Daily Gains Letter

How Low Can Gold Prices Actually Go?

By for Daily Gains Letter |

Why Gold Bears May Be Wrong on Their PredictionsGold prices fell into turmoil after the Federal Reserve announced it might be slowing the pace of its quantitative easing. Prices tumbled and broke below the support level, which was formed after gold’s previous decline in mid-April to around $1,350.

Since the beginning of the year, gold prices have been in a continuous decline and have plummeted from trading at about $1,650 an ounce to below $1,300—a drop of more than 21%.

With this slump in gold prices came an increased amount of noise. Some are saying gold has lost its “haven” status, while others are saying we actually may see deflation ahead, so buying gold isn’t the brightest move for investors. Their estimates may vary, but it’s clear that they are extremely bearish on the yellow metal.You can see this decline in the stock chart below:

Gold - Spot Price Chart

Chart courtesy of www.StockCharts.com

With all the negativity around the precious metal, everyone is wondering: how low can gold prices actually go?

It actually turns out that the supply and demand side of gold suggests that the bears might be wrong in their projections.

While the gold prices have taken a hit, the demand remains exuberant. The World Gold Council (WGC) reported that in the first quarter of 2013, 963 tonnes of gold bullion was sold. In that period, central banks bought more than 100 tonnes for seven consecutive quarters, and buyers in India and China, the biggest gold-consuming countries, were resilient and bought even more. (Source: “Global demand for gold Jewellery up 12% in Q1 2013 driven by significant increases in India and China,” World Gold Council web site, May 16, 2013, last accessed June 24, 2013.)

On the supply side, according to the U.S. Geological Survey, gold production from mines in 2012 totaled 2,700 tons. (Source: “Mineral Commodity Summaries,” U.S. Geological Survey web site, January 2013, last accessed June 24, 2013.)

If we assume that the demand for gold stays at 963 tonnes per quarter, then that would mean a total supply of 3,853 tonnes would be needed for prices to stay stable, but current estimates predict a shortfall of 1,152 tonnes. Even if some of the demand is satisfied from recycling gold, the price decline will play a major role.

Consider this scenario for a gold mining company: if the company takes out gold from the ground at a cost of $1,300 an ounce, it would be doing so at a loss. At this pace, the miners would only be able to go on for so long until they would need to shut down production. As a result, the supply would decrease.

Regardless, what holds true is that markets can stay irrational for an extended period of time. When panic strikes, investors just run through the door, so gold prices may head even lower. (You can read more on why you shouldn’t bail on gold in “Gold Slides Lower—Time to Sell It All?”)

While there are pressures on gold prices, the fundamentals for gold as an investment actually look to be improving. The supply-and-demand picture is telling me there’s a bullish future for gold ahead.

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