Daily Gains Letter

Two Factors Suggest Problems in Gold Market Will Get Bigger?

By for Daily Gains Letter |

Gold Market Will GetGold bullion prices are taking a big hit. The precious metal continues to slide lower, and sits at the lowest level since July; negativity towards it is exuberant. There’s a significant amount of noise that says gold bullion prices will go much lower, and those who are against it can be found saying that it’s not worth the investment—those who are bullish on the precious metal are ridiculed.

As I have said before, I continue to be bullish on gold bullion prices going forward. It is certainly difficult to take this stance, but the odds are stacking higher with this notion; time will be the better judge.

One of the factors that affect prices is the supply. At the end of the day, gold bullion prices—or the price of any other commodity or stock for that matter—are very dependent on the supply. If there’s an abundance of the commodity, you’ll see prices go lower; if the supply is dismal, one can expect prices to go higher. This is Economics 101.

I see constraints to the supply of gold bullion going forward, with demand remaining robust.

One way to assess the future supply of gold bullion is to look at the exploration costs of gold mining companies. At their very core, increasing or decreasing exploration costs tell us if there will be more production. As it stands, we see companies reducing their exploration costs, meaning they are not as active in looking for more gold bullion.

Consider Yamana Gold Inc. (NYSE/AUY). In the first nine months of this year, the exploration and evaluation costs at this company totaled $83.9 million. In the same period a year ago, these expenses were $109.4 million; this is a reduction of more than 23%. (Source: “2013 Third Quarter Report,” Yamana Gold Inc., web site, last accessed December 4, 2013.)

Another supply constraint I see is the reduction in capital expenditure (capex). When capex at a company increases, you can expect production to increase—and with it, supply. When capex declines, it suggests that production won’t be as robust, meaning less supply. Continuing with the Yamana Gold example, in the first nine months of this year, the company’s capex was $758.85 million. In the same period a year ago, this was $1.16 billion. In just a year, Yamana Gold’s capex has declined more than 35%. (Source: Ibid.)

While this may just be old news, we know prices of gold bullion are depressed going forward. If this continues, I expect exploration costs and capex to decline further, causing the supply side to suffer even more.

With all this in mind, I would not be surprised to see gold bullion prices go lower in the short run. There’s too much negativity towards the metal these days, and if the price remains dreary over the long term, the supply side will eventually give in. With demand coming from central banks and individuals, the result will be an increase in prices.

Investors looking to find opportunities in gold mining companies have to be very careful. One strategy would be to avoid companies with high production costs. With gold bullion prices remaining bleak, I see some well-known, low-cost producers selling for very cheap.

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