by Mark Goldstein
The outcome of last month's Greek election does not fundamentally change the situation in Europe. The pro-Euro and pro-austerity New Democracy Party won, but the situation in that country is still unstable and uncertain. Major debt problems in other countries, such as Spain and Italy, remain. So the debt crisis will continue.
That was very bad news for gold stocks because it caused bullion prices to fall. Bullion fell by 6.7% on June 28 because of concern that European leaders meeting in Brussels could not find a solution to the debt problem. That was the worst day for gold since 2004, according to Business Week.
This is also bad news for mining companies such as Newmont Mining (NEM) and Freeport-McMoRan (FCX), which are counting on high gold prices to make up for low prices for other metals, such as copper, silver, and platinum. One stock that could take a real fall on this news is AngloAmerican, which is heavily exposed to both gold and platinum. Platinum prices have actually fallen below gold prices in the market.
Not even gold specialists such as Barrick Gold (ABX) and GoldCorp (GG) could be immune from this. They need a fairly high gold price to maintain their cash flow, especially with prices for silver falling as well. Without a high gold price, expect these companies stock value to keep falling. Smaller gold miners will be hurt the most.
What is Causing Precious Metal Prices to Fall?
So, what is going on here? Why are precious metals prices falling despite the "economic fix" unveiled by Europe's leaders on June 29 and the Greek election? More importantly, how will it affect mining stocks, and how long will it continue?
The cause of this fall in metals prices is uncertainty. Investors certainly want to know if the market is definitely going to go up or down before they take any sort of plunge. No investor is going to buy gold if he or she thinks that the price is about to fall. This is doubly true for value investors who don't like the idea of losing money.
Those people are going to stay out of the precious metals market until they think it has hit bottom. So a lot of people think the gold market has not hit bottom yet. That means a lot of investors are going to stay out of the market.
To make matters worse, such volatility encourages speculators to bet against gold. This strategy counts on prices to stay low, so it actually increases volatility while driving down prices.
The European crisis makes matters worse because people don't know what is going to happen next in Europe. Events in Europe could have a profound effect on gold prices. Concern that the euro is about to collapse could cause a frenzy of gold buying as Europeans, particularly Southern Europeans, rush to protect their assets from the inflation or hyperinflation that would probably quickly affect new Spanish, Greek, or Italian currencies. Such currencies would have little or nothing to back them, so they would quickly become worthless.
The Future of the Euro and Gold
What seems to be happening now is the reverse of what Europeans and others think, that the euro will stick around because European leaders seem to be committed to saving it. The decision to set up a European equivalent to the FDIC that would regulate banks and protect depositors from collapses should do more than anything else to stabilize the situation and protect the euro. If a strong European-wide banking system emerges, much of the incentive to invest in gold will vanish because safer and more convenient bank investments will be available.
This development could be good for gold mining stocks in the long run because it could give Europeans more money to invest with. It will also make it easier for Greeks or Italians to invest in companies in other countries. Some of the most attractive stocks to them will be gold stocks, including penny gold stocks such as Pershing Gold (PGLC) and Pacific Gold (PCFG.PK).
It could be bad for physical gold prices because Europeans will have less incentive to invest in physical gold as a hedge against inflation or currency collapse. A strong euro in which Europeans and others have confidence in will decrease the demand for physical gold, yet it will boost the demand for stocks with a high cash flow, including European gold miners such as Rio Tinto (RIO) and Xstrata (XSRAY.PK), which traditionally have high cash flows.
Gold Could Flow out of Europe
An interesting development here could be that bullion could flow out of Europe and into more volatile countries such as China and India. The Chinese and Indians are historically big gold buyers, and they have a lot of cash. Their gold buying usually increases as their economies weaken.
This process may have already begun, because gold buying is already up in China, where investors bought 98.6 metric tons of bullion the first quarter of 2012. Gold purchasing fell by about 30% in India in the same period because of a new tax, but is expected to climb in the second half of the year.
Part of the reason for the increased demand for gold in China could be the low prices created by the situation in Europe. Low prices make gold more attractive to Chinese and Indian investors, so they snap it up. In India, gold purchasing is also being driven by the continuing fall in value of that nation's currency, the rupee. The rupee fell to a record low on June 22 and it has not come back up.
Not surprisingly, many Indians are turning to gold as a hedge against this inflation. Reuters reported that the large-scale conversion of rupees to dollars by gold importers was partially to blame for the rupee's fall. That would indicate that the gold imports to India are increasing- which is good because India's is the world's largest gold importer.
This development would indicate that gold mining stocks are still a good long-term play, even if their prices are in for a short-term fall. The global demand for gold seems to be strong, even though the European demand for it is low and likely to continue to fall. The lack of European demand should be made by the increased demand from India and China.
The biggest beneficiaries from this situation should be those companies with the biggest gold reserves. This includes Newmont Mining, which has estimated gold reserves of 98.8 million ounces, and Barrick Gold, which has an estimated 139.9 million ounces in its reserves.
These giant miners should be well-positioned to survive the short-term drop in gold values that will accompany the continuing economic adjustments in Europe. They are also in a great position to profit from the resurgence in gold prices that will probably come sometime next year when the European situation starts to stabilize.
If the debt crisis really is over, expect gold prices to take a fall for the next few months, then start to creep back up. Gold prices and gold-mining stocks should recover by next year because of the high Indian and Chinese demand.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.