In case you haven’t heard, the price of gold is in free-fall. The yellow metal hit a five-year low on Monday, plunging as low as US$1,088.05 per ounce on the Shanghai gold exchange before recovering slightly. As of this writing, gold has fallen by 15% since mid-January and by 40% since August 2011.
This is not good news for gold miners such as Goldcorp Inc. (TSX:G)(NYSE:GG), Yamana Gold Inc. (TSX: YRI)(NYSE: AUY), and Kinross Gold Corporation (TSX: K)(NYSE: KGC).
So, why have gold prices slumped so much? And are they due for a rebound? Most importantly, should you buy these companies?
A perfect storm for gold
There are a number of reasons why gold prices have been declining. First of all, American interest rates may rise as early as September, which makes the U.S. dollar less scary. The turmoil in Greece is also prompting investors to flock to the U.S. dollar, putting pressure on gold prices. And now we can add another item to the list: Chinese selling.
Chinese citizens unloaded gold at record levels on Monday, with over three million lots trading during the day. Entering the day, the average had been 30,000 lots per day. This whiffs of panic selling, which is not unheard of in China.
Earlier this month, China’s stock market plunged by a third from its mid-June peak, a rout that only ended with massive government intervention. Clearly, many Chinese people responded to falling prices by selling their holdings, which can make bear markets very severe. So, with gold prices edging down in recent weeks, Chinese investors responded as they usually do. Unfortunately for gold investors, Chinese authorities don’t have a vested interest in gold.
Where do we go from here?
Gold prices are practically impossible to predict with certainty. So, if anyone tells you he or she knows which direction prices are going, they’re lying to you.
That said, there are many reasons why it can fall further. If you’re thinking that gold must have reached a bottom by now, and that gold stocks are perfectly safe, you should think again.
First of all, unlike companies, gold has no potential to produce cash flow. Its price is solely determined by the willingness of buyers to speculate. This means there’s no theoretical limit to how low prices can go.
Furthermore, gold prices are still high by many standards. Even after falling recently, gold has still quadrupled since 2001, far outpacing inflation. When looking at the historical cost of gold vs. housing, the metal theoretically should trade below US$1,000 per ounce. And even at this price, producers are still making healthy profits. So, even if gold falls below US$1,000, you’re unlikely to see any major supply shortages.
Should you buy these stocks?
It still may be tempting to buy gold stocks. After all, Goldcorp has fallen by about two-thirds since early September 2011. In this same period, Kinross and Yamana have each fallen by over 80%. They must look pretty cheap right now.
But I would hold off. All of these companies have had their own struggles, whether it be unwise acquisitions, failed projects, or operational issues in Latin America. Furthermore, if the gold price falls anymore, these stocks will face a beating. Yamana and Kinross could find themselves in serious financial trouble. You should look elsewhere for better opportunities.
