Just when we thought things couldn't get any worse for the miners, Ben Bernanke throws a ball at the dunk tank. On Thursday, after Bernanke signaled that the Fed may soon start turning down the printing presses, global markets across multiple sectors have sold off their holdings - most noticeably in the mining sector. Gold finished off the day down 7%, about $95 to $1,278 an ounce - the lowest level in 2.5 years and well below the psychological resistance point of $1,300 - and silver was off by even more than 7%. This article discusses the significance of the day and why investors should prepare for more falling precious metals prices.
Gold has declined almost 17 percent since mid-April driven by a benign global inflationary environment. Today, after Ben Bernanke's comments that U.S. bond buying could be slowed later this year, the appeal of Gold as a hedge against inflation has lessened significantly.
Gold Prices Headed Lower
Back in April I warned investors that Gold prices could fall to $900/oz by early 2014 and it looks like it will be headed in that direction. On April 15, a sharp fall in gold prices led to the Chinese buying 300 tons of gold-more than a third of the gold China purchased in all of 2012 - which helped the price of gold recover from that fall. The drop on Thursday was much greater and I don't think the retail demand from China can help gold prices recover this time (not to mention the weak industrial demand coming from China and India as a result of economic slowdowns).
For those of you who regularly read my articles, you know I normally formulate investment decisions based on fundamental analysis. However, the technical chart below (200-week moving average) derived from Yahoo Finance figures reveals an interesting trend that investors should keep a close eye on.
Source: Yahoo Finance
If you had bought gold at the bottom of that 200-week moving average back in 2011 (at the white circle), you would have made a 600% return on investment. We now broke below the 200-week moving average, back in April (at the red circle), for the first time in over a decade. Again, I'm not much of a technical wizard, but this chart clearly shows the downward momentum that is pulling on Gold prices. In this market environment that we find ourselves in, momentum seems to play a huge part on stock rallies (take a look at virtually every single resource-based stock and technology stock).
Prices Could Fall Below $1,000
By the end 2013, I think gold prices are headed down towards $1,200-$1,100 an ounce (on the upside). In the downside scenario, prices could break below the $1,000 psychological resistance point. Having said that, I don't think that is the end of the world for miners. Average production cost of gold worldwide is about $1,200 an ounce, therefore at spot prices of $1,200 about 10% of the world's gold producers will enter a loss-making threshold. If spot prices fall to the $1,100 level, around 44% of the world's gold producers will be operating at a loss. On the upside, some of the best gold miners in the world operate at below $800 all-in cash costs. Keep in mind that these all-in costs include administration costs, sustaining capital expenditures, depreciation and, most importantly, the cost of development and exploration.
Even as gold prices fall, I'm still looking for miners to invest in. I continue to like Silver Wheaton (NYSE:SLW), Goldcorp (NYSE:GG), Silver Standard Resources (NASDAQ:SSRI) and Sandstorm (NYSEMKT:SAND) because I believe in the companies and their abilities to manage costs effectively. However, I'm currently sitting on the sidelines on the resource space not because of falling spot prices but because of the global slowdown in demand for gold and metals (and materials in general).
What Am I Watching For?
I'm waiting for demand in China and India to pick back up, or for some country to emerge and demand more metals. My concern is not on falling spot prices because I believe the costs of companies are much lower than reported. Companies have an incentive to reveal much higher all-in cash costs to ensure that prices remain high accordingly (as we've seen). Back in early 2000, gold prices were $300 an ounce yet producers still continued to mine gold and make money. It's very difficult to imagine that production costs have risen about three times what they were since 2005.
I truly believe that once the global demand picture recovers, the best gold miners world-wide will be profitable whether the prevailing spot rates are $1,400 or $900.
Disclosure: I am long GG, SLW, SSRI, SAND. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.