We first became bearish on gold prices in August 2011, when gold traded at $1,848 an ounce. Even though we understand systemic risks in the Euro Zone were real, we thought gold was highly overbought at the time. We subsequently became even more bearish on gold prices in late 2012, when it became apparent to us that the year 2013 was shaping up to be an “anti-climatic” year as global and European systemic risks began to dissipate. We articulated our bearish views on gold in our January 25, 2013 global macroeconomic issue–when gold traded at $1,660 an ounce–sticking our neck out with a 12- to 18-month $1,100-$1,300 price target. Our call was made several weeks ahead of similar calls by Goldman Sachs and Credit Suisse.
Over the last 18 months, we have reiterated our bearish views on both gold prices and gold miners; in our July 7, 2013 commentary (“A Technological Revolution in the Making – The U.S. Giant Awakens“), we further lowered our price forecast to $1,000-$1,200 an ounce as gold production remained high despite the decline in gold prices. Recent developments suggest that deflation and increasing production efficiencies remain alive and well in the gold mining industry. As such, we are lowering our price target range for gold yet again to $950-$1,100 an ounce. We believe this target will be hit over the next six months. Figure 1 below shows our calls on the price of gold during and post the 2008-09 global financial crisis.
From a classic economic standpoint, gold production should be declining given the decline in gold prices over the last 18 months. But this has not happened in the gold mining industry, for two reasons: 1) almost all gold miners had a bloated cost structure going into the recent price decline; as such, many gold miners were able to cut production costs and stay marginally profitable even as gold prices declined, and 2) some gold miners–post production cost cuts–had to produce and sell more gold to stem cash flow problems.
As the cost of production declines, miners are able to produce more gold at lower prices. According to the World Gold Council, mine production hit 765 tonnes during Q2 2014, a 4% year-over-year increase from Q2 2013, despite an average market price of $1,288 an ounce, or a decline of $125 an ounce from Q2 2013. Figure 2 below shows that global supply of gold has remained steady despite the decline in gold prices in the last 18 months.
Interestingly, at the September 15-17, 2014 Denver Gold Forum, some gold miners are indicating a higher allocation of capital for development projects, such as Goldcorp (Cerro Negro, Eleonore, and Cochenour), Newmont (Merian), New Gold (Rainy River), and Eldorado (Skouries). With the exception of the Eldorado project, all of these projects are expected to come online with an all-in-sustaining-costs (AISC) of $1,000 an ounce or below. This means almost of these projects will remain profitable (taking into account regular future capex and maintenance costs) even if gold falls below $1,000 an ounce in the long-run. At the same time, many gold miners indicated that cost-cutting remain their main objective. The combination of more ambitious expansion plans and ongoing cost-cutting initiatives suggest that mine production (i.e. gold supply) will continue to increase even if gold prices continue to fall. We thus do not believe gold miners will curb production significantly until gold falls to below $1,100 an ounce and stays there for at least several months.
Finally, we assert that from a sentiment and psychological standpoint, gold is oversold but still not sufficiently oversold for us to buy. In our July 7, 2013 commentary–when gold traded at $1,220 an ounce–we stated that the two most reliable indicators for at least a tradeable bottom were absent. Quoting our July 7, 2013 commentary:
The two most reliable psychological indicators for a tradeable bottom in any asset class are: 1) Panic, or 2) Indifference. The best time to invest in any asset class is after years of investors’ indifference. That–along with other screaming buy indicators–was the reason why I invested in physical gold and unhedged gold miners at under $275 an ounce in late 2000.
One sentiment indicator that we track is the change in the holdings of the gold ETF, GLD. Holdings in GLD are highly indicative of marginal/short-term demand given its daily liquidity and the types of speculators it attracts. As shown in Figure 3 below, GLD holdings peaked at 45 million ounces (orange line; right axis) in early January 2013, and have since declined to 25 million ounces, a drop of 44% over the last 18 months.
While a 44% drop in GLD gold holdings is dramatic, keep in mind that all of this drop occurred from January 2013 to December 2013. Since the beginning of 2014, GLD gold holdings has actually remained steady–suggesting that retail investors have neither capitulated nor panicked into selling their GLD just yet. We do not believe that gold prices will bottom until there is another selling panic similar to that in April 2013 (when the price of gold dropped by $200 an ounce in just two weeks).
The combination of steady/higher gold production and the lack of investor panic in GLD suggest that gold prices have more downside to go. Bottom line: We reiterate our bearish stance on gold. New evidence suggests that gold production is more resilient and less sensitive to lower gold prices than we believed as gold miners continue to cut costs to achieve higher efficiencies . This is leading us to revise our target range downwards to $950-$1,100 an ounce over the next six months. Stay short gold.