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Gold loses more of its lustre

The gold price has been under pressure, sliding 2.3% today to trade at US$1,247 an ounce, its lowest level in almost three years. With US economic data showing the economy is recovering – overnight, house prices had their biggest rise in seven years – and the US Federal Reserve warning that it is getting set to take the foot off the economic stimulus accelerator pedal, a strong US dollar is pushing gold prices down.

That seems to be a trend, and it appears inevitable that gold will drop further from here.

For Australia’s largest gold miners like Newcrest Mining (ASX:NCM), Evolution Mining (ASX:EVN), Medusa Mining (ASX:MML) and Regis Resources (ASX:RRL), already hit by falling gold prices, the bad news is never-ending. At current prices, several high cost gold mines will be forced to close – further falls will see many more shut down. Smaller miners with a single high cost gold mine could be forced out of business altogether.

There is an upside

The upside for gold as I see it, is that more than 50% of gold produced each year ends up in the hands of consumers as jewellery, and another 28% as coins and gold bars. The market and price though are more driven by sentiment and the movement in Exchange Traded Fund (ETF) holdings. That’s despite the total holdings of gold in ETFs representing less than 1% of the total available gold.

In the last quarter, ETFs saw an outflow of 177 tonnes, either contributing to the fall in gold or because of it. More than offseting that, jewellery demand was 550 tonnes, and close to 300 tonnes was snapped up by retail investors in coins and bars.

But is there a floor?

It appears that there is a disconnect between actual demand for gold and the actual gold price, but obviously that affects the price gold miners get. No matter what ‘normal’ investors think of gold having no intrinsic value, some retail investors and plenty of consumers clearly ‘value’ it.  I suspect that as the gold price falls, demand from retail consumers will rise – as we’ve seen recently with the Perth Mint reporting huge jumps in demand for gold coins and bars, perhaps putting a floor under the gold price.

Interestingly, demand for physical gold, in jewellery, bars and coins is rising, especially in emerging nations China and India, and that might continue for some time as those economies evolve. At some stage demand will drop off, perhaps when those consumers gain more confidence in other assets, such as equities, property, fixed income, cash and paper money.

Foolish takeaway

In the end though, gold miners are tough businesses – like most resources businesses they are highly capital intensive – and so far have not delivered the returns to shareholders they deserve, either in the form of dividends of capital gains. That may change in future, but it appears unlikely.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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