Beware the South Wind - Metals & Miners Weekly Roundup

Morning Miners!

It is 5:27 AM. Have a cup of Monday Nitro. Boy-oh-boy, this was a fun weekend in Eureka. We started out with the first ever drag races at the airport and then 100+ beautiful rides at the car show on Main Street Saturday. For us old timers there's isn't anything much better than Beach Boy's car tunes and 1957 Chevrolets. Yee-ha!



Beware the South Wind - Metals & Miners Outlook

If you have been following this report for awhile, you know the ole Colonel is a born optimist. Historically, optimists have been right more times than pessimists. Here's the proof: If the opposite were true we'd still be living in caves only they'd be smaller, there'd be less to eat and your pessimist neighbor in the cave next door would be predicting that things will get worse.

Having said that, there are times for caution. In these parts, a strong south wind in is a good example. We got through the car show just fine then had a "souther" that blew off a chunk of my wood shed roof followed by a wet spring snow with more to come this week. Good-bye sunshine.

I'm starting to think the same about the broader markets. Miners have been in the doldrums for months while the DOW and S&P 500 have sailed merrily along setting new highs. We saw this same pattern before when copper and bellwether miner Freeport-Mc-Moran(FCX) broke down and several months later the broader markets took a nosedive. The red metal and FCX crashed in December 2008 only to be followed by the S&P 500 fall down the mineshaft in March 2009. A similar, but much less severe, case occured last year as Freeport stumbled several times early in the year and then everybody hit the skids in early June. Fortunately, this was followed by a terrfifc rally by the metals & miners for the remainder of 2010.

There is a reason for these early warning signs. Copper has been a very reliable proxy for global growth for the last several years. When investors are happy about global prospects, copper prices soar and copper giant Freeport-McMoran reaps the rewards. When global doubts arise, copper prices decline and large investors flee Freeport along other mining stocks as if they are unwanted relatives at the door.

The Report often looks at share price with respect to moving averages to gauge when problems are on the horizon. Here are the some 2011 warning signs from Freeport:

FCX broke below its 150-day moving average 3/9, 4/14 & 5/4
FCX is now below its 200-day moving average

Another tell is the correlation of copper with gold. It has suffered bouts of negative correlation with gold since early February, a very bearish sign in my view (see analysis below). Kitco's Debbie Carlson interviewed Ian McAvity, publisher of the newsletter “Deliberations on World Markets,” who shares a similar view as mine on copper:

INTERVIEW: Equity Markets Could Be Ready For Break, Commodities Break May Suggest Deflation (Debbie Carlson Of Kitco News, 13 May 2011, 02:48 p.m.)

His thoughts on the red metal warning sign:

"McAvity said copper’s divergence from the rest of commodities for the past three months has been 'most interesting.' He noted that prior to silver’s huge run-up in the early spring, copper was leading silver as copper represented the economic-trade aspect and silver the monetary aspect. Silver sometimes plays both a monetary and industrial role because of its dual use. He noted when silver rallied sharply, copper was unable to keep up."

McAvity goes on to observe that a break in commodity prices (like copper) could portend trouble for the broader markets and even a deflationary period before inflation sets in. The ole Colonel isn't worried about the deflationary theme quite yet as long as copper stays above $3.50/lb. Stay tuned, pardner, there may be more south winds coming in the markets.

Eureka Miner's Index (EMI)

The Eureka Miner's Index (EMI) gives us the market temperature for the factors that have the greatest impact on mining in Eureka County. Below is a chart of the EMI at Friday's close. The magenta line shows the EMI; a composite of three benchmark miners, key oil and metal prices, the 10-year Treasury rate and market volatility (.VIX). A 1-month moving average is given by the blue line (a larger, more readable chart can be found near the bottom of the blog page):


This morning the Eureka Miner's Index(EMI) is above-par at 262.12, down from from Friday's's close at 263.75 and above the 1-month moving average of 414.48. The EMI continues to be down from the high set on January 4th, it set a new 2011 low on May 12th of 248.09. The 1-month moving average has established a troubling downtrend.

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 relevant to Eureka County.

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 below-par at 78.48 up from Friday's close of 78.24 and below the 1-month moving average which is now 73.25. Gold is presently gaining value. The GVI high for 2011 is 79.96 set 5/12. Today's Value Adjusted Gold Price (VAGP) is $1,594.3/oz.

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.

The Value Adjusted Gold Price (VAGP) is a level that supports current oil, copper & oil prices based on historical commodity norms. If the daily COMEX gold price is below the VAGP, then gold is undervalued; if above, overvalued.

Below is a chart of the GVI at Thursday's close. The magenta line shows the GVI, a 1-month moving average is given by the blue line and the dotted line represents a "fair value" for a commodity-based valuation based on historical data (a larger, more readable chart can be found near the bottom of the blog page):



Daily Oil Watch

Latest Nevada Fuel Prices

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 (MENA). It is now above $110/bbl with a large 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 $99.96
ICE North Sea Brent crude $113.13
Spread (ICE- NYMEX) = $13.70(Last Friday $14.56)

Here are the August contracts* with a narrower spread:

NYMEX light sweet crude $100.34
ICE North Sea Brent crude $112.65
Spread (ICE- NYMEX) = $12.31(Last Friday $12.54)

* NYMEX futures contracts have rolled forward, we now show June & August for a 2-month look-ahead

Prices are off their crisis highs but we still have $110+ Brent and $100+ NYMEX in August favoring higher oil prices throughout the summer. My December prediction that we would see NYMEX $100/bbl oil before the Fourth of July came true on February 23rd.

Oil & Copper Correlations with Gold

Oil & copper correlations with gold give us insight into what may happen next for the metals & miners. With supply and demand fundamentals returning to the commodity space, diminishing correlations between key commodities are less alarming but trends should still be carefully monitored especially with spiking oil prices.

Here are the latest correlations given this morning's NYMEX/COMEX trading:

Oil/Au correlation +0.5067 (1-month) +0.6674 (3-month)
Cu/Au correlation +0.0969 (1-month) -0.4964 (3-month)
Cu/Oil correlation +0.8794 (1-month) -0.0464 (3-month)

Here are the numbers from the last Monday (5/09/2011):

Oil/Au correlation +0.4226 (1-month) +0.8315 (3-month)
Cu/Au correlation -0.3628 (1-month) -0.5263 (3-month)
Cu/Oil correlation +0.6464 (1-month) -0.4194 (3-month)

We now have only two negative correlations with some improvement in copper versus gold. Oil and gold remain in the quadrant of positive correlation. Copper versus gold have just stepped outside the inversion quadrant (i.e. both one-month & three-month correlations are negative). Copper versus oil has an increasing positive 1-month and decreasing 1-month negative correlation. The metals & miners tend to do best when all correlations are positive.

According to my April models (see bottom of blog page): oil is presently undervalued with respect to gold by -3.96-standard deviations and copper is undervalued by -2.78-standard deviations. Copper is presently undervalued with respect to oil by -3.36-standard deviations. The May models will soon be availbale for comparison.

One way to visualize these correlations over time is to plot the "near-term" 3-month versus the "short-term" 1-month correlations (aka "rho") as shown below in a graph of oil versus gold and copper versus gold. The blue line indicates the correlation trajectory since October 1st; the magenta line is more recent data (ref: China to the Rescue?):



In the case of oil versus gold, we start out on 10/1/10 in the "+,-" or "yellow" quadrant and move upward until both are positively correlated (i.e. in the "+,+" or "green" quadrant). Copper correlated positively faster than oil last fall and has was initially in the green quadrant longer. Correlation data in this region is typically considered bullish. After a brief venture into the "-,+" quadrant, the return of oil vs gold to the "+,+" side is bullish; the movement of copper vs gold for a return trip back to the "-,-" inversion region is a decidedly bearish development although recent movement back to "+,-" is somewhat encouraging.

Gold:Oil, Oil:Copper & Gold:Copper Ratios

The Report has been tracking the stability of the gold:oil, oil:copper & gold:copper ratios. Although they ended last year rock solid (<3% variation, 1-standard deviation/mean) the ratios have diverged. The period of divergence is what prompted my January 14th comment to Adella Harding, Elko Daily Free Press, "The recent divergence of our lustrous friend [gold] from copper and oil...may signal a near-term correction for the overall metals and mining sector.". The mining sector remains on shaky ground.

Once the ratios exceed 3% error, they become less useful in predicting the price moves of one commodity with respect to the another in the ratio pair.

For the past 3-months we have these statistics given this mornings' numbers:

Gold:Oil ratio

mean 14.02 bbl/oz
variation > 3.0% limit at 4.82% (1-standard deviation/mean)

Oil:Copper ratio

mean 24.03 lbs/bbl
variation > 3.0% limit at 6.98% (1-standard deviation/mean)

Gold:Copper ratio

mean 339.97 lbs/oz
variation > 3.0% limit at 6.02% (1-standard deviation/mean)

Weekly Molybdenum Roundup

Spot prices for molybdenum oxide have fallen from $17/lb territory with 16.69/lb out West and $16.98/lb in Europe. Western and Euro moly spot prices remain in a moderate contango with both 3-month and 15-month London Metal Exchange (LME) seller contracts. (contango occurs when the price of a commodity for future delivery is higher than the spot price, or a far future delivery price is higher than a nearer future delivery; backwardation is the opposite of contango).

The 3-month seller at $17.01/lb is comfortably above the Colonel's mid-range moly price target for 2010 of $15.71/lb but below my target of $20.21/lb for 2011. The Report will give moly prices a "yellow-green" light on the Eureka Outlook Dashboard for now. I did believe we could see much higher prices this year although recent commodity reversals have put a damper on that expectation. There is an excellent analysis of the supply/demand argument for $20+/lb moly provided by General Moly's Seth Foreman in the General Moly Update.

Here is a detailed pricing summary for last week:

Western Moly Oxide $16.69/lb (FeMo65, the price tracked by Infomine - see the side bar graph in the lower right column)

Moly Oxide, Europe (Mo Drummed Molydbic Oxide EU) $16.98/lb (the price reported in the Metals Bulletin)

LME Futures Contracts

LME cash seller is at $37,200/metric ton $16.87/lb

3-Month (Buyer) $36,500/metric ton $16.56/lb
3-Month (Seller) $37,500/metric ton $17.01/lb

15-Month (Buyer) $37,725/metric ton $17.11/lb
15-Month (Seller) $38,725/metric ton $17.57/lb

Here is a 1-year chart of the LME 3-month contract (seller):




Daily Market Roundup

Enough talk, let's walk the walk:

Eureka Outlook Dashboard

4-WD is ON - The miners are in a very rough patch; The VIX or "fear index" is below 25; bellwether Freeport-McMoRan (FCX) is below its 200-day average of $49.88(our new warning level, 05/16 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 ORANGE light is turned on our Fuel Gauge with oil above $90/bbl

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 $0.16 in early trading at $99.96 (June contract, most active); Gold is up $3.9 to $1497.5 (June contract, most active); Silver is down $0.123 to $34.890 (July contract, most active); Copper is down $0.0100 to $3.9735 (July contract, most active)

Western Molybdenum Oxide is $16.69; European Molybdenum Oxide is $16.98; LME moly 3-month seller's contract is $17.01, LME cash seller is $16.87

Stock Market Morning Update

The DOW is down 46.47 points to 12,549.28; the S&P 500 is down 2.94 at 1,334.83

Miners are up:

Barrick (ABX) $45.47 up 1.02%
Newmont (NEM) $53.35 up 1.08%
US Gold (UXG) $6.80 up 1.80%
General Moly (Eureka Moly, LLC) (GMO) $4.21 up 1.45%
Thompson Creek (TC) $10.66 up 0.38%
Freeport-McMoRan (FCX) $48.77 up 1.06% (a bellwether mining stock spanning copper, gold & molybdenum)

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

ArcelorMittal (MT) $33.48 up 0.15% - global steel producer
POSCO (PKX) $105.65 down 0.03% - South Korean integrated steel producer

The Eureka Miner's Grubstake Portfolio is is up 0.46% at $1,687,617.93(what's this?).

Cheers,

Colonel Possum

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

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