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Economy Jun 29, 2013

Gold bears, watch out; there may be life in the metal yet

By R Jagannathan

The continuing crash in gold prices has brought out the bears in full force. Prices are ruling around $1,200 per ounce, and in the domestic markets, Friday saw the metal lose Rs 1,150 per 10 gm in Delhi - hitting a 23-month low of Rs 25,650.

Jamal Mecklai, writing in Business Standard, has an I-told-you-so confidence about him when he cockily predicts that gold could go as low as $900 an ounce. "There are many signals that the world could be entering yet another phase of risk aversion. The continuing collapse of gold (I told you $1,200; now I'm saying $900 - remember you read it here first); the sudden seven percent dive in the Nikkei a week ago; protests in many of the brighter stars of the emerging markets firmament. Any or all of these could be pointers to another sudden bout of market terror."

Reuters

Reuters

He could be right. For the markets are always manic-depressive. They always over-shoot or over-correct. So one can't rule out gold hitting $900.

But I wouldn't count on it. For several reasons.

First, there is something called the economic cost of producing gold. At $1,200, many gold mines in South Africa will be losing money, and it is only a matter of time before they start cutting production. When supply falls, prices will start stabilising.

Mark Cutifani, CEO of mining conglomerate Anglo American, is quoted in this report as saying that gold production could "see significant cuts in response to the tumble in the metal's price." As wellCutifani said: "I don't see the gold price staying low for a protracted period of time because the drop in production that will occur will be quite significant and will surprise everybody."

According to Mining Australia, "South Africa's high-cost gold producers have very little margin for output mishaps at price levels around $1,400 per ounce." If this is the case, at $1,200, mines will but cutting capacity like there is no tomorrow.

Second, it is difficult to see how price drops will not lead to an increase in demand. In May, gold imports soared in India precisely because of this price fall. The government responded by raising import duties and forcing banks to reduce gold sales.

But elsewhere in the world, there is no such restraint. While investment demand is weakening due to a likely revival in the US economy and rising bond yields (speculators are selling gold exchange-traded funds, or ETFs), there is no sign that jewellery demand is taking a dip .

According to the World Gold Council (WGC), in the first quarter (Q1) of 2013 (January-March), demand for jewellery went up 12 percent. It was 185 tonnes in China and 160 tonnes in India. It was investment demand which ruled flat, with ETF outflows at 177 tonnes. But overall investment demand was flat, not down, at 320 tonnes.

But here's the interesting part: central banks were busy buying gold even while the government of India has been saying don't buy the stuff. According to the WGC, Q1 was the ninth straight quarter in which "central banks have been net purchasers of gold." They bought 109 tonnes.

But here's another tit-bit: the 25-30 percent gold price crash over three months spells a short-term rally in it, if the past is any guide.

Adrian Ash, writing in BullionVault, notes that there is an 80 percent chance of gold rising over the next three months after the collapse of the previous three.

"Over the last 45 years, when gold has dropped this much or worse in three months, it has typically rallied hard over the following four weeks. Better than four-fifths of the time in fact, with an average one-month rise of 11.1 percent. On those occasions when gold fell and extended its loss, however, the average drop for dollar investors who held on was 5.3 percent."

So, gold buffs, take heart. For Indians, who love the feel of gold for its own sake, never mind the price, this may be a good time to start investing in paper metal through systematic investment plans (SIPs) in ETFs. Who knows, you may even find a short-term bonanza.

by R Jagannathan

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