I just got done rebuilding a mercruiser 5.7 and it is now in the boat and running. Immediately a couple problems came up, the first being low oil pressure. It runs about 20 psi at idle and maybe climbed to 30 when I was at 3000 rpms. So I pulled the valve covers, ran it, and had a very slow stream of oil coming out the rockers. While running with the valve covers off all oil was staying in the heads (not shooting anywhere) This is where things really went south. While watching for oil to shoot out the rockers, I watched the oil start to turn milky....

I shut it off immediately and started inspecting. There was definitely water droplets in various spots down the throat of the carburetor and droplets were still falling from the jets down after the motor had been shutoff and throttle in nuetral. I tried to get some of the droplets on my finger but failed. Really did not smell like gas. I put about 4 gallons of fresh gas in before ever starting the motor but that gas was added to maybe 5 gallons that was already in the tank and I have no idea the condition of that gas.

Is it possible that there was moisture in the old gas that was already in the tank and that is what's making my motor oil milky?

No

Where is the water droplets in the carburetor I'm seeing coming from then?

I will also add that there was no sign of milky oil on the dipstick and the oil level did not raise at all. The only milky oil I saw was coming from the rockers with the valve covers off.

Are you running on the hose? What t-sta? Circ. Pump or cross over?

Yes running it on the hose. T Stat is a new stock replacement
not sure exactly what you mean on pump type

I just ran it from the hose again but this time pulling fuel from 5 gallon external tank I have and I did NOT change the oil. I only ran it for a minute or so but it ran significantly better than before. I had a bad hesitation throttling off idle that is gone and it starts with just a turn of the key where before I had to give it some throttle. Part of that I'm thinking is due to a sticking choke though. Still no water showing up on the dipstick and fluid level has not rose even a millimeter on the dipstick. Going to change the oil and filter now, continue running it from the external tank and see where were at.

If air temps are down it could of been condensation that you where seeing

Cold water being pushed by high city water main pressure could be making the intake sweat like a cold beer can. I have had it happen, especially with a crossover and thermostat bypass.

Since starting the motor we have seen 40 degree temps and 80 degree temps here in holland. Ran it one more time on the external tank with the valve over off and got a picture of the oil. Dipstick still is at the same level and oil on it looks like brand new.