Part II - Why the Colonel Isn't Worried about the Price of Gold

Morning Miners!

It is 6:17 AM and the sun is warming up Diamond Valley with a smile - no more rain, hail or snow (maybe). Have a cup of Raine's famous TGIF Red Label and let's get ready for a great weekend...

Part II - Why the Colonel Isn't Worried about the Price of Gold

Yesterday, we talked about the price of gold and its recent trend down from its record price of 1,577.44/oz set in early May. We noticed that although gold has been down in terms of U.S. dollars, it has been steadily gaining in value with respect to oil, copper and silver. This breaks a roughly 11-month trend of gold's declining value with respect to these key commodities. Today, I thought we'd move a little further down the stope and see what this turnaround may be telling us about the outlook for mining stocks.

Last year, the day after Thanksgiving was an unremarkable market day. The DOW and S&P 500 closed down a bit and it wasn't until December 1st that stock and commodity markets would bolt to new highs and finish 2010 as charging bulls. In retrospect, what makes November 26th memorable for me was its lack of excitement - commodity prices relative to gold were finally returning to historical norms and enjoying a brief period of rock solid stability after the horrific market churn of the 2008-2009 period.

For example, the closely watched gold/silver ratio was 51 after Turkey Day, comfortably in the 50-56 range prior to the Bear Sterns collapse and ensuing financial meltdown (the gold/silver ratio surged to the 80s after the Lehman Brothers bankruptcy). In late April of this year the pendulum had swung in the opposite direction when the ratio reached the low-30s and silver courted $50/oz. Today it is headed back up at 41.7; not in the 50s yet but steadily moving to more normal levels.

Alas, the period of November calm started to storm in early in 2011. The new year began with a divergence of key commodity ratios and prompted my January 14th comment to Mining Editor Adella Harding of the 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 corrected then rallied then fell down the shaft to the present levels of pain. Two good examples: General Moly (GMO) is below $4 again this morning and bellwether miner Freeport-McMoRan (FCX) share price is struggling between its 200-day and 400-day moving averages. For the latter, breaking the 200-day is generally a signal for miners to head for higher ground.

So what now? If we use the pendulum analogy, last November represented a mid-point from extremes and it looks like we may be headed back to that stable condition. This report's Value Adjusted Gold Price (VAGP) is a good way to gauge our progess (see below). The 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. When the VAGP and gold price are equal we return to the normalcy of last November - this may prove to be a necessary step before we can expect the next sustained mining rally.

Are we there yet? Today COMEX gold price is presently trading at $1,500.8/oz and the VAGP is $1,604.0/oz. By my argument, gold is still undervalued with repect to the combination of our three reference commodities. We're about 100-bucks low but it has been much worse. The VAGP peaked at $1,848.6 on April 25th when gold was just a little higher than today's price ($1,513.0/oz versus $1,500.8/oz) for a spread of $335.6. Stay tuned - the gap is closing in gold's favor, pardner.


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 277.73, down from yesterday's 304.27 and below the 1-month moving average of 385.78. The EMI continues to be down from the high set on January 4th and set a new 2011 low May 17th. The 1-month average continues a troubling negative trend.

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 below-par at 78.18, up from yesterday's 76.84 and above its 1-month average of 74.60. The gold-gaining-value trend is intact. Today's Value Adjusted Gold Price (VAGP) is $1,604.0/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 of 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.

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 $98.70
ICE North Sea Brent crude $111.30
Spread (ICE- NYMEX) = $12.60 (Yesterday's $12.56 )

Here are the August contracts* with a narrower spread:

NYMEX light sweet crude $99.59
ICE North Sea Brent crude $110.91
Spread (ICE- NYMEX) = $11.32 (Yesterday's $11.47 )

Prices are off their crisis highs but we now have $110+ Brent and $90+ 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.

Eureka Outlook Dashboard

4-WD is ON - The miners are on very rough roads; The VIX or "fear index" is below 25; bellwether Freeport-McMoRan (FCX) has broke below its 200-day moving 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 The Federal Reserve will phase out buying Treasurys (aka QE2) but maintain low interest rates for now

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

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, Democrats seek to repeal mining tax from the constitution, Rhoads, Ellison oppose repeal of net proceeds tax, Proposal could change net proceeds tax, 'You get to deduct WHAT???' Nevada lawmakers ask gold miners

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

Commodity Market Morning Update

NYMEX/COMEX: Oil is up $0.26 in early trading at $98.70 (June contract, most active); Gold is up $10.0 to $1500.8 (June contract, most active); Silver is up $0.028 to $34.960 (July contract, most active); Copper is up $0.0385 at $4.0910 (July contract, most active)

Western Molybdenum Oxide is $16.87; European Molybdenum Oxide is $16.72; LME cash seller is $17.21, LME moly 3-month seller's contract is $17.24

Stock Market Morning Update

The DOW is down 66.22 points to 12,539.10; the S&P 500 is down 7.58 at 1,336.02

Miners are mixed:

Barrick (ABX) $45.25 down 0.70%
Newmont (NEM) $53.81 down 0.46%
US Gold (UXG) $6.49 down 1.07%
General Moly (Eureka Moly, LLC) (GMO) $3.97 down 1.73%
Thompson Creek (TC) $10.58 down 0.19%
Freeport-McMoRan (FCX) $48.08 up 0.23% (a bellwether mining stock spanning copper, gold & molybdenum)

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

ArcelorMittal (MT) $32.83 down 1.47% - global steel producer
POSCO (PKX) $104.70 down 0.69% - South Korean integrated steel producer

The Eureka Miner's Grubstake Portfolio is down 0.68% at $1,659,641.80(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 (source: Wikipedia)

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