NOTE: Originally published for Metal Augmentor subscribers on January 6, 2010 at 10:22PM EST.
Over the past year or so, I’ve written several times about the interesting situation in the crude oil market that essentially allows a few big players to lock in an arbitrage profit by storing crude oil in tankers offshore and selling the oil forward on the NYMEX or other futures market. For example there is this posting called Watch the Contango in Oil!
It turns out that in these earlier studies of the subject matter of the crude oil contango and storage scenario, I used a fixed price for the cost of crude storage but in fact the price has been quite variable as demonstrated in a recent post by Mike Shedlock called 26 Mile Long Glut of Idle Oil Tankers. In his commentary, we find a Bloomberg story that references the daily rental cost of a supertanker as around $30,000 right now. By contrast, according to the sources I quoted earlier last year, the rental cost was $75,000 per day. At the time, I calculated that it would cost $1.10 per barrel to store crude oil for one month on a tanker. Using the lower rate of $30,000, however, the monthly cost would be around $0.45 per barrel. In addition, it is possible that individual rates might be negotiated even lower (especially since the tankers are basically just floating and therefore have reduced operating costs). Perhaps the $30,000 per day being quoted for this year is higher than the rate that some players have been able to negotiate. If so, the monthly cost would be lower than $0.45 per barrel.
Why is this worth discussing, you might ask? Because, as Mike Shedlock and others have pointed out, all of this stored crude will eventually come to market and if it does so quickly because storage is no longer affordable then we could literally have a major liquidation event in the crude oil market, causing a sharp and seemingly inexplicable drop in oil prices. That in turn could create ripple effects in other commodity markets including the metals. But even if the reverberations are minor, there could be a very attractive speculative play in just crude oil itself if we are able to recognize the early signs and act appropriately.
Such “early signs” in this case include primarily the same signals that we look for in the gold and silver basis — a shrinking of the contango. Thus, I’ve dolled up a crude spread chart that I think might be useful in taking a look at the situation. The chart below is the spread between the current front month February 2010 NYMEX crude oil futures contract and the December 2010 futures. This chart will be adjusted as the NYMEX crude contract rolls to the next front month (e.g. by January 15 the front month will be the March contract). I’ve drawn a line showing the $0.45 per barrel storage cost ($4.50 per barrel based on the 10 months between expiration of the February 2010 and December 2010 contracts). As the chart shows, crude prices have been flirting with this breakeven $0.45 per barrel-month storage level and it seems like we should keep an eye on the situation. Trading ideas to follow if and when appropriate.
Click on the chart below for a full size image.
silverax Windbag Wisdom
Recently Adam Hamilton, CPA turned newsletter writer, wrote about conspiracy theories involving the huge SPDR Gold ETF, GLD. We think Mr. Hamilton is quite smart but often he gets bogged down in verbose details just like we do. In any case, he lays out a very strong case for why GLD (and by extension other ETFs) are legitimate holders of metal. That hasn’t stopped some conspiracists such as Jeff Nielson from responding that Even Gold Experts [are] Fooled by Bullion-ETF’s. Unfortunately, Mr. Nielson’s arguments are vapid and one-dimensional: “do not buy GLD or SLV unless you trust bankers”. We would suggest that anybody who is convinced by this line of “reasoning” should also not have bank or brokerage accounts, mortgages, credit cards, insurance policies, stocks or bonds. They should also stay away from any object that is sharp, heavy or capable of launching projectiles at a high rate of speed.
Normally. we’d tell you to go read both of these dueling GLD conspiracy articles. But in this case, why bother? It turns out that hidden within the several thousand words written by Mr. Hamilton, he reveals the only thing that actually matters:
Provocatively, GLD does actually have third-party audits of its physical gold despite conspiracy theorists’ rants to the contrary. This ought to be really embarrassing to the conspiracy theorists, as it proves they just parrot old rumors rather than doing original research on their own. GLD hires Inspectorate, a venerable commodities-testing and inspection company founded in 1927. Each year it performs one complete physical-bar count and a second random-sample count at a different date. It certifies the results.
In tennis, this is what we call game, set and match. Why Mr. Hamilton buries this information deep in his anti-conspiracy theory rant is puzzling. Frankly, we weren’t aware that GLD (actually, GLD’s sponsor) has recently hired a firm separate from GLD’s external auditors to perform a complete physical count and reconciliation of the gold bullion held by the SPDR Gold Trust. We suspect this additional bar count was specified to put the conspiracy theories about GLD to bed once and for all. And that it does. In fact, if after reviewing the Inspectorate certificate [PDF], somebody still claims that GLD does not hold the gold that it says it does, that person is being disingenuous at best and a downright liar at worst. Exceptions can be made for those who do not trust bankers, but only if they don’t have bank or brokerage accounts, mortgages, credit cards, insurance policies, stocks or bonds.
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NOTE: Published for Metal Augmentor subscribers on December 17, 2009 at 11:27PM EST.
An acceleration of market sentiment away from risk (Greece’s sovereign credit rating was downgraded by S&P) and toward the idea that the U.S. economic recovery is credible and will lead to the Fed raising interest rates sooner than later, combined with profit-taking on the anti-dollar trades that have done so well this year, resulted in a big drop today in gold and silver and a jump in the dollar to its highest level since early September.
There is formidable resistance for the dollar index around the 78 level which is where the move got stopped out today and so there is a decent chance that the dollar will pull back from here, perhaps after a brief sojourn into breakout territory tomorrow or perhaps even Monday. Continued strength in the dollar above 78 on the index would imply that the move has somewhat further to go, perhaps to 80. Gold and silver both appear vulnerable to accelerated liquidation if the dollar does make a beeline for the 80 level, but for now we are comfortable with the thesis that the monetary metals may be very near if not at an interim bottom. If so, we should expect a quick bounce back up next week possibly to be followed by a more measured move toward $1200 in gold and $19 in silver by early January.
We are getting ready to deploy some sidelined funds for the upcoming bounce but our net short-term market positioning can still be classified as overall bearish (red flag). Decent speculative value continues to exist in companies such as MAG Silver and Dynasty Metals while most of the EveryInvestor and speculative plays identified by Metal Augmentor are holding up extremely well on this market pullback. Of course this was by design.
silverax Windbag Wisdom
NOTE: Next time, I’ll try to post these types of market updates earlier.
Most markets continue to trade in a consolidation pattern with gold apparently well supported above $1,110 and silver finding stability between the $17 and $18 level. As we’ve noted recently, December tends to be a tricky month for making money in the markets especially when it comes to gold and silver. We still expect gold to retest the $1200 level in the short term and perhaps even attempt a move to new highs before embarking on an extended correction.
The timing isn’t certain but the bottom for this pullback in gold and silver might already be in or it could come during the next couple of days. If so, we would expect a measured rally back toward $1200 in gold and $18.50 in silver by mid-January at the latest. Beyond that we will need to see more data before hazarding a guess.
One thing to take note of is the recent subtle shift in market psychology back toward greater awareness of risk (Dubai debt default,etc.) at the same time as there is growing confidence that the economy is stabilizing (TARP money is being repaid, etc.) These are two diametrically-opposed frames of mind that may contribute to significant cross-currents for the markets during the next several months as additional economic data comes in and the two sides fight over who is right. Under these circumstances the U.S. dollar may continue to see moderate strength especially to the extent that greater awareness of risk is focused on highly-leveraged markets like Dubai, Greece, the UK and even China while growing confidence in economic stability is centered on countries that have already suffered massive asset declines such as the United States.
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silverax Windbag Wisdom
NOTE: Although written about a month ago for Metal Augmentor subscribers (published on November 17, 2009 at 2.17 A.M. EST), the following is arguably even more relevant today.
Brent Cook wrote an excellent article last week, Pig Farmers are Making Brent Nervous. This is a must read and in many ways reinforces the themes we’ve discussed here for several months now with respect to the speculative nature of the current rally in commodities, base metals and precious metals. What makes us nervous more than the excellent points made by Brent Cook is that he seems to be one of the few to lend a voice to what is so obviously a disaster in the making.
Yes, we’ve read the story before that Chinese pig farmers are speculating in copper but we weren’t aware that Chinese goose farmers are speculating in aluminum! In other words, there is quite a bit of this story that has received almost no coverage yet it seems to explain much better the mentality that is currently driving the gold market than the idea of imminent hyperinflation or the “dollar carry trade”.
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silverax Windbag Wisdom
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