The Future of Gold

May 5, 2014

The Future Price of Gold

As always, the opinions as to where gold is headed are as varied as can be. A few of these opinions follow:

  • As China slows down, the demand for gold will decrease and accordingly the price of gold will fall.
  • This particular theory is akin to the theory that China is trying to accumulate gold as a way to boost its currency to the level of the US$ so that trading can be done in Yuan Renminbi. Therefore the demand for gold will increase and this will drive the price of gold up.
  • As India reduces its demand for imported gold because of government restrictions, the worldwide demand for gold will decrease as will the value of gold.
  • Because money is being freely printed by the US Fed, currency will inevitably lose its value, and the only true store of value is gold, and therefore gold will increase in value.
  • Inflation is being held artificially low, and therefore when inflation returns, the value of gold will skyrocket as the value of money decreases.
  • Interest rates are sure to rise when the government releases their hold on them, and higher interest rates mean gold becomes increasingly expensive to hold, and therefore the price of gold is sure to fall.
  • and of course, the old standby conspiracy theories – “evil governments are manipulating the price of gold”.

These are only a few of the passionate theories held that foretell what will happen to the price of gold. 

 

Betting on the Price of Gold

If you like going to the casino, perhaps you will like betting on the price of gold. If you examine the historical trading pattern tracking the price of gold, many of these theories will prove themselves obviously inaccurate, and it will be obvious if you chart any of these events over time against the price of gold over that same time period.

The reality today is that gold has diminished in importance as a measure against currencies. When Nixon did away with the “Gold Standard” in 1971, about 45 years ago, the use of gold as a backstop of currencies became an obsolete concept, except for certain believers of course. The gold standard was done away with because the value of currencies around the world started to far exceed the value of gold existing, and the fixed exchange rate between currencies and gold became untenable. President Nixon did not abandon the gold standard because of some ideological belief. He was forced to abandon the gold standard because countries around the world started realizing that they could demand payment in gold rather than currency, and obtain far greater value. Accordingly they increasingly demanded payment in gold, which amount demanded was quickly exceeding the physical amount of gold available.

So a political decision was made – a decision that was unavoidable – abandon the gold standard.

In today’s world, the amount of US$ currency sloshing around the world is far greater than ever, and even if some politician decided to attempt to sway voters by re-introducing the gold standard, the amount of gold necessary to back up the US$ would be unimaginable. Thus, certain gold buffs feel the price of gold has to rise to extreme values – $5,000 per ounce, or $50,000 per ounce in order to match gold to the currency.

Let’s get real here – it ain’t gonna happen.

 

Gold is a Commodity

Today’s price of gold is determined by many factors, including supply and demand, governments desire to hold gold, and so many other factors. Investors can trade in this commodity that trades on the markets worldwide by being realistic about what gold is. It is a commodity extracted from the earth, in limited quantities. The average cost of extracting this metal from the earth ranges from a $400 cost in certain very exceptional places, to an average exceeding $1,000 per ounce in other places. If it costs more than $1,000 per ounce to extract, the economics of extracting gold become very difficult at today’s market value which is hovering around $1,300 US$.

Thomson Reuters GFMS Gold Survey 2014 which CymorFund referenced recently, gives some quite accurate numbers as to the cost of extracting gold from the ground. To quote “In spite of massive deflation in costs around the world, the actual (average) cash cost of producing an ounce of gold, remains constant at $767.”   

 

A Gold Chart from Ankur Garg

A technical trader (see link) has published that following chart, and is of the belief that gold will rise modestly in the near future until it intersects with the trend line. This is quite a reasonable analysis, though we are not sure that this pattern actually foretells the result claimed by the author. The point is that if you wish to trade in gold, some historical analysis is essential. Each person can determine their own belief based on the information available.

 

 A Chart from Kitco

 

Kitco is a marvelous site that provides excellent information. The link is above. We think that this chart (5 year gold) is quite important.

An analysis of this chart shows that gold reached an “exuberant” level of $1,900 in 2011. This resulted from a “jump on the bandwagon” mentality that is universal in the market. When something is moving up, more and more traders bet on the momentum continuing, until the rise in value collapses from its own weight. The price of gold collapsed as quickly as it rose, moving rapidly from $1,900 to $1,500. All bubbles collapse in a similar fashion, whether the tech NASDAQ bubble of 1999, or the gold bubble of the 1980’s or the gold bubble of 2011.

Then gold tried to move up again, resulting in a “triple top” and could not reach those elevated heights again. As a result, the value of an ounce of gold drifted downward, dropping to slightly below $1,200 per ounce, where it stabilized. If you talk to seasoned traders, they will say that irrational exuberance is usually followed by a 40% drop in value. Where gold is trading today is remarkably close to a 40% drop in value from the height.

it bounced off support at $1,200 twice, making technical analysts believe that the bottom had been reached. We share this view. The current price of gold has moved above and below $1,300 since last summer, and seems to have established a narrow range of value around $1,300 per ounce.

 

How To Play Gold

 Junior gold explorers are currently massively out of favour. The junior explorers stock prices have been devastated, and many are now trading at as little as 10% of their value of 18 months ago. If you wish to see what happened, have a look at our blog of April 4, 2013, just over 1 year ago. As both Warren Buffet and Baron Rothschild have advised, buy when others are running away. When a fire sale occurs, and when prices are extremely cheap, it is time to buy. In the future, when others look at how well you have done, they will marvel at your insight and stock picking ability.

We have published many blogs giving stock picks that either have risen in value, or are expected to rise in value.

 

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By Larry Cyna

Mr. Cyna is an accomplished investor in the Canadian public markets for over 20 years, and has managed significant portfolios. He is a financing specialist for private and public companies, and has expertise in real estate and debt obligations. He has assisted private companies accessing the public markets, has been a founding director of public companies and continues as a strategic consultant to selected clientele. He is and has been a director, a senior officer and on the Advisory Board of a number of TSX and TSXV public companies in the mining, resource, technology and telecommunications sectors, and the Founding Director of two CPC’s with qualifying transactions in mining and minerals. He was an honorary director of the Rotman School of Management MBA IMC program, has completed the Canadian Securities Institute Canadian Securities Course & Institute Conduct and Practices Handbook Course, was a former Manager under contract to an Investment Manager at BMO Nesbitt Burns, a roster mediator under the Ontario Mandatory Mediation Program, Toronto, a member of the Institute of Corporate Directors of Ontario, a member of the Upper Canada Dispute Resolution Group, and the Ontario Bar Association, Alternate Dispute Resolution section. He obtained his designation as a Chartered Accountant in Ontario in 1971 and was the recipient of the Founder’s Prize for academic achievement together with a cash reward. He became a CPA in the State of Illinois, USA in 1999 under IQEX with a grade of 92%. He is a Member of the Institute of Chartered Accountants of Ontario and the Canadian Institute of Chartered Accountants. He holds certificates in Advanced ADR & in Civil Justice in Ontario, Faculty of Law, University of Windsor, certificate in Dispute Resolution from the Ontario Institute of Chartered Accountants. Previous accomplishments are Manager of Cymor Risk Consultants LP specializing in Risk Management Assessment; CEO of Cyna & Associates specializing in mediation and ADR; Founder & Senior Partner of Cyna & Co, Chartered Accountants, a fully licensed and accredited public accountancy firm with international affiliations; and was a partner in a large public accountancy firm. Mr. Cyna is well known in the Canadian Investing community. He is invited to, and attends presentations given by public companies usually 3 or 4 times each week. These presentations are intended by the various hosting companies to present their inside story to sophisticated parties and Investment Managers for the purpose of attracting funding, or of making parties more interested in acquiring shares of those companies. Being a part of this keeps Mr. Cyna deeply involved in the current market and leads to numerous investment opportunities.