How low can gold go?

Of late, the likelihood for a drastic lowering of gold prices (COMEX:GCZ13) has become a common talking-point, with many analysts – ourselves included – believing that a drop to $1,000/oz should not be ruled out in the next year.

Indeed, although the Syria-led rally in oil prices has resulted in a recent upturn in gold prices, the rise is unlikely to be cemented in any longer-term positions. Certainly, a more accurate outlook for gold prices needs to take into account the impacts of developments in three key areas: Investor demand, central bank behavior and trends in the mining industry.

In the past decade (and even more so in the post-crisis environment) these areas have experienced massive shifts, which have largely contributed to the supply and demand disequilibrium that is now of concern. Furthermore, investors still seem wary of gold’s dramatic collapse in the first half of this year. The question has since become, how low should gold be priced in order to bring supply and demand into equilibrium? Let’s try and determine this answer by examining the broader trends currently taking shape.

Investor demand

Whether for bars, coins or exchange-traded products (ETPs), investor demand for gold has historically held steady at around 8%-9% of total demand.

Since the onset of the financial crisis, however – and encouraged by quantitative easing (QE) – investor demand expanded to a high of almost 1,300 tonnes in 2012 (nearly 30% of total demand), helping to propel gold prices to record highs. Undoubtedly, this was an unsustainable rise. And now that U.S. interest rates are rising and the dollar is strengthening – thanks to the Fed’s likely “tapering” of its QE program – investors are relinquishing their holdings of gold.

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