April’s gold crash has brought prices back down from unprecedented levels that were holding steady earlier for the year. With prices reduced by more than 10% in less than a week, questions have been raised about whether or not such volatility is representative of the intangible nature of the commodity, and as to whether or not there is a ‘supporting price level’ based on some level of tangible value. This becomes a particularly interesting study when we start to look then at how it is that governments are selling off gold reserves to support a failing Euro, cash out of foreign reserve exposure to the USD, and taxing its consumption in major consuming nations.
The trick to understanding the feasible price point of Gold in the current market environment is to start by breaking down exactly what happened during the flash crash in April that caused prices to drop to about $1,400/oz. Specifically, by looking at how it is that European nations began liquidating their reserves to raise capital for their dysfunctional banking units, as well as the way in which the Chinese government has been reported as selling off their own reserves to mitigate their exposure to the depreciating USD, we can immediately see that there is downward pressure coming from major players.
That being said, despite the fact that major governments are setting out to sell off major quantities of gold, there is a huge demand volume that is still supporting the market all the way down to $1,400 and beyond, meaning that incremental decreases in the price will come with increasing resistance from other investors wanting to take on exposure to gold as it declines. This means that there is still liquidity in the gold market, and that the prices are likely to remain fairly efficient in terms of their ability to price in its function as both an inflation hedge and an intangible asset. From there, we can start to look at how it is that production restraints impact the increasing supply of the commodity itself, and therefore contains price points to certain fundamental points.
To understand gold’s fundamental price point (the other side of the equation), we can start by looking at what point the producers need the price of gold to be at in order to maintain profitability. Looking at historical data, we can break down production, transportation, and storage costs in a way that implies a per-ounce cost of production. Based on growth from last year, it has been generally forecasted that producers require approximately $1,100/oz prices to maintain the profitability of their operations based on their current size (as a function of capital expenditures this year). This means that the cost pressures of gold production require the price to gold to be above $1,100 to break even, and will likely require a point of above $1,200 to beat out their require return rate for investors.
From there, looking at historically present technical standards, we can also see how it is that there is a statistical support level for gold at approximately $1,300/oz, which represents a particularly aggressive low point against its previous highs. The end result is that we have evidence supporting a fundamental supply-side restriction at the $1,100-1,200/oz point, and a technical indication of support at $1,300/oz, which provides us with some indication of context around how it is that prices at their current point ($1,400) fit into the overall equilibrium perspective. In plain English, this means that we’re probably pricing things in accurately, despite the fact that the cost is cheap in the historical context.