Wednesday, March 23, 2011
What Is the Value of Gold? Ask the GVI
It is 5:49 AM. Have a cup of hump day bliss. Old Miner Woden is in a huff this morning because I questioned the value of gold. You would have thought I said something unkind about his dear departed mother...
The Gold Value Index (GVI)
As the U.S. dollar plumbs new depths and gold prices on the rise again, it is not unreasonable to question the value of gold with respect to other commodities. Last month the Report looked at the value of gold with respect to oil, silver & copper (Gold's Dramatic Drop in Value, 2/28/2011). We noted that a barrel of NYMEX oil fetched about 22 pounds of copper, roughly the same as last Thanksgiving. By contrast, an ounce of gold bought far less copper last month than last November. Even though gold prices were above $1400/oz in late February, an ounce of gold bought far fewer ounces of silver than when it was trading in the $1350+/oz range during the fall of 2010.
To carry this line of thinking a little further, the ole Colonel thought it may be fun to look at gold in relation to a composite of three popular ratios - gold/oil (Au:Oil), gold/silver (Au:Ag) and gold/copper (Au:Cu). Removing the currency dependency, we are asking the same questions, "How many barrels of crude can I buy with an ounce of gold? How many ounces of silver? How many pounds of copper?"
Let's call this composite a "gold value index" or GVI. For the math buffs, I've included the formulation for the GVI in Note 2 at the end of the blog page. Basically, the GVI gives you a single number that rolls up the relative value of gold with respect to oil, silver and copper. Somewhat arbitrarily I chose June 7th of last year to give the GVI par-value of 100. As you may remember, this was the day the DOW closed below the so-called "flash crash" low recorded a month earlier (note 3) and was arguably one of the worst days for the metals & miners in 2010.
Here is a plot of our newly minted GVI (magenta line) from last June to today (a larger and more readable chart is included near the end of this blog page):
Somewhat surprisingly, the GVI has been below par ever since that fateful day in June. The gold/silver ratio is a big driver in this formulation falling lately to sub-40 multi-decade lows. However, gold has also lost considerable value to both copper and oil. The latter case has seen some relief recently but nonetheless the GVI remains on a downtrend (note the 1-month average, blue line). To add insult to injury, the GVI pegged a low at 69.85 on the day COMEX gold set a new record on March 7th. Ironically, the GVI was driven down by silver's new reach for the heavens on that same day.
Here are the end-points for relative value comparison:
Gold/oil: 25.9 bbl/oz (6/7/10) 13.6 bbl/oz (today) down 47.5%
Gold/silver: 68.3 oz/oz (6/7/10) 41.5 oz/oz (today) down 39.2%
Gold/copper: 449 lbs/oz (6/7/10) 323 lbs/oz (today) down 28.1%
By contrast, copper has actually risen in value with respect to oil over the same period:
Copper/oil: 0.0385 bbl/lb (6/7/10) 0.0420 bbl/lb (today) up 9.1%
A gold miner like Barrick is now paying more for fuel in terms of their product than last June; copper miners like Freeport-McMoRan are paying less. Since miner's use refined oil products, we can tune up this comparison by figuring out how many gallons of diesel can be bought with an ounce of gold and a pound of copper*:
One ounce of gold buys 373 gallons (6/7/10) 338 gallons (today) 9.4% less diesel
One pound of copper buys 0.83 gallons (6/7/10) 1.04 gallons (today) 25.6% more diesel
*(Eureka retail diesel prices were used for this analysis. In fact, miner's pay a bulk rate and some may hedge fuel costs. The comparison is nonetheless illustrative for relative value comparison)
Today the GVI is at 70.84 down 29.2% from 6/7/10. The Report will soon begin to carry the Gold Value Index so we can see if glitter can recover some shine.
Pete Goicoechea talks about field audits for Nevada mines
Mining Editor Adella Harding of the Elko Daily Free Press ran a good article on Pete Goicoechea's thoughts on the pending field audits for Nevada mines:
Goicoechea: No field audits in 7-8 years (Adella Harding, Elko Daily Free Press, 3/22/2011)
Stay tuned, there will be more to this story, pardner.
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 $105.20
ICE North Sea Brent crude $115.46
Spread (ICE- NYMEX) = $10.26 (Yesterday $12.06)
Here are the July contracts* with a narrower spread:
NYMEX light sweet crude $106.10
ICE North Sea Brent crude $115.20
Spread (ICE- NYMEX) = $9.10 (Yesterday $10.71)
*(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 362.77, down from yesterday's 366.99 and below the 1-month moving average of 387.02. The EMI continues to be down from the high set on January 4th and up from the March 15th low of 262.02
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.
Eureka Outlook Dashboard
4-WD is ON - The miners are in a real rough patch; The VIX or "fear index" is just below 25; bellwether Freeport-McMoRan (FCX) is between its 100-day and 150-day moving average and 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 $0.17 in early trading at $105.02 (May contract, most active); Gold is up $3.8 to $1431.4 (April contract, most active); Silver is up $0.196 to $34.465 (May contract, most active); Copper is up $0.1150 to $4.4280 (May contract, most active)
Western Molybdenum Oxide is $17.00; European Molybdenum Oxide is $16.90; LME moly 3-month seller's contract is $16.78, LME cash seller is $16.58
Stock Market Morning Update
The DOW is up 3.06 points to 12,021.77; the S&P 500 is down 3.56 at 1290.21
Miners are mixed:
Barrick (ABX) $50.59 up 0.74%
Newmont (NEM) $53.43 up 0.49%
US Gold (UXG) $7.80 up 0.65%
General Moly (Eureka Moly, LLC) (GMO) $5.26 down 0.75%
Thompson Creek (TC) $12.40 down 0.48%
Freeport-McMoRan (FCX) $52.81 up 1.01% (a bellwether mining stock spanning copper, gold & molybdenum)
The Steels are down (a "tell" for General Moly & Thompson Creek):
ArcelorMittal (MT) $35.03 down 0.60% - global steel producer
POSCO (PKX) $111.49 down 0.63% - South Korean integrated steel producer
The Eureka Miner's Grubstake Portfolio is is down 0.03% at $1,826,170.93 (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).
Note 2 - Mathematically, the root-mean-square seems like a good honest broker for a relative value roll-up. Let's try this for a "gold value index":
Gold Value Index = (100/SQRT(3)) * RSS( Au:Oil, Au:Ag, Au:Cu)
where RSS is the root-sum-of-squares.
For our calculation the respective ratios are normalized so we're rolling up dimensionless quantities. I picked June 7th of last year for normalization, arguably one of the worst days for the metals & miners in 2010. Arbitrarily, the "gold value" is 100 on that day since each normalized ratio has a value of one:
Gold Value Index= (100/SQRT(3)) * RSS( 1,1,1) = 100
Note 3 - The May 6, 2010 Flash Crash also known as The Crash of 2:45, the 2010 Flash Crash or just simply, the Flash Crash, was a United States stock market crash on May 6, 2010 in which the Dow Jones Industrial Average plunged about 900 points - or about nine percent - only to recover those losses within minutes. It was the second largest point swing, 1,010.14 points, and the biggest one-day point decline, 998.5 points, on an intraday basis in Dow Jones Industrial Average history (Wiki).
Headline photograph by Mariana Titus (Eureka December 2005)
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