Understanding the Price of Oil

Alaskite columnar formations, Devil's Gate, Eureka, Nevada

Latest Nevada Gas Prices (click this link)

NEW FORMAT for 2012

Morning Commentary
Daily Market Roundup
- Gold & Silver Report
- Copper & Molybdenum Report
- Oil Watch
- Debt Crisis Watch
- Stock Market Morning Update
- Eureka Miner's Million Dollar Grubstake Portfolio

My Latest International Business Times commentary: Silver & Gold, “Situation Normal…” (03/26/2012)

My latest Kitco commentary: Copper Bids Adieu to Gold and Silver (3/19/2012)

This morning's...
COMEX Gold price = $1,692.6/oz (April contract most active)
Eureka Miner’s Gold Value Index© (GVI) = 88.26 (gold value pause from trending down)
Value Adjusted Gold Price© (VAGP) = $1,602.4/oz
COMEX - VAGP = $90.2/oz; gold is trading at a declining premium to key commodities; the gold-to-copper ratio remains below its 3-month average, compression stalling (Cu neutral)


Morning Miners!

It is 5:51 AM. Have a steaming cup of Ruby T's Bull Run Java, good to the last drop. On a week when the broader markets are up and away breaking multi-year highs, the Colonel hates to bring up a party-pooper subject. If you've just filled up your tank, you know what I'm talking about...

Understanding the Price of Oil

This report has carried a link to Nevada gas prices just below the headline photograph ever since prices started to head north earlier this year. Of course, the big culprit in the rise has been the price of crude oil. Prices have shot up with escalating tensions in the Middle East, notably Iran the and the fear that there could be an interruption in supply coming out of the Persian Gulf region. Let's break this down into pieces and understand what today's price of oil is really telling us.

First, here are the latest Nevada gasoline prices this morning:

Highest $4.66/gal Exxon, 217 Kingsbury Grade near US-50
Lowest $3.67/gal Shell, 710 W Front St near Circle Way, Battle Mountain

The average Nevada price is $3.962/gal compared to a national average of $3.820/gal. Ouch.

In recent years, the cost of crude oil has become an ever growing factor in the price of gasoline and other oil derivatives dwarfing, for example, refining costs. There are two popular benchmarks for crude oil prices: North Sea Brent crude on the ICE futures exchange and Western Texas Intermediate or "Texas light sweet crude", traded on the NYMEX. The former is considered a global benchmark and the latter, a price gauge for domestic production. Here's a 10-year chart of Brent crude oil prices:

On February 1st, 2011, we identified North Sea Brent crude oil to be a good barometer for the unfolding crises in the Middle East and North Africa (MENA). At the time all eyes were on Libya, today the next big conflict could be in the Persian Gulf.

Prior to the 2011 "Arab Spring" the two benchmarks were typically very close in price. Since then there has been a significant spread between Brent and WTI. This morning the most active ICE futures contract is trading at a sobering $125.71/bbl compared to NYMEX WTI at $107.23/bbl - a spread of $18.48/bbl. This report strikes the warning bell when the spread exceeds $20/bbl which occurred during the height of the Libyan crisis.

One way to understand the spread, which lately some call the "Iran premium", is to compare the price of crude to the price of gold. If we divide today's COMEX price of gold at $1,692.6 per ounce by the price of NYMEX WTI the ratio is 15.8 barrels per ounce of gold. Interestingly, this is very close to 16 barrels per ounce considered by many to be a "historically normal" value. Even though most folks think $107/bbl oil is an absurdly high price for the gooey stuff, its price relative to gold is fairly valued historically.

This is not so when we do the same math for Brent crude - that gold-to-oil ratio is 13.4 barrels per ounce, a full 16% below the norm. When oil prices peaked in April, 2011 the WTI ratio also approached these levels with a low of 13.1 barrels per ounce. If a geopolitical shock drives us down to this level again, our domestic benchmark could easily rocket to $129/bbl given today's price of gold (i.e. $1,692/13.1 = $129/bbl). Adding on the greater-than-$20/bbl "scary spread", we easily find ourselves in $150/bbl territory for the global benchmark.

If you believe as I do that an Iran conflict would give a bid to gold prices, the calculation gets even scarier. Let's say we retest 1,900+ per ounce gold, our ratios and spreads give us $145+/bbl WTI and $165+/bbl Brent. That's a big ouch.

The "Daily Oil Watch" below reports all these prices and spreads on a daily basis. We got your back covered, pardner.

Daily Market Roundup

Mining Report

This morning's mining stocks...

Barrick (ABX) $44.45 down 0.09%
Newmont (NEM) $53.33 down 0.22%
McEwen Mining (MUX) 4.40 up 0.69% (formerly US Gold, UXG)
General Moly (Eureka Moly, LLC) (GMO) $3.44 up 0.58%
Thompson Creek (TC) $7.08 up 1.14%
Freeport-McMoRan (FCX) $39.38 up 1.29% (a bellwether mining stock spanning copper, gold & molybdenum)
Quadra FNX (TSE:QUX) $n/a
Timberline Resources (TLR) $0.50 up 2.04%

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

ArcelorMittal (MT) $19.71 down 0.71% - global steel producer
POSCO (PKX) $85.27 up 0.39% - South Korean integrated steel producer

The Eureka Miner's Index© (EMI) was re-calibrated 2/8 to reflect current 200-day moving averages for benchmark miners.

The EMI is above-par at 201.15, up from last report's 199.77 and below the 1-month moving average of 193.45. The 1-month average is falling but still above the key 100-level.

The EMI gives us the market temperature for the factors that have the greatest impact on mining in Eureka County. The record 2010-2012 high for the EMI is 816.78 set 01/04/2011; the low was set 10/4/2011 at 22.88. An EMI of 100 is the boundary between hot and cold markets for the metals & miners.

Gold & Silver Report

This morning's...

COMEX gold is up $7.0/oz at $1,692.6/oz (April contract, most active)

COMEX silver is up $0.225/oz at $32.975/oz (May contract, most active)

The gold-to-silver ratio (Au:Ag) is 51.330 oz/oz

Silver 1-month CRS© is 1.76% (bullish level); CRS© convergence (Ag bullish)

The Eureka Miner’s Gold Value Index© (GVI) is below-par at 88.26, up from last report's 88.07 and just above its 1-month average of 88.21. Gold value is taking a pause from trending down. The record high for 2010-2012 is 109.97 set on Oct. 4, 2011.

The Value Adjusted Gold Price© (VAGP) is $1,602.4/oz which is only $90.2/oz below the current COMEX gold price.

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 price is less than the VAGP, then gold is undervalued; if above, overvalued.

Copper & Molybdenum Report

This morning's...

COMEX copper is down $0.0010/lb at $3.8865/lb (May contract, most active)

The gold-to-copper ratio is 435.51 lb/oz; ratios in excess of 400 lb/oz are considered "recession levels"; the ratio is below its 3-month moving average of 448.25 (Cu bullish trend has paused in Price Domain B)

Copper 1-month CRS© is 2.21% (bullish level); convergence, compression stalling (Cu neutral)

The latest molybdenum oxide spot and futures prices (courtesy of Thompson Creek Metals):

Metals Week Average:
US$14.00
As of March 26, 2012
(updated weekly)

Ryan's Notes Average:
US$14.00
As of Mar 23, 2012
(updated twice weekly)

European Molybdenum Oxide (Bloomberg average price, updated Wednesday & Friday):
US$14.05/lb

London metal Exchange (LME) molybdenum 3-month seller's contract:

US$14.06/lb (US$31,000/metric ton)

Daily Oil Watch

Latest Nevada Gas Prices (click this link)

On February 1st, 2011, we identified North Sea Brent crude oil as a good barometer for the crises in the Middle East and North Africa (MENA). The next conflict could be in the Persian Gulf. Brent remains above $120/bbl maintaining a spread above the North American benchmark, Western Texas Intermediate or "Texas light sweet crude", traded on the NYMEX.

Here are the key front-month contracts this morning:

NYMEX light sweet crude $107.23
ICE North Sea Brent crude $125.71
Spread (ICE- NYMEX) = $18.48 (last report, $18.49)

Here are the July contracts* with a narrower spread:

NYMEX light sweet crude $108.19
ICE North Sea Brent crude $124.25
Spread (ICE- NYMEX) = $16.06 (last report, $16.24)

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

NYMEX WTI 1-month CRS© is 2.40% (bullish level); CRS© weak divergence (Oil neutral)

Prices are near highs for 2012, we have $120+ Brent and $105+ NYMEX in July favoring high oil prices this spring into summer. A front-month spread between Brent and WTI >$20/bbl is a trouble sign, OK for now.

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 and GVI indices. Today, the DCI is 70.2 up from last report's 69.4. A level above 200 is time for serious concern - we are now well below that level. The highest level recorded since inception was 271.0 Aug. 9, 2011; the lowest level is 65.1 on Mar. 13, 2012

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 and continuing into 2012.

Stock Market Morning Update

The DOW is down 2.12 to 13,293.51; the S&P 500 is up 1.68 points at 1,418.19

The Eureka Miner's Grubstake Portfolio is up 0.42% at $1,467,817.95 (what's this?).

Cheers,

Colonel Possum

Headline photograph supplied by Mariana Titus

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