Hi agentzh,
Thanks for the response. It is not happening on my uat site as I have redone the configuration and tested with the full setup. However it happened on my try out setup where I did not want image/* content-type to be cached.
2013/06/12 15:51:43 [info] 11016#0: *19 key: "%252fsanta.jpg" was not found by memcached while reading response header from upstream, client: 192.168.0.61, server: -, request: "GET /santa.jpg HTTP/1.1", subrequest: "/memc"
Maybe my configuration problem :(
Thanks again for the support and the setup is now cached by MIME types also; we are running ngx_srcache without a problem. :)