How Low Can Gold Go?

The price of gold crashed to a three-year low this week, tumbling to $1,180 per oz. earlier today. Gold also is on the verge of its biggest quarterly decline in the US since public trading began in the early 1970s. On a global basis, it’s the worst quarter going back to the 1920s.

Gold hit an all-time high of $1,920 in September 2011, after surging some 700 percent since 2002. Since then, the Midas metal now has fallen about 38 percent, and 2013 threatens to be the first losing year for gold in that time.

Gold held up well until October 2012, when it was unable for the third time to get past $1,800 again. From there, gold declined in eight of the next nine months.

It’s no coincidence that this failed rally preceded by just a few weeks the advance in the S&P 500 that began in November and continued with little interruption until June. Gold tends to do well when stocks don’t, and vice versa.

The Bottom Fell Out


Even in 2013, the decline was relatively orderly until April. That’s when it gave way, with gold suffering its worst two-day drop in more than 30 years. The trigger: talk of gold sales from Cyprus to Spain and elsewhere.

The collapse accelerated again just last week, when Federal Reserve Chairman Ben Bernanke provided a theoretical timetable for when the central bank might begin to cut back its monthly bond purchases.

It was unusual that both gold and US Treasury bonds, both considered safe havens from financial turmoil in recent years, suffered sharp declines in the wake of the Fed’s commentary on its possible exit from quantitative easing (QE).

But gold had already lost luster as a QE beneficiary, failing to rise even as Japan last November launched its own massive buying program. Japan’s QE is roughly three times as big as that of the Federal Reserve, relative to the size of each nation’s economy.

All told, the precious metal has fallen some 25 percent in the second quarter, which ends today. Some gold-mining stocks have lost 40 percent to 50 percent.

The Market Vectors Gold Miners exchange-traded fund (GDX) is now at its lowest point since late 2008. It’s off 38 percent for the quarter and 64 percent from its 2011 peak. The Market Vectors Junior Gold Miners ETF (GDXJ), started in 2009, is down 46 percent in the quarter and 80 percent from its high.

The carnage stemmed primarily from heavy selling by two types of investors.

One is long-term investors who bought gold primarily as a hedge against the threat of inflation and a devaluation of currencies triggered by QE. But global inflation continues to fall, with some of the US measures now at a 50-year low.

The second area of big liquidations was hedge funds and other speculators who were forced to sell because of margin calls or the dramatic shift in global interest rates and currencies that crushed their positions.

For example, Japan’s incredibly low interest rates and declining currency have made it possible to borrow yen, use the proceeds to make leveraged investments elsewhere, then repay the loans in cheaper yen. But sharp reversals in Japan’s currency and bonds in May and June forced speculators to reduce their risk.

Amid the heavy selling, it was perhaps inevitable that Wall Street analysts would pile on. Several recently have dropped their price targets, typically from $1,050 to $1,125 per oz.

Among them is UBS, usually among the gold bulls. It recently slashed its 12-month forecast from $1,750 to $1,050 per oz. Goldman Sachs, which has made several timely calls on gold, now has a $1,050 target for 2014.

The tumble recently forced Australia-based Newcrest Mining Ltd (ASX: NCM, OTC: NCMGF, ADR: NCMGY) to write down the value of its reserves by AUD5billion-AUD6billion, the largest one-time charge in gold-mining history. That brings the industry total to about USD17 billion in the past 16 months, according to Bloomberg.

Other major gold miners almost certainly will follow. For examle, Newmont Mining Corp (NYSE: NEM) currently uses a price of $1,400 per oz. to calculate reserves. Barrick Gold Corp (NYSE: ABX) uses $1,500 for most operations, while Goldcorp (NYSE: GG) generally carries a $1,350 value.

Another likely consequence of the price decline will be production cutbacks. For many miners, gold now is hovering near marginal production costs of about $1,000/oz.

But the gold price is affected much more by emotional factors than by supply. For example, previously mined gold is still in circulation today. So it’s mostly about demand, which is driven largely by investor psychology.

Unfortunately, it’s impossible to put a specific value on gold. It produces no income and generates no earnings. It’s not a broadly recognized medium of exchange.

Personally, I currently own no gold and haven’t done so for quite a while. I view it as insurance and a hedge against trouble. But I am considering buying again.

I prefer the best combination of direct ownership and convenience. For me, this means investing through an exchange-traded fund (ETF). SPDR Gold Shares (GLD) is the biggest among several gold ETFs.

Note that there’s a significant tax negative for gold ETFs, if you hold them in a taxable account. They don’t qualify for the long-term capital-gains rate of 20 percent or less. Instead, profits are taxed at 28 percent or more. Consequently, gold ETFs are best held in a tax-deferred retirement plan.

Some people prefer to hold the metal itself, typically as bars or coins. However, storage is a concern. Gold certificates are another option.

Some investors like gold-mining shares. Historically, these have done much better than the metal when prices are rising, and worse when prices fall. This is because of their operating leverage relative to production costs.

In recent years, however, mining stocks have been laggards even when the gold price was rising. This was primarily because of poor capital allocation, including costly acquisitions, and rising production expenses. And the gold stocks have been dismal performers during the downturn, as the above numbers show.

It’s hard to say when and why gold will stop falling, begin to stabilize and rebound again. Buying something that has declined a lot, particularly in a short time, is also difficult. But now the investment risk is considerably lower, not higher.

At the very least, gold is worth a look now.