kirkland Lake, Ontario, the one event which garnered the most glaring headlines was the accusation of sexual crimes against Dominique Strauss-Kahn, known also by the initials DSK, Managing Director of the vitally important International Monetary Fund. His reputation had grown to the point where he was considered a favourite in the upcoming election for the Presidency of France. As a result of his immense legal problems and the torrents of adverse publicity, DSK has now resigned from his position with the IMF and obviously, he no longer appears to be a viable candidate for any elected office.

The relevant question is whether his resignation will play any important part in the ongoing difficulties of nations such as Greece, Portugal, Ireland and Spain which are either receiving aid from the IMF or are in danger of needing such aid in the future.

Our own opinion is that DSKs difficulties will have little to no impact since those problems are based on social and economic mismanagement which has taken place over the past several decades.

Markets are generally on the quiet side this morning and, as of 9:20 AM PDT, we find financial markets in Canada and the USA are diverging with the TSX down by about 20 points and the Dow Industrials ahead by a similar amount. Precious metals are little changed and base metals are moderately lower on balance while mining share indexes are close to unchanged as well.

In other markets, the US Dollar Index has declined by about 20 basis points; crude oil has sold down to below $98 per barrel and long term interest rates are recovering some recently lost ground.

All quotes US$ unless otherwise noted.

Next Melman Minute scheduled for tomorrow, May 20, 2011.

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