Could not connect: Lost connection to MySQL server at 'reading initial communication packet', system error: 0
You might want to check your /etc/hosts.deny where:
ALL: ALL: DENY
or
mysqld: ALL: DENY
is your enemy.
check from that host
shell> telnet IP 3306
If MySQL is up and reachable you'll see mysql version in telnet output.Otherwise check firewall, etc until telnet succeeds.
Then I advice you first connect with native mysql client to exclude Rails from problem aria.