Ever since Goldman Sachs (GS) issued a sell recommendation at $1,500, gold has been dropping like a rock.
On top of that, a lack of inflation and the sluggish world economy have upended, at least for now, the bull market in precious and industrial metals.
Several prominent technical analysts are now warning that if gold breaks the $1,125 support level, the crowd (what’s left of it) will run for the door.
I won’t be following them.
Predictions that gold will fall back to its 1980 high make me very happy. That’s because I know where the yellow metal is really heading, and I’ll give you that exact number in just a moment … and how you can arrive at this very same figure yourself …
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Gold Setting Up for a Quick
Bounce … Shorts Beware!
I’m bullish on gold in long term. In fact, I think the market will eventually become red-hot.
Unlike many gold analysts, I think gold is heading much higher because its supply-side balance is about to suffer a MASSIVE SHOCK thanks to international speculators.
I’m not talking about individuals moving the markets. I’m referring to big speculators — literally hundreds of millions dollars in shorts from Asia and Europe, coming from exchanges around the world.
Traders and market experts see what’s going on, and it’s worthwhile to watch the near-term action … and reaction. Just last week on Yahoo! Finance we learned that …
“A trader in Sydney said selling emerged ahead of the opening of Chinese markets, adding that stop-loss orders were triggered when gold was sitting on the edge of $1,200.
“Prices failed to find support even after markets opened in China, the world’s second-biggest gold consumer.
“‘Chinese buying is not strong enough to support prices. Instead, speculators in China are selling,’ the trader said.”
My research tells me that we are setting up for a $200 to $300 bounce … and it will be quick when it comes. I expect the swing in the price of gold down and then back up to as much as $300 to take only 72 hours, perhaps less.
But $1,400 to $1,500 gold in short order is just the beginning.
Goodbye, $1,200 Gold?
How do I know this? Well, it all starts with what gold costs to produce.
As with most physical assets, gold’s most-important pricing factor is the total cost of production (or replacement). If producers aren’t making money, they stop producing.
And for the affluent who like to wear their wealth in the form of gold jewelry … for the central banks who hoard gold to prepare against disaster … and for investors who add to their gold holdings to both hedge and build their wealth, especially in the face of a declining dollar … there simply is no substitute for the yellow metal.
And right now, today’s low gold prices are simply unsustainable for the industry.
Since I wrote my gold book (“The New Bull Market in Gold”) in 2003, the precious metals industry has consolidated through mergers and acquisitions. As they get bigger, these companies expand their operations beyond gold production and include other precious metals and mining businesses.
Just as there are no pure oil exploration and production public companies, there are very few pure gold mining companies. It is difficult to determine the cost to produce gold for some diversified precious metals miners.
WGC: Standardized Production
Prices Could be on the Horizon
Another important recent development in the precious metals industry is the re-evaluation of their costs. For decades, precious metals companies were understating their costs.
Now, major gold producers and the World Gold Council are working on a standard for the industry that better represents the total cost of producing gold.
The final standard is expected in the middle of this year. The biggest changes will include long-term costs like capital expenditures.
I analyzed the total costs of producing gold for six precious metals companies (four large and two small). Below is what I’ve found:
The average cost of both small and large precious metals companies is $1,104 per ounce of gold. As expected, on average, smaller companies have a higher cost per ounce than large companies, but not by much.
Compare the total cost for gold in 2003 ($164) to the 2012 total cost ($1,104).
If we compare apple to apples via Barrick’s cash cost in 2003 of $177 to its 2012 cash cost of $584 (we’re not using the “all costs” of $945 in the table), we see an increase of about three times.
This is much higher than the rate of inflation.
We’ve seen that whenever prices go below cost, producers will normally cut production until prices recover. Therefore, the breakeven point is good support for an asset’s price.
Can prices go below breakeven? Sure — but normally not for very long. Prices can also move above historical premiums.
We’ve also seen that part of the price of an asset is its cost to produce (or replace), plus a premium. For housing, the premium can range from a small amount up to three times the cost. For silver it’s two to four times. For oil, the premium is normally about three times its cost.
If we add the historical premium, we can forecast price targets for gold:
The average total cost to produce gold is about $1,104, and this should act as price support.
Note that this is a moving target and has been moving higher (much greater than the global inflation rate) as costs have jumped.
Gold demand promises to remain strong. Meanwhile, gold’s cost of production provides a floor under prices, and historical premiums indicate the $2,340 level as a price target.
How Will We Get to $2,340 Gold?
The first leg of the current bull market in gold was driven by fear and financial market panic. The next leg of this bull market will be driven by the skyrocketing cost of gold production, which will trigger an enormous number of mine closures.
Gold may be set to nearly double from current levels, but it didn’t drop in a straight line and it won’t return to (and surpass) its previous highs in a straight line, either.
For now let’s watch and wait to see if it overshoots. If you own gold, you can stay put. But if you’re looking to add to or initiate a position here, my suggestion is to do nothing and to get ready to buy when the time is right. And stay tuned to your inbox on Mondays for my updated outlook.
We have a lot of ground to cover together in the coming weeks, and I look forward to showing you when to jump into a new opportunity and when to exercise patience. And when it comes to gold, let’s leave the kneejerk reactions to everyone else, and we’ll make our own moves with confidence.