Can Anything Stop the Drop in Gold?

NEW YORK (TheStreet) -- On June 28, gold prices hit their lowest levels in nearly three years, just above $1,180 per ounce.

This bear move wiped out $66 billion in investor holdings since the metal hit its all-time highs in 2011. What's worse, current values suggest that some mines will be unable to break even without something in the way of a corrective rally.

Last month, a string of downgraded forecasts (from UBS, Morgan Stanley and BNP Paribas) put many investors on the defensive, and it now appears there is nothing that can stop prices from heading lower into the later parts of this year.

Key factors driving this decline can be seen in the fact that the eurozone debt crisis and macroeconomic risks as a whole have largely stabilized. This removes some of the safe-haven attraction that gold tends to provide.

In addition, real bond yields experienced sharp increases in the second quarter. The 10-year Treasury yield hit highs above 2.6% this month (an increase of more than 1% since the beginning of May).

Rising yields lead to higher opportunity costs in holding assets like gold, which offers no yield. Gold in the second quarter saw its biggest declines since the U.S. dollar was taken off the gold-standard in 1971. Those holding the SPDR Gold Trust ETF ( GLD) have seen losses of more than 25% this year alone.

Potential Upside

Is there anything that can halt the decline in gold? From a longer-term perspective, it should be noted that the average cost to produce one ounce of gold is roughly $1,200. Billions in mining asset values have been written off, and this reduced incentive to produce will likely lead to long-term contractions in supply.

This limits near-term profit prospects for companies like Kinross Gold ( KGC) and Newmont Mining Corp. ( NEM), which have seen dropoffs of more than 34% so far this year, but this also adds credence to the possibility of a run higher for gold in the future.

Shorter term, there are other scenarios that could slow the latest bear moves.

First, safe-haven demand generated by another banking crisis would be gold-bullish. Continuous scrutiny of austerity plans in Greece and credit problems in China show that this possibility still exists.

Second, a sustained global recovery would boost emerging market demand for the metal (in areas like jewelry and other luxury items.

Third, on the other hand, a weakening global scenario would leave emerging markets vulnerable to external shocks. Negative developments that cause declines in stock markets would also drive investors back into safe-haven assets, pushing gold prices higher.

The final area to watch is inflation. Recent comments from Federal Open Market Committee members have indicated that inflationary pressures are expected to return as we move into 2014. Since gold is often used as to protect against inflation, any evidence of higher prices can boost the metal.

The 23% drop in gold during the second quarter has been one of the biggest market stories of the year. At the moment, there is little in the way of bullish reasoning to suggest that these declines have reached their lows.

Gold itself has no intrinsic value, so calling a bottom in the commodity is a difficult practice. Since the U.S. dollar was taken off the gold standard, inflation-adjusted prices in gold have averaged something near $750 an ounce.

So even with this year's declines, one should clearly consider the downside potential. But this does not mean there aren't any scenarios in which prices could rebound.

Those exposed to the metal, either through ETFs or mining stocks, must consider each of these possibilities.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is a university teacher in international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of websites, including MarketBulls.net, Seeking Alpha, FX Street, and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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