Gold Prices: Short-Term Volatility, but Bullish Long-Term

Gold Prices The Next Big TradeAs the bearish sentiment prevails, I continue to pay attention to the demand and supply metrics to see where gold prices are headed next. Looking at these factors, it’s clear why I’m bullish on gold.

Central Banks to Drive Gold Prices Higher

Central banks have been very active when it comes to buying gold. They have been buying since 2009 and haven’t stopped, as many suggested they would. In 2014, they bought almost 17% more than the previous year. (Source: World Gold Council, February 12, 2015.)

In 2015, we have already started to hear about their buying. In February, Kazakhstan added 2.7 tonnes of the precious metal to its reserves. It has been buying for a very long time now. In addition to this, central banks from Malaysia and Tajikistan also added gold to their reserves. (Source: Reuters, March 25, 2015.) In January, the central bank of the Netherlands bought gold bullion for the first time since 2008.

I can’t stress this enough: it will not be major central banks that will be buying the yellow metal; it will be smaller nations that are significantly impacted by the currency mayhem going on in the global economy. (And I expect them to do it quietly.)

Central banks’ gold purchases, if anything, are telling me they don’t really care about what price they get the metal at; it seems they just want to buy more and more of it. Going forward, I expect small central banks to ramp up their gold buying. They know that the yellow metal can really reduce the variance in their reserves created by the fiat currencies they hold.

This phenomenon alone can take the price of gold much higher. If you add demand coming from India and China, it would be foolish to believe gold prices will see a massive decline going forward.

Gold Bullion Supply Crunch Continues

As the demand is increasing, the supply side continues to face troubles.

Consider the U.S. mine production of the precious metal as one example. In the first 11 months of 2014, U.S. mines produced just 193,000 kilograms of gold. In the same period of 2013, they produced 209,700 kilograms. In other words, gold production at U.S. mines has declined by almost eight percent in the last year. (Source: U.S. Geological Survey web site, last accessed March 31, 2015.)

What’s also interesting to note is that if you look at the long-term supply, it looks gruesome at the very best. In its most recent presentation (March), Goldcorp Inc. (NYSE/GG) said that this year, gold production will peak. That means it will only decline from 2015 on, with expectations of a drop from about 95 million ounces this year to just slightly above 80 million ounces in 2022. (Source: Goldcorp Inc. web site, last accessed March 31, 2015.)

Basic Economics at Play in Gold Market

What we see in the gold market is basic economics. We see the demand is the same, if not increasing. Buyers remain, and I believe they will only increase in numbers going forward. Those who have the ability to produce are struggling. On top of all of that, production is about to face some major obstacles. Saying the least, this is a perfect recipe for higher gold prices.

To me, at their current value, gold bullion prices seem wildly undervalued. The risk of rising interest rates has spooked investors and as a result, they sold. There’s nothing much more to it than that.

I truly believe the yellow precious metal will surprise investors. It’s the next big trade in the making.