Is there a supply shock in store for the Gold Market in 2014?

As the negativity towards gold bullion increases, and the influx of easy money is in jeopardy, one key question is being asked: how low can the prices of the yellow shiny metal really go? Remember the decline in gold bullion prices in late June? When the prices fell below $1,200 an ounce then, we heard calls for a bottom. Now we are closing in on that level again. 

As I have said before, predicting tops and bottoms is really difficult; sometimes, tops and bottoms may already be in place, and we just don’t know it until later. At this point, we don’t know if the level reached in late June was really the bottom. 

For now, the chart of gold bullion shows nothing but negativity. You can see it for yourself below:

Chart courtesy of www.StockCharts.com 

With all this in mind, I remain bullish on gold bullion prices ahead. I don’t know where the bottom will be placed, but one basic principle of economics keeps me bullish: supply and demand. 

As I have said before, the most basic factor that drives prices is supply and demand. If the supply remains the same and demand declines, you can expect the price of gold bullion, or any other commodity or stock for that matter, to go down. On the other hand, if the demand remains the same or increases but the supply declines, the prices head higher. 

The lower the gold bullion prices go, the bigger the supply shock is going to be. Consider this: if the price of gold bullion is $1,200 an ounce and the cost to extract one ounce from the ground is $1,250, then that gold producer will lose $50.00 on every ounce it takes from the ground. The more it produces, the bigger the loss. 

Imagine this: in the third quarter, Goldcorp Inc. (NYSE/GG, TSX/G) reported that its all-in sustainable cost to produce one ounce of gold bullion was $992.00. Now, if prices go below this level, Goldcorp’s losses are going to start adding up. (Source: “Goldcorp reports 2013 third quarter results,” Goldcorp Inc. web site, October 24, 2013.) Keep in mind that Goldcorp is one of the cheapest gold producers, too.

If gold prices continue to slide lower, gold producers will eventually have to halt their production—or face massive losses. Once this happens, the supply side of gold bullion will face troubles. I’m sure you know how robust the demand is for the yellow shiny metal among consumers and central banks. 

Finding an exact bottom or top is impossible. Currently, the trade seems to be to sell gold and follow the trend, but when I look at the basic fundamentals, it seems there’s not much downside left. Certainly, time will draw a better picture, but if this scenario does come into play, investors may profit from the SPDR Gold Shares (NYSEArca/GLD) exchange-traded fund (ETF), since it holds gold bullion and is unaffected by production costs. 

~ by Mohammad Zulfiqar, BA

This article Gold Market to See Supply Shock in 2014? was originally published at Daily Gains Letter