Tuesday, March 29, 2011
$1,700 Gold or $3.90 Copper? Introducing VAGP
It is 5:53 AM. Ruby T just brewed a fresh pot - have a cup and it's time to do some space travel...
$1,700 Gold or $3.90 Copper? A Solar System Analogy
After all is said and done, the ole Colonel still believes that gold is the sun in the commodity solar system. As I told Mining Editor Adella Harding of the Elko Daily Free Press last week, "I think gold will always be the final arbitrator of value." Today, let's do a little planetary exploration to understand what I meant by that statement.
We've been talking a lot about the value of gold lately, not its dollar price which remains above $1,400/oz, but its "value" in relation to several key commodities. Last Thursday we chose oil, copper and silver to develop a "gold value index" or GVI to gauge the relative value of gold independent of currency. These three commodities were chosen for relative value comparison because 1) oil is a common cost element for all miners, 2) copper has been a reliable proxy for global growth and 3) silver is a precious metal that now competes with gold for investment and as a hedge against fiat currencies.
If you missed it, Adella kindly summarized my thoughts on gold and the GVI in last Friday's Elko Daily Press:
Gold prices slip after hitting record (ADELLA HARDING Mining Editor, Elko Daily Free Press, Friday, March 25, 2011 3:59 pm)
Here's the bottom line: although gold prices have been on the rise, the GVI has been trending down since 6/7/2010 when we gave it a value of 100. Today it is 70.0 up slightly from its low for 2011 of 69.40 set last Friday.
OK, gold is undervalued with respect to some commodities, so what? With the same data, you could also claim that commodities are presently overvalued with respect to gold. This brings us to the solar system analogy.
Folks used to think that the earth was at the center of the universe and the sun, planets and stars merrily rotated about our planet. Measuring gold's price movements relative to say copper is a bit like watching a golden sun rise and set on a red metal planet. Hey, copper has drawn much attention lately but I'm not willing to place it at the center of my universe! The ole Colonel maintains that copper is just another metallic planet (albeit a big'un like Jupiter) with an orbit still ruled by the laws of value imposed in a gold-centric solar system...
Value Adjusted Gold Price (VAGP)
If my solar system analogy is more confusing than helpful, let's try putting some numbers behind the concept. If you really believe copper, silver and oil are ruling the heavens it's not unreasonable to expect the "gold value gap" to eventually close with a rise in gold prices. Let's first establish a "fair value" for gold. I'm going to choose November 26th of last year because the gold/oil, gold/copper and gold/silver ratios were all closer to historical norms then than now:
November 26th, 2010
gold/oil ratio: 16.27 bbl/oz vs 13.53 bbl/oz (Friday close)
gold/copper ratio: 362 lbs/oz vs 323 lbs/oz (Friday close)
gold/silver ratio: 51.1 oz/oz vs 38.5 oz/oz (Friday close)
If we plug these into my gold value formulation we get a GVI of 83.57 (GVI_norm). If we say this is a "fair value" of gold closer to historical expectations, then present oil, copper and silver prices should support a much higher gold price. If we take Friday's closing price for COMEX gold at $1,426.2/oz then a "value adjusted price" can be calculated from the fair value GVI:
Value adjusted gold price (VAGP) = (GVI_norm/GVI)* gold price
Value adjusted gold price (VAGP) = (83.57/69.40)* $1,426.2/oz = $1717.4/oz
There, that should make the goldbugs happy - life in a "commodity-centric" universe. If you believe in the "gold-centric" version, everything is presently overvalued and will come falling back to proper orbit by the pull of the golden sun. Using the "more normal" 11/26/10 ratios,
$1,426.2/oz gold will support:
oil price: $87.66/bbl
silver price: $27.93/oz
copper price: $3.937/oz
It is somewhat reassuring that the above oil price falls right in the middle of the present range of fundamental support, $85-$90/bbl (i.e. without the Arab world crisis premium). There are some that are also seeing a silver correction on the horizon. Checkout this article in the London Telegraph:
Commodities column: Is the silver price heading for a fall? (Garry White, and Rowena Mason, Telegraph, 6:02PM BST 27 Mar 2011)
The authors use a similar argument on silver valuations but site the gold/silver ratio long term average to be closer to 40 (which is about where we are now). I prefer to use a ratio of 50 (or where we were last November) to represent "normal" because this was roughly the level prior to the 2008-2009 financial melt-down. Pick your poison.
The absolute numbers are less important than the trends - will gold pull commodity prices back down or will commodity prices lift gold up to close the "value gap"? I'm leaning towards the former case being a gold-centric guy, the answer may lie somewhere in between. Stay tuned, these are exciting times.
I plan to start updating the daily VAGP as well as the GVI to check our progress (see below).
Daily Oil Watch
On February 1st we identified North Sea Brent crude oil as a good barometer for the developing crisis in the Middle East and North Africa. It is still above $100/bbl with a large but narrowing spread from the North American benchmark, Western Texas Intermediate or "Texas light sweet crude", traded on the NYMEX (see note 1). The Report normally follows the latter but will track both until things settle out in the region.
Here are the key front-month contracts as of this morning:
NYMEX light sweet crude $103.77
ICE North Sea Brent crude $114.63
Spread (ICE- NYMEX) = $10.86 (Yesterday $10.94)
Here are the July contracts* with a narrower spread:
NYMEX light sweet crude $104.77
ICE North Sea Brent crude $114.12
Spread (ICE- NYMEX) = $9.35 (Yesterday $9.42)
*(the most active front-month contracts are now May so we moved from June to July contracts for a 2-month look-ahead).
Although prices are off their crisis highs, we have $100+ Brent and NYMEX in July favoring higher oil prices through the summer. My December prediction that we would see NYMEX $100/bbl oil before the Fourth of July came true on February 23rd.
Daily Market Roundup
Enough talk, let's walk the walk:
Eureka Miner's Index(EMI)
This morning the Eureka Miner's Index(EMI) is above-par at 390.26, down from yesterday's 448.62 and just above the 1-month moving average of 383.78. The EMI continues to be down from the high set on January 4th and up from the March 15th low of 262.02 - a trend reversal may again be in the works.
The EMI gives us the market temperature for the factors that have the greatest impact on mining in Eureka County. The record high for the EMI is 816.78 set 01/04/2011; the low was set 6/7/2010 at 50.7. An EMI of 100 is the boundary between good lands and bad lands for the metals & miners.
200-day averages are used in the EMI to normalize current mining company share price and are updated monthly. Upper and lower trend lines are updated weekly.
Gold Value Index (GVI)
Our newly minted Gold Value Index (GVI) is 70.04 up from yesterday's 69.73. The 1-month moving average is 71.25. Today's value adjusted gold price (VAGP) is $1,691.67
The GVI gauges the value of gold in relation to oil, copper and silver independent of currency. Although gold prices have been on the rise, the GVI has been trending down since 6/7/2010 when it had a value 0f 100. These three commodities were chosen for relative value comparison because 1) oil is a common cost element for all miners, 2) copper has been a reliable proxy for global growth and 3) silver is a precious metal that now competes with gold for investment and as a hedge against fiat currencies.
Eureka Outlook Dashboard
4-WD is ON - The miners are still in a real rough patch but Freeport may pull us out of the mud hole yet; The VIX or "fear index" is below 25; bellwether Freeport-McMoRan (FCX) moved above its 50-day and 100-day moving average today and is comfortably above its 200-day average of $44.85 (our new warning level, 03/04 update); 10-year Treasurys are safely below 4% preserving a low-interest rate environment.
The GREEN light is turned back on for Commodity Reflation with copper trading comfortably above $3.50/lb
The GREEN light is turned on for Stable Markets with the VIX below the 30 level (what's this?)
The YELLOW light is turned on for Inflation Watch as the Federal Reserve resumes buying Treasurys (aka QE2)
The GREEN light is turned back on for Investor Confidence as investment returns to the equity markets
The RED light is turned on our Fuel Gauge with oil above $100
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, U.S. House committee debates miner workplace safety bill, R&R Partners parts ways with Nevada Mining Association, Obama budget includes mining royalty , Mineral commission fights consolidation
Otherwise, all lights are green on the Eureka Outlook Dashboard (upper right, what's this?)
Commodity Market Morning Update
NYMEX/COMEX: Oil is down $0.21 in early trading at $103.77 (May contract, most active); Gold is down $2.0 to $1419.3 (June contract, most active); Silver is down $0.265 to $36.930 (May contract, most active); Copper is down $0.0280 to $4.3220 (May contract, most active)
Western Molybdenum Oxide is $17.00; European Molybdenum Oxide is $16.72; LME cash seller is $17.26, LME moly 3-month seller's contract is $17.46
Stock Market Morning Update
The DOW is down 8,32 points to 12,189.56; the S&P 500 is down 2.62 at 1307.57
Miners are down:
Barrick (ABX) $50.61 down 0.67%
Newmont (NEM) $52.94 down 0.62%
US Gold (UXG) $8.22 down 0.84%
General Moly (Eureka Moly, LLC) (GMO) $5.09 down 0.78%
Thompson Creek (TC) $12.25 down 1.69%
Freeport-McMoRan (FCX) $53.60 down 0.89% (a bellwether mining stock spanning copper, gold & molybdenum)
The Steels are mixed (a "tell" for General Moly & Thompson Creek):
ArcelorMittal (MT) $35.82 down 0.20% - global steel producer
POSCO (PKX) $115.08 up 0.66% - South Korean integrated steel producer
The Eureka Miner's Grubstake Portfolio is is down 0.62% at $1,848,949.19 (what's this?).
Note 1 - West Texas intermediate (WTI), also known as Texas light sweet, is a type of crude oil used as a benchmark in oil pricing and is the underlying commodity of New York Mercantile Exchange's (NYMEX) oil futures contracts. The price of WTI is often referenced in North American news reports on oil prices, alongside the price of North Sea Brent crude (Wiki).
Headline photograph by Mariana Titus (Eureka December 2005)
Write Colonel Possum at email@example.com for answers to your questions or to request e-mail updates on the market