"The history of Eureka lies in its future." - Lambert Molinelli, 1878


The author/editor of the Eureka Miner owns common shares of local mining stocks, General Moly (GMO) and Newmont Mining (NEM); together with benchmark miner Freeport-McMoRan (FCX). Please do your own research, markets can turn on you faster than a feral cat.

Thursday, July 1, 2010

Two Heavyweights Help the Eureka Miner - GMO drops below $3

Morning Miners!

It is 5:56AM. Pour yourself a cup of Thor's thunderous java and in a moment we'll meet two heavyweights that have dropped by the break room to give us a hand. On the first day of the second-half of this year and a Thursday before tomorrow's big Labor Department report and national holiday, it's pretty silly to read market tea leaves. In the words of the London Metal Exchange (LME) morning report, "Metals adopt holding pattern after edging lower..." Holding pattern, pardner, let's do some house cleaning.

So who are this morning's guests? Our old friends gold and silver, no strangers to our state - the former a big part of our local economy; the latter, our history. They are going to help tune up the Eureka Miner's Index (EMI) so we can be even better prepared for upcoming market events that may influence our future. Now I know some of you think I'm backtracking from an argument I made for not including gold in the EMI:

"Gold as we have seen in the past six months wears many hats: fellow traveler with commodities during rallies, safe haven during crisis, alternative to fiat currencies to hedge inflation fears. To build a mining index, I'd rather track Barrick whose share price rolls up gold price together with all the realities of mining (fuel and labor cost, government regulation etc.)" (Eureka Miner's Market Report, 6/8/2010)

I still stand by this thinking but the addition of gold to the EMI may make good sense if we normalize its price relative to silver. "What the heck do you have up your sleeve, Colonel? This sounds like more of your smoke and mirrors!"

Actually not, the ratio of gold to silver is a well established metric for tracking the performance of precious metals. Here is a three-year chart of the gold/silver or Au:Ag ratio:

For this morning's COMEX data the Au:Ag ratio is 66.98 (i.e. gold @ $1233.6/oz divided by silver @ $18.415/oz). Before the Great Recession which began 12/07, the ratio was fairly constant, just north of 50. Let's look at the same graph (green line) together with the S&P 500 (red line) over the same period:

Near the S&P 500 pre-recession high in the Fall of 2007, the Au:Ag ratio was roughly 55-56. As the financial crisis worsened the ratio blew up to 75 after the collapse of Lehman Brothers (9/08) and peaked around 85 when folks feared a run on the banks beginning that October.

The Au:Ag ratio is therefore a pretty good "market fear" gauge. This Report already relies on the S&P volatility index or "VIX" (what's this?) to measure the level of fear in the marketplace - how are these two different? It's important to first understand why the Au:Ag ratio tends to widen during crisis. In less traumatic times, silver faithfully tracks its lustrous cousin as a precious metal. However, silver is different from gold because of its broader industrial application and tends to feel more downward price pressure when economic output declines. This causes the ratio to increase.

Another factor that occurs during extreme crisis is asset liquidation. Silver had become the darling of many hedge funds when times were good because it tends to rise in price faster than gold (often referred to as a "high-beta" metal). Since the opposite is true in declines, silver is often the first treasure overboard when it's time to lighten the boat. Silver has a much smaller market than gold, so liquidations have a greater impact on price. Extreme times can therefore cause the ratio to increase dramatically.

If the VIX is a decent "fear index", the Au:Ag ratio may be considered a good "hyper-fear index". Looking at our comparison chart, the ratio remained in the 50-56 range before, during and after the collapse of Bear Stearns (3/17/08). Only after the S&P 500 entered bear country (mid-2008, see note 1) did the ratio start its upward trend accelerated by Lehman's collapse followed by banking solvency fears. Here is a summary of the VIX and a range of Au:Ag near those key events:

03/17/2008 VIX=35.6 Collapse of Bear Stearns, Au:Ag 50-56
09/15/2008 VIX=31.9 Collapse of Lehman Brothers, Au:Ag 65-75
10/23/2008 VIX=96.4 Highest VIX, fear of a run on the banks, Au:Ag 75-85
03/09/2009 VIX=51.3 S&P 500 March closing low 676.53 ("the bottom"), Au:Ag 68-75

The broader markets opened this morning with a VIX around 34 and the Au:Ag (that we just calculated) at 67. Judging from the our past history, we are in scary times buckaroo. For this reason, I've decided to include the Au:Ag ratio in the Eureka Miner's Index by the following formula:

EMI (w/Au:Ag) = 68.33 x (COMEX silver/COMEX gold) x EMI

The Au:Ag ratio was 68.33 on 6/7, the recent low for the EMI - it's inclusion in the formula therefore causes the EMI with and without Au:Ag to be the same on that day. Here is a plot of both for the month of June (a larger, more readable chart is included at the bottom of this blog page):

We notice that the inclusion of the Au:Ag ratio has only a slight influence on the EMI to date. If there is something really scary ahead, I would expect the difference to widen noticeably giving us a little more accurate assessment of where the metals & miners may be headed. Today's EMI (with Au:AG) is a sub-par 57.07 compared to yesterday's 75.31 and heading quickly towards the 6/7 low of 50.67. Remember, an EMI greater than 100 is good times for metals & miners. Ouch!

Enough talk, let's walk the walk:

4-WD is ON - rough roads in the marketplace; The VIX or "fear index" is above 25; metals & miners remain on shaky timber with benchmark FCX trading in the the high-$50s well below its 200-day average of $76 (our new warning level), 10-year Treasurys are safely below 4% preserving a low-interest rate environment

The YELLOW light is turned back on for Commodity Reflation with copper trading below $3/lb

The YELLOW light is turned on for Stable Markets the VIX above the 30 level (what's this?)

The YELLOW light is turned back on for Investor Confidence as further market corrections are likely

The GREEN light remains turned on our Fuel Gauge with oil below $80

A ORANGE light is ON for possible adverse regulation/legislation: Mine Safety Violations, Miner's claim fee, Miner taxation, Cortez Hills, mercury emissions &
General Moly Mt. Hope Water Rights

Otherwise, all lights are green on the Eureka Outlook Dashboard (upper right, what's this?)

NYMEX/COMEX: Oil is down $1.00 in early trading to $74.63 (August contract, most active); Gold is down $12.3 to $1233.6 (August contract, most active); Silver is down $0.293 to $18.415 (July contract, most active); Copper is down $0.0560 to $2.8945 (September contract, most active)

Western Molybdenum Oxide is at $16.00; European Molybdenum Oxide is at $14.50; LME moly 3-month seller's contract is $15.42, LME cash seller is $15.19

The DOW is down 105.84 points to 9,668.18; the S&P 500 is down 15.54 to 1015.17. The miners are hurting:

Barrick (ABX) $43.97 down 3.17%
Newmont (NEM) $60.05 down 2.74%
US Gold (UXG) $4.81 down 3.99%
General Moly (Eureka Moly, LLC) (GMO) $2.98 down 3.25%
Thompson Creek (TC) $8.52 down 1.84%
Freeport-McMoRan (FCX) $57.50 down 2.76% (a bellwether mining stock spanning copper, gold & molybdenum)

The Steels are mixed, (a "tell" for General Moly & Thompson Creek):

ArcelorMittal (MT) $26.82 up 0.22% - global steel producer
POSCO (PKX) $92.68 down 1.74% - South Korean integrated steel producer

The Eureka Miner's Grubstake Portfolio is is down 2.48% to $1,299,695.19 (what's this?).


Colonel Possum

Note 1: The closing high for the S&P 500 was 1,576.9 on 10/11/2007 just prior to the The Great Recession which began that December. The bear market officially began the following July when the S&P 500 fell 20% (on 7/7/2008 the S&P 500 closed at 1252.31); although there was some recovery in August, the S&P 500 continued its downward trend plunging to the "Devil's Triple-6" on 3/6/2008 (S&P low of 666.79 on an intraday basis). The S&P closing low ("the bottom") followed several days later at 676.53 (3/9/2008). The closest we've come to date of reaching the 1252 level was on 4/26/2010 when the S&P 500 hit an intraday high of 1219.8.

Write Colonel Possum at colonelpossum@gmail.com for answers to your questions or to request e-mail updates on the market

Headline photograph by Mariana Titus

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