Why Gold Isn't Going Up

NEW YORK (TheStreet) -- In my last gold update, I didn't receive one negative comment. I found it surprising because normally I receive blowback from gold perma-bulls using comments to explain my egregious errors of concluding that gold prices have peaked.

I trade gold primarily in two ways: I track the S&P Gold Trust ETF (GLD) and own physical gold at times (not currently). I cut my trading teeth trading gold futures, but since I moved to a focus on equities, I find the GLD works well for me. Investing and trading in gold doesn't have to be overly complicated.

So much focus is placed on the Federal Reserve's actions, and in my opinion, it's largely misplaced. Sure, the Fed does influence inflation -- no one will question that -- but it's only one factor and not the most decisive factor to consider.

The most influential factor are energy prices. Energy prices trump the Fed and every other influence over the long run. You can track oil prices the same and easy way that I do, through the United States Oil Fund ETF (USO). I'll explain how oil prices influences gold prices and why they are the most important compass to determine the direction of gold prices, but let me touch on gold miners briefly because it ties in together.

The Market Vectors Gold Miners ETF (GDX) will allow you to quickly compare any given mining company against its peers. You can read 10Ks, and press releases until you're blue in the face, but nothing cuts to the chase like comparing recent stock performance of a miner you may add to your portfolio against the GDX.

You can find considerable differences between the performance of Allied Nevada Gold (ANV) Newmont Mining (NEM) and Barrick Gold (ABX), but your most efficient way to filter between them and others is to overlay any given chart with GDX. Now is maybe appropriate time to do so.

When gold was trading above $1,600, a lot of management "sins" get washed away unnoticed, not unlike a poorly configured sluice box losing more product than desired. When you're making money hand over fist, efficiency can become a secondary thought.

Now gold is trading slightly above production costs for many companies, and many gold bugs understandably believe a natural floor has been created as a result. It's reasonable to think so -- after all as prices go down, demand increases and supply dries up. Simple economics 101 in play, right? Not exactly.

Fuel costs, specifically diesel fuel costs, are a significant cost component for miners. As energy prices decline, the cost of production declines. Decreasing production costs mean marginally profitable mining operations can continue to produce even with lower revenue per ounce. The impact is relatively small compared with the much bigger impact on consumers.

Gold isn't worth over $1,200 an ounce because of industry use; the primary catalyst driving gold prices is speculation. Buyers want the yellow metal to hedge against inflation.

Because of America's oil boom, refineries are able to produce diesel cheap enough to export it to other countries. Another product from oil cracking is gasoline, and if you filled up lately, you know prices are lower than a year ago.

Without fear of inflation, demand for gold by speculators will fall, resulting in gold prices stabilizing not much higher than production cost. If you're hoping for a bounce in gold, you will first have to see a bounce in energy prices.


At the time of publication, the author does not hold a position in any stock mentioned.

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

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