Understanding Gold's Descent

My latest Kitco Commentary: Buy or Sell Gold Now? Check the VAGP First
(8/22/2011)


Þūnresdæg
Morning Miners!

It is 5:38 AM. have a cup of  Thor's Summer Thunder. It is time to understand gold's price descent. We are experiencing an overdue correction but the long term outlook for gold is positive and intact...

Understanding Gold's Descent

There is a natural tendency to believe gold's recent heyday is in the rear view mirror after seeing more than a $200/oz price drop from its all-time COMEX record of 1,917.50/oz set just Tuesday to an intraday low of $1,705.4/oz this morning. There will be all manner of talk about bursting bubbles and a "fool's investment." The ole Colonel is amused that the some of the talking heads that promoted gold as a safe haven asset just several days ago are now claiming that it's all over for the barbarous relic.

This report uses the Eureka Miner’s Gold Value Index© (GVI) and Value Adjusted Gold Price© (VAGP) to understand the real dynamics behind the price movements of gold. You can read about both in my latest commentaries in Kitco News (click on the links for each) and the GVI and VAGP are updated daily in the mornings and at the Friday market close in this report.

As I said recently in my August 8 commentary, "...for those who believe in a slow-but-steady growth outlook, gold prices are showing signs of being very over-extended with a re-convergence of gold price and VAGP overdue." What does that mean?

Let's start by looking at a chart of the GVI from the day the DOW closed below the "Flash Crash" low on June 7, 2010 to this morning's COMEX gold price (a larger more readable chart is given near the bottom of this blog page):

The GVI (magenta line) is the value of gold in relation to key commodities and independent of currency. This report assigned the GVI a value of 100 on June 7, 2010 which represents a "high value" on a day that commodity and equity markets were dramatically falling. With the recent sovereign debt worries in Europe and our own concerns in the U.S., gold prices and relative value have surged. The GVI surpassed 100 to score a high of 102.7 on August 19.

We consider a GVI equal to 83.6 to be a market norm where gold's value is in line with the historical commodity norms of its components (namely, oil, copper and silver). A GVI above 83.6 indicates gold is overvalued; a value below, undervalued. When the Federal Reserve's second round of quantatative easing inflated commodity prices this spring, the GVI fell to a low of 67.7.

This morning, with COMEX gold now trading at $1,720.16/oz, the GVI is quickly approaching its one-month average (93.2 versus 92.7). I would expect to see both the GVI and its average to fall closer to the market norm (83.6) in the next several weeks unless there is a European bank failure or other such headline horror. As one expert on CNBC Business News described it yesterday, "chronic event risk" could spike safe haven assets and crater markets. So if the GVI is heading back to normalacy where do gold prices go? Ask the VAGP...

Value Adjusted Gold Price© (VAGP)

The VAGP adjusts price of gold in for a selected currency to 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. Here is a chart of the VAGP denominated in U.S. dollars over the same time period as the previous GVI chart (a larger more readable chart is given near the bottom of this blog page):

The COMEX gold price (dark blue line) is recorded just before the broader markets open in the U.S. (daily update, approximately 9:20 AM EDT). As such, the peak price for that time occurred August 22 at $1,872.9/oz (the record $1,917.50/oz occurred in late afternoon electronic trading on August 23). At its peak, the VAGP was in the low-$1,500/oz level indicating a very high disparity between actual and commodity-relative prices. COMEX price and value quickly descended from these heights and today COMEX gold at $1,720.6/oz is quickly approaching the VAGP of $1,541.9/oz. I would guess that in the next several weeks COMEX will trend down and VAGP will trend up so both end up in low-to-mid-$1,600/oz territory (lacking a "chronic event risk").

Conclusion? Gold is experiencing an overdue correction but there is solid support below. COMEX gold at $1,620-$1,650/oz is nothing to be too tearful about - hang tight, pardner.As Kitco's Jim Wyckoff  said this morning, "It would take a move in nearby gold futures prices below the $1,480.00 level to begin to produce some significant longer-term chart damage." (Kitco News, 8/25/2011)


Daily Market Roundup

Enough talk, let's walk the walk:

Eureka Miner's Index(EMI)

This morning the Eureka Miner's Index(EMI) is below-par at 93.28, up from yesterday's 96.16 and below the 1-month moving average of 134.09. The EMI

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 hot and cold markets 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)

The Gold Value Index (GVI) is below par at 93.24, down from yesterday's 99.44 and approaching its 1-month average of 92.68. The record high for 2011 was 102.71 set Friday, August 19th. Today's Value Adjusted Gold Price (VAGP) is $1,534.6/oz or $291.8/oz below the current COMEX gold price.

Although gold prices were on the rise, the GVI initially trended down from 6/7/2010 when it had a value of 100; gold regained value recently reversing the trend, moved sideways for a time and and headed back up with vigor. It is showing signs of being a little "toppy" now that it is around the 100-level again.

The GVI gauges the value of gold in relation to oil, copper and silver independent of currency. These three commodities were chosen for relative value comparison because 1) oil derivatives are a common cost element for all miners, 2) copper has proven to be a reliable proxy for global growth and 3) silver is a precious and industrial 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 Debt Crisis Watch

July 26th we introduced the Debt Crisis Index (DCI). The DCI is computed in the mornings and at the market close Friday in much the same way we do the EMI & GVI indices. Today, the DCI has a value of 219.5 up from yesterday's 212.1. Our benchmark is 100, the value of the DCI on July 22nd; a bigger number suggests a worsening impact on markets (note 2). This Report has identified an elevated level surpassing 200 is time for serious concern. We are now dangerously above that level.

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 $100/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 $86.30
ICE North Sea Brent crude $111.38
Spread (ICE- NYMEX) = $25.08 (yesterday, $24.24)

Here are the December contracts* with a narrower spread:

NYMEX light sweet crude $87.01
ICE North Sea Brent crude $110.63
Spread (ICE- NYMEX) = $23.62 (yesterday, $22.61)

* NYMEX futures contracts have rolled forward, we now show October and December for a 2-month look-ahead

Prices are off their crisis highs and we have $110+ Brent and $80+ NYMEX in December favoring high oil prices throughout the fall and into early winter although there are now signs of weakening prices. 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 above 25; in early morning trading, bellwether Freeport-McMoRan (FCX) is seriously below its 200-day moving average of $52.70 (our new key level, 08/22 update); 10-year Treasurys are safely below 4% preserving a low-interest rate environment.

The GREEN light is turned on for Commodity Reflation with copper trading comfortably above $3.50/lb

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

The YELLOW light is turned on for Inflation Watch The Federal Reserve phased out buying Treasurys June 30th (aka QE2) but will maintain low interest rates until mid-2013

The ORANGE light is turned back on for Investor Confidence with investors adverse to commodity-sensitive equities

The YELLOW light is turned on our Fuel Gauge with oil above $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, 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 $1.14 in early trading at $86.30 (October contract, most active); Gold is down $36.7 to $1720.6 (December contract, most active); Silver is down $0.353 to $39.515 (September contract, most active); Copper is up $0.0950 at $4.0930 (September contract, most active)

Western Molybdenum Oxide (Infomine) is $14.97; European Molybdenum Oxide (Bloomberg) is $14.55; LME cash seller is $14.97, LME moly 3-month seller's contract is $14.97

Stock Market Morning Update

The DOW is down 112.99 points to 11,207.72; the S&P 500 is down 10.41 points at 1167.19

Miners are mixed:

Barrick (ABX) $49.31 0.65%
Newmont (NEM) $59.97 down 0.48%
US Gold (UXG) $5.54 down 0.36%
General Moly (Eureka Moly, LLC) (GMO) $3.69 down 3.40%
Thompson Creek (TC) $7.74 down 0.51%
Freeport-McMoRan (FCX) $43.80 up 0.76% (a bellwether mining stock spanning copper, gold & molybdenum)
Quadra FNX (TSE:QUX) $12.31 down 0.33%
Timberline Resources (TLR) $0.73 down 1.35%

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

ArcelorMittal (MT) $20.31 down 1.46% - global steel producer
POSCO (PKX) $89.25 down 0.63% - South Korean integrated steel producer

The Eureka Miner's Grubstake Portfolio is down 0.84% at $1,548,802.81(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)

Note 2 - The impact of the U.S. debt ceiling debate affected investment decisions for weeks before its resolution August 2nd and was followed by an S&P credit downgrade. Global sovereign debt issues have been an overhang on markets for many, many months starting with the Dubai crisis in late November, 2009 and spreading to the euro-zone in 2010-2011.

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