Seeking Alpha
, Market Bulls (76 clicks)
Macro, commodities, medium-term horizon, contrarian
Profile| Send Message|
( followers)  

Possible Catalysts for a Gold Rally

One of the biggest market stories this year has been the total collapse in gold prices. The end of June saw new lows for the year (near the $1,180 level), and at this stage it might appear that almost nothing could reverse this trend. This has generated substantial losses for holders of the SPDR Gold Trust ETF (NYSEARCA:GLD), which tracks gold and has dropped nearly 25% year-to-date. To make matters worse, if the current valuations in the yellow metal continue to hold at these levels, many mines will be below their break-even points. Last month, we saw a variety of analyst downgrades for the price of gold (from names like BNP Paribas, UBS, and Morgan Stanley). This clouds the prospects not only for investors with direct gold exposure, but for those with long positions in miners like Newmont Mining Corp. (NYSE:NEM) and Kinross Gold (NYSE:KGC), both of which have seen sell-offs of more than 35% this year.

But is there truly no end in sight? Is there nothing that can stall or even reverse these declines? While the near-term outlook for gold leaves little reason to be excited, there are still scenarios where these trends could reverse (or at least stall), and it is important to understand these possible events in order to spot them if they happen. So far, much of the weakness has been driven by the fact that the eurozone debt crisis has stabilized and macroeconomic risks are being removed by the global recovery. This means investors are less interested in moving into safe-haven assets (where gold is a strong historical example). Furthermore, bond yields have moved sharply higher in the last three months. Yields on the 10-year Treasury note have risen to recent highs near 2.65%, which is a sharp increase from what was seen in May. Higher yields mean higher opportunity costs for those invested in gold (as it offers no yield).

Possible Bullish Scenarios

While these factors are dominant, there are scenarios where the paradigm could shift. With the average cost to produce an ounce of gold holding near $1,200, billions of dollars in mining assets are experiencing write-offs and this takes away most of the incentive to produce. Eventually, this will eat into supply prospects, and long-term reductions would ultimately lead to bullish price changes.

For those looking for potential short-term catalysts, we have to consider the possibility for another banking crisis. Constant obstacles in Greece's attempts to implement austerity can be taken alongside a newly emerging credit crunch in China mean that this cannot be ruled-out. Any evidence of another banking crisis would be bullish for gold as a safe haven asset. Other factors can be found in emerging markets. In a more positive scenario, continued strength in the global recovery will mean that emerging markets experience increased demand for gold (as a luxury item and in things like jewelry). In a more negative scenario, a weaker global recovery would mean that emerging markets will be more susceptible to external risks (and declining demand for exports). This would also be gold bullish, as it would appeal to investors seeking protection against market volatility.

Last, we must consider inflation. Voting members at the U.S. Federal Reserve have suggested that pricing pressures at both the producer and consumer levels will start to make their influence known as the U.S. economy heads into 2014. Because of this, it will be critical for gold investors to watch inflation numbers into the later parts of the year, as gold is typically used as a hedge against inflation, and any upward pricing pressures would be another potential bullish catalyst for gold.

Price Perspective

Given all these factors, it will be critical to look for evidence that the bear drop in gold has come to an end. This can be done either through the SPDR Gold Trust ETF, and through industry leading miners, such as Newmont Mining Corp. and Kinross Gold.

(click to enlarge)

GLD has seen major declines this year, but the stock has entered oversold territory and could see a bounce out of the 61.8% Fib retracement of its long-term rally.

(click to enlarge)

The 35% decline in NEM has been forceful, but with prices coming close to the long-term lows from the end of 2008, bounces out of the low 20s cannot be ruled out.

(click to enlarge)

KGC is seeing a similar scenario, but prices are now trading at very important support at 4.80, which suggest that the stock can be bought at current levels, using tight stop losses.

Source: Possible Catalysts For A Gold Rally