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Can Gold Come Back From The Brink?

After tripling in value between 2000 and 2011, commodity prices continue to crumble. Commodity indices have lost about a quarter of their value, a decline that quickened over the summer, when gold, oil, coal, corn, soy, and grain all hit multi-year lows.

Much of the slide can be attributed to the slowing global economy. Most notably, decelerating growth in China has slashed demand for all types of commodities. Also, enormous capacity that was planned during the boom years has come online, increasing global supplies. The combined effect has brought about the end of the commodity “supercycle,” according to several major investment banks.  

The story of gold over the last few years epitomizes the supercycle narrative.

China’s commodity-driven growth turbocharged demand for gold. Also, easy money from the U.S. Federal Reserve made the precious metal an attractive investment vehicle. The boom saw gold’s price rise from around $300 per ounce to more than $1,800 per ounce in 2011, a six-fold increase, as the Kitco chart below illustrates.

Gold - London PM Fix

But prices have since come down from the highs of 2011-2012. Gold dropped below $1,200 per ounce on Oct. 3 for the first time this year, a price point that has important psychological value.

Related: Mining Sector To Experience Major Investment Over Coming Months

The end of the commodities supercycle could hurt several commodity exporters. Take Australia, which holds about 10 percent of the world’s gold resources, but is the second largest producer after China. Gold is Australia’s third largest export by value, so a down period for the industry could put a damper on the Aussie economy.

And Western Australia, which accounts for about two-thirds of Australia’s gold production, could feel the effects disproportionately. The slump in prices is already hurting mining production in the dusty western state. That’s because, in addition to slumping prices, the state also suffers from rising costs and is having increasingly difficulty finding new gold deposits.

The managing director of Australia’s second largest gold mining company recently predicted a dark future. “The painful reality is that at this rate …Western Australia in 10 years’ time will only have one open-pit gold mine in production…That reflects many factors, including the simple truth that Western Australia’s remaining deposits are deeper and harder to find,” Northern Star Resources’ Bill Beament said at an industry conference.

Conditions could get even worse. Due to the downturn, the Australian state is considering a hike in the royalty rate, a policy change the industry vociferously opposes.

Australian gold mining companies have taken a hit. By early October 2014, Northern Star Resources (ASX: NST) saw its share price shave off nearly one-third of its value from three months earlier. Australia’s largest gold mining company, Newcrest Mining (ASX: NCM), has fared better this year, but has still lost around 75 percent of its value since peaking during the heydays of 2011.

Pessimism for gold is also being impacted by a potential development that could be just over the horizon.

The U.S. unemployment rate has dropped to 5.9 percent, the lowest level since the summer of 2008. The improvement has increased the chance that the U.S. Federal Reserve will rein in its policy of easy money, which could further scare commodities markets. The Fed is in the process of unwinding its extraordinary asset purchase program, and will eye an increase in short-term interest rates in 2015.

On the other hand, in their latest meeting, Fed officials expressed some concerns about the strength of the dollar and its effect on the economy. Gold prices jumped on the news, as it indicated the Fed may not take the punch bowl away too soon.

Related: Here's A New Update in India's Gold Saga

Moreover, there is a bit of a disconnect between the physical market for gold and the investment market for gold.

Gold is getting harder to find, and economics 101 tells us that when facing scarcity, a commodity becomes more expensive. Some gold market veterans believe that gold production is at an all-time high. “I don't think that we will ever mine as much gold as we do in 2015. That's positive for the gold price,” Chuck Jeannes, CEO of Vancouver-based Goldcorp, told Reuters.

Some companies may be forced to shutter some mines in the short term, but a cutback in supplies will only hasten the resurgence of gold prices as shortages hit, benefitting companies that remain in operation.

Overall, it is unclear how things will shake out. Over the long term, much depends on the ability of mining companies to tap new deposits. But over the next several months, the price of gold will be largely at the mercy of the U.S. Federal Reserve.

By Nick Cunningham of Oilprice.com

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