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July 11, 2013

Gold’s Decline Is International Concern

All that glitters isn’t paying off as it did only a couple of years ago. In April the precious metal entered a bear market, driven by the threat that Cyprus could be forced to sell some of its bullion to cover its bailout and by fears that QE (quantitative easing) in the U.S. might be approaching an end. That was followed at the end of June by its worst quarter ever, when it lost 23% in value, as investors still worried over a possible end to QE. It fell as far as $1,180.71 at the end of June, its lowest level in nearly three years.

While April’s nosedive in price of more than $200 in two days stimulated a buying frenzy that helped bring the price back up—for a while—no such rescue took place in June, even though the price drop was nearly as dramatic: almost $200 over a 10-day span. All over the globe, it seems that many buyers are waiting—maybe for better prices, maybe out of fear that if they buy now they’ll see the bottom drop even lower.

It doesn’t help that in India, new import restrictions have slowed the country’s normally heavy consumption of physical gold and in China, buyers are more or less sitting out the market. ETFs haven’t done well, either, with the price drop sending outflows soaring. That’s probably not surprising, considering the drop not just in the price of gold in but mining stocks as well, which have lost even more than gold.

Many mining companies are trading at junk levels despite having actual ratings higher than junk; Toronto-based Barrick, for instance, which is the world’s largest gold mining company, holds an investment grade of Baa2 but its implied bond rating, according to Moody’s, has deteriorated to Ba1. With gold futures trading at the end of June in the neighborhood of $1220 an ounce, down 36% below the record they set in September of 2011 of $1,923.70, it’s not an encouraging atmosphere.

But getting back to ETFs: If they’ve invested in gold, they’re not happy. The SPDR Gold Trust, which at one point was actually the world’s largest ETF, has lost half its value, falling from $76 billion down to $38 billion as of the beginning of July. It is now only the fifth largest ETF, thanks to the fall in gold prices and to the actions of worried investors, who have withdrawn some $18.1 billion.

According to Morningstar analyst Janet Yang, the rout in gold prices is hardly unexpected. The equity team has been expecting gold to be around $1,200 an ounce, even when it was $1,900, she said. “This is a story that’s been going on for the past two or three years,” she said. “In 2011, gold was still going up, but gold mining companies had been going down and a lot of people thought there was a lot of value there—almost an arbitrage opportunity between buying gold and buying mining companies. The discrepancy stayed, and as gold goes down, it can get even more dire [for mining companies].”

Yang said, “In terms of investing in physical gold, a big reason that people piled into it in the last few years was central bank action. That situation hasn’t necessarily changed, but at the same time, the inflation people were so worried about has not materialized. So that’s been a big contributor to gold prices going down, and that affects the miner.”

The interesting thing about the gold mining industry, she said, is that “gold miners have never been accused of being well-run companies. It’s been kind of a growth-at-any-cost mantra, and I think the past three years have opened their eyes, as they’ve seen share prices fall.” Therefore, the companies, some of which had “basically tied their dividends to gold prices,” have been revising their dividend policy. “These stocks have benefited from this environment, but if gold prices keep going down there’s no way they can keep paying the dividend they’ve been paying the past few years.”

Yang said, “It’s pretty interesting, because basically in 2009 and 2010 all these companies took off the hedges that were on their books for gold prices, because people wanted exposure to gold and they certainly got it. Investors weren’t thinking about what would happen if [gold prices] went in this direction.” As a result, though, mining companies are “paying more attention to management, and being more careful about how they spend shareholder’s money.”

While much of the gold news may be grim, and Goldman Sachs predicts further falls in the metal’s price in response to an end to U.S. QE, that hasn’t dimmed the metal’s luster for some. According to a report from BullionVault, an online service investors use to buy and sell physical gold and silver, while some have been taking profits as the price of gold fell, others have seen it as a buying opportunity, maintaining its Gold Investor Index at 53. Anything above 50 indicates more buyers than sellers. And Swiss-based UBS AG has begun offering vault service in Singapore, indicating that despite the fall in gold prices, there is demand among clients there and in Hong Kong for a place to store their holdings of bullion.

Singapore has worked to attract business in bullion trading. In 2012, it did away with a 7% tax on investment-grade metals, hoping to draw more business in the region as a precious metals trading hub. In addition, on July 3, it also launched the world’s first physical precious metals exchange with peer-to-peer bullion trading capabilities integrated into the trading platform. The Singapore Precious Metals Exchange (SGPMX) has an MOU with Certis CISCO to act as custodian for bullion storage.

It is likely only a matter of time before the price begins to rise again. Bloomberg Industries has pegged the cost to mining companies of producing an ounce of gold at $1,201 per ounce, which means that, if mines are to continue to produce, continued physical demand will drive the price back up.

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