Daily Gains Letter

Why Negativity Toward Gold Bullion Isn’t Affecting Physical Demand

By for Daily Gains Letter |

gold bullion pricesGold bullion prices fell below $1,200 an ounce by the end of June; now, they are trading above $1,300, down from well above $1,600 in January. Looking at this price action in the gold bullion market, investors are asking if the recent surge after making lows is just a rally based on short covering—investors who were short-closing their positions—or if it’s due to fundamental reasons.

I stand in the camp that believes the rise in gold bullion prices we are seeing is due to fundamental reasons. That said, the sell-off we witnessed in the precious metal prices could take some time to recover.

In spite of the negativity and the notion that gold bullion isn’t useful in one’s portfolio, the physical demand continues to increase. Keep in mind that those who buy gold in physical form tend to have a long-term focus, compared to those in the paper market, who are there to speculate.

We are seeing demand increase here in the U.S. economy. For example, look at the demand for gold bullion coins sold at the U.S. Mint; Richard Peterson, acting director of the U.S. Mint, described it as “unprecedented.” (Source: Mason, J., “U.S. bullion coin demand still at ‘unprecedented’ levels: Mint,” Reuters, last accessed July 29, 2013.) But in the Far East, the demand is much higher.

Consider this: UBS AG (NYSE/UBS), one of the biggest gold-dealing banks in the global economy and based in Switzerland, announced that it will start to store gold bullion in Asia—specifically Singapore—for the first time.

What are the reasons for this move? “Notwithstanding the drop in gold prices, we are still receiving queries on the offering from clients who are keen to reap the benefits of asset and geographical diversification,” said Peter Kok, the regional market manager of Singapore and Malaysia for UBS Wealth Management. “These clients tend to hold a long-term view on gold and enjoy the stability and security benefits which come with holding gold as an asset class.” (Source: Freeman, F. and Wallop, C., “UBS Opens Gold Vault in Singapore Amid Asian Push,” Wall Street Journal, July 2, 2013.)

Mind you, UBS isn’t the only one making this sort of move as the demand for gold bullion in the Far East region is increasing. Other banks, like Deutsche Bank AG (NYSE/DBS) and JPMorgan Chase & Co. (NYSE/JPM), have done the same.

Now, this was just a mere reflection of demand; we must also consider the supply side as well.

As the gold bullion prices decline, the viability for miners to profit declines as well. In short, if the gold bullion miner takes out the precious metal from the ground at $1,250 an ounce, all costs in, and the price goes lower than the extraction costs, that miner’s profitability decreases. This can also force miners to shut down their production and stop future exploration projects, eventually hurting the supply.

One example, Goldcorp Inc. (NYSE/GG), reported a loss of $1.93 billion in the second quarter. This was because it had to write down $1.96 billion for its exploration at Penasquito Mine in Mexico. “Penasquito continues to possess strong exploration upside, but due to lower metals prices, the current in situ market value of exploration potential has decreased significantly,” said Chuck Jeannes, Goldcorp’s CEO. (Source: Koven, P., “Goldcorp reports massive US$1.93-billion second-quarter loss on Penasquito impairment,” Financial Post, July 25, 2013.)

Investors need to focus on risk management and consider their risk and rewards. Those who hold a bullish view on gold bullion may want to look at exchange-traded funds like the SPDR Gold Shares (NYSEArca/GLD) to profit.

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