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Gold's Next Mountain!

You Can Still Make Money Buying Gold

Written by Briton Ryle
Posted January 27, 2014

The last several years sure have been a wild ride for gold, its producers, and its investors. Charts clearly show a crossing of the mountain range — up, across, and back down again.

In 2011, gold prices saw a steep climb, with the benchmark SPDR Gold ETF (NYSE: GLD) ranging $57 from a low of $128 to a high of $185. Prices then plateaued in 2012 in a range of just $24 from $150 to $174. And we are all well aware of 2013, when GLD came back down the other side of the mountain in a $50 range from $165 to $115.

Converted into price per gold ounce, those ranges were approximately $570, $240, and $500. That is a typical cresting pattern — spike up, plateau across, dagger down.

By the looks of some 2014 price forecasts, changes in investment demands, and the state of producer operations, the new year looks as though it will be contained within another narrow range of some $300 between a low of $1,000 and a high $1,300 per ounce.

The question now is: Is this next narrow range going to be a valley toward another spike up the next mountain? Or is it just a landing that leads to another plunge still further down the mountainside?

To get a feel for what the next move in gold might be, let’s look at gold’s demand and the shape of some of its producers...

Gold Demand

Thomson Reuters GFMS (Gold Fields Mineral Services) last week released the second update to its highly regarded annual global gold survey.

In a nutshell, 2013 should not be seen simply as "the year gold sold off" — that's just what happened in the West. In the East, gold continued to be hoarded.

Gold simply moved from West to East.

"The centre of gravity in the physical market moved dramatically eastwards during the middle of 2013 as the professional investor disgorged metal, for it to be snapped up by rampant demand in Asia and the Middle East," the report indicates.

While gold selling in the West from ETF liquidation (paper gold investments) released some 880 tons of gold into the marketplace, physical gold purchases in East Asia, India, and the Middle East amounted to 1,066 tonnes — as much as 1,338 tons globally. On net, 2013 saw more gold buying than selling by 458 tons.

In other words, all the gold that was released through ETF liquidation in the West was completely soaked up by the Eastern hemisphere plus another 458 tons more, which ultimately came out of the miners' gold inventories, reducing above-ground supplies.

GFMS sees this strong appetite for gold continuing throughout 2014. Although it does expect "gold to take a back seat to other asset classes," it fully expects "strong physical demand will sustain" the gold price at "an average in excess of $1,200."

At the upper end of the range, the firm expects the continued reduction of U.S. Federal Reserve monthly bond purchases to keep Western interest in gold "muted," with a cap at around $1,330.

For the lower end of the band, the report emphasized that Eastern physical demand should keep the price "supported" at above $1,000. It also added that "central banks are expected to remain on the buy side of the market."

"This points towards the possibility of brief tests of $1,000 should there be any further investor retreat in the second and quite possibly the third quarters of [2014], but physical demand is expected easily to be robust enough to defend any test of this level and any such dips would be short lived," the report summed up.

As far as gold demand goes, then, it looks like the shape of 2014's leg on the graph might be a relatively flat approach toward the next mountain range up in 2015 — a move for which the gold miners seem to be well positioned.

Miner in Shape and Ready for Action

One strong indication gold miners expect higher prices in the future is a dramatic reduction in their gold hedge books. "The global hedge book contracted by 50 tonnes to stand at just 73 tonnes at year-end," the report confirmed.

The "hedge book" is the amount of gold miners have pre-sold, mostly through futures contracts. Pre-selling future production allows producers to lock in prices just in case they fall.

Less hedging means producers expect higher prices down the road. It also means investors can expect higher profits and higher stock prices in the producer space — which could outperform gold's rather soft forecasts noted above.

Gold producer stocks are coming out of one of their worst years ever, with the Market Vectors Gold Miners ETF (NYSE: GDX) falling 45% and the Market Vectors Junior Gold Miners ETF (NYSE: GDXJ) falling 53% over the past 12 months — compared to GLD's fall of 25%.

But the miners took advantage of the opportunity to write off a number of losses — from expensive mine acquisitions to equipment purchases to operating expenses — much of which were booked as charges in the second quarter of 2013.

The idea behind booking these write-offs in the midst of a bad year is that since 2013 was going to be a loss anyway, you might as well flush everything down the drain now instead of ruining even more quarters ahead.

Producers also focused on cost-cutting, closing their more expensive mines and reducing production. Small-cap Alamos Gold (NYSE: AGI), for instance, reported 50% less revenue in Q4 of 2013 over Q4 of 2012.

The plunge in revenues came not just from a slumping gold price, but also from strategically selling less gold in an effort to keep supply down and prevent further price drops.

To save mining costs, the company chose to tap into its stored inventory by some 8,200 ounces — selling a total of 198,200 ounces in 2013 when it produced only 190,000 ounces.

It expects to further reduce new supply by mining even less in 2014 — just 150,000 to 170,000 ounces. Similar output reduction industry-wide should stop prices from falling as an increasing demand fights over a reducing supply.

And the company’s efforts paid off, cutting its break-even all-in sustaining costs to between $960 and $1,000 per gold ounce. CEO John A. McCluskey indicated, "2013 was a challenging year with the sharp decrease in the gold price, yet with our low cost structure we continued to generate strong cash flow."

With $400 million in cash and no debt, a leaner and meaner Alamos — with most of its write-downs behind it — is ready for a profitable 2014.

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At the other end of the scale, large-cap Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) followed the industry-wide trend of writing down losses in 2013. Where Q4 pre-loss earnings came in at $0.84 per share, writedowns of $0.16 per share reduced the quarter’s net earnings to $0.68 per share, almost 13% below the $0.78 per share earned in Q4 of 2012.

Cost-saving measures at Freeport’s copper operations have managed to shave more than 24% off of consolidated average net cash costs from $1.54 per pound of copper in Q4 of 2012 to just $1.16 per pound last quarter. The company expects consolidated unit net cash costs to fall even further in 2014, well below 2013's averages due to further cost savings and a focus on higher ore grades at its Indonesia operations.

With analysts expecting copper to outperform gold in 2014, Freeport’s position as the world’s second-largest copper producer would make it a great multipurpose holding in a year when gold is not expected to do much. The company is also a major producer of oil and gas.

For 2014, Freeport expects sales of 4.4 billion pounds of copper, 1.7 million ounces of gold, 95 million pounds of molybdenum, and 60.7 million barrels of oil equivalents.

Investors are Holding On

While 2014 gold prices are expected to flatten in their range, there will be some swings. Dips should be bought, rallies should be sold, and miners represent bargains not seen in years. After clearing out losses in 2013, closing mines to cut costs, and with smaller pre-sold hedge books, gold miners look poised to outperform gold into 2015.

Even so, some diversification across multiple fields would be wise, with Freeport McMoRan being one of the strongest candidates as a multipurpose metals and energy producer.

Just remember that while stimulus reduction in the U.S. will continue to apply downward pressure on gold, increasing stimulus in Japan and Europe should counteract that. Add to that the relentless buying of physical precious metals across all of Asia, and 2014 should see prices well supported in a relatively narrow trading range.

All we have to do now is stick to our percentage or dollar allocation and not get greedy. Buy what you can, and sell when you can — using a trading scale where you scale your purchases every 2 or 3% down and sell a little every 2 or 3% up. 2014 should be a good year for dollar-cost averaging.

Until next time,

Joseph Cafariello for Wealth Daily

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