Why Two-Thousand-Dollar-Ounce Gold Becomes Plausible Scenario

The rise in gold bullion prices since the beginning of the year has been very hard to digest for those who said the precious metal is useless. To me, this rise in gold bullion prices isn’t surprising at all.

And the small pullback in the price of gold we have experienced this week is very healthy and positive for gold. Gold was up 13% since the beginning of 2014. Like any investment that is going up in price, you want to have small price corrections along the way as investors take some money off the table and new players enter.

I have been writing in these pages how the demand and supply picture of the gold bullion market is getting out-of-whack. The producers don’t have much incentive to produce when precious metal prices are low. But on the other hand, with uncertainty in the global economy and other factors, we are going to see a lot of buying activity.

The main reason for the decline in gold bullion production: gold miners, in order to cut their costs, have reduced their exploration budget. Spending less on exploration and development of mines essentially leads to lower production in the future. This isn’t the case in the U.S. alone; gold companies around the world are pulling back on their exploration budgets.

According to Natural Resources Canada, a department of the Government of Canada, mineral exploration and deposit appraisal expenses in Canada declined by 41% in 2013—from $3.9 billion in 2012 to $2.3 billion in 2013. In 2014, these expenses are expected to drop further. (Source: Natural Resources Canada, March 2014.)

Looking at the demand side of gold bullion, it’s very robust.

As I have said before, low gold bullion prices continue to give the average buyer an opportunity to buy more. And without a doubt, they are buying more. We saw China become the biggest buyer of gold bullion last year, overtaking India.

In 2013, we saw the Indian government and the central bank work together to curb the demand for gold bullion in India. The World Gold Council (WGC) says gold bullion demand in India was 975 tonnes in 2013. Imports of the precious metal into the country were only 655 tonnes in the first 11 months of the year. This means the rest came through smuggling. The WGC expects the smuggling of gold bullion into India to increase if the government keeps on trying to reduce the demand. (Source: Reuters, February 18, 2014.) This should give you some idea about the appetite for the precious metal in India.

I continue to believe there are great opportunities for investors in the mining sector, especially on any pullbacks in the price of gold bullion. Well-known gold producers are trading for very low price-to-earnings multiples. If gold bullion prices increase to $2,000 an ounce, as I expect, their shares will double, if not triple in price.

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Courtesy of Michael Lombardi, MBA

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