Why Gold Prices And Miners Stocks Are Melting

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Gold prices and gold mining stocks collapsed Thursday as the World Gold Council reported that global gold demand fell sharply in the third quarter from the year-ago period because of global weakness, high prices and slower demand from China.

Gold market watchers expect prices to fall much further before finding a floor.

In midday trade, spot gold prices sank 0.69% to $1,716.60 an ounce.SPDR Gold Shares ( GLD ), tracking a 10th of an ounce of bullion, fell 0.63% to 166.09. PowerShares DB U.S.Dollar Index Bullish ( UUP ), measuring the dollar against a basket of global currencies, was nearly flat at 22.20.

The World Gold Council reported :

1. Global gold demand in the third quarter fell 14% year over year to 1,084.6 tons, worth about $57.6 billion. However, demand rose 10% over the second quarter.

2. Investment demand in Q3 dropped 16% from the year-ago period.

3. Global jewelry demand for gold fell 2%, while demand from technology fell 6%, "reflecting global head winds and high absolute prices."

4. Demand from ETFs shot up 56% to 136 tons.

5. Central banks continued to buy gold in Q3 -- 97.6 tons worth $5.2 billion -- but at a slower pace and accounted for 9% over overall demand.

6. Gold supply shrank 2% year over year.

Although the WGC's report was widely credited for Thursday's price moves, some gold experts have little faith in its report, which is based on surveys.

"The WGC-computed investment demand figure is entirely irrelevant to gold demand and the price of gold," said Paul van Eeden, president of Cranberry Capital, a private Canadian firm that invests in explorers. The WGC's data don't add up to him because the amount of gold that's actually traded daily as tracked by the London Bullion Market Association  far exceeds what the WGC computes on an annual basis.

"It doesn't make any sense," van Eeden said.

Supply And Demand Dynamics

So what's really driving supply and demand and thereby prices? The gold bugs contend that gold prices are bound to rally as central banks buy bullion to diversify their reserves. Central banks' demand weakened as prices rose in the third quarter and they'll likely start buying more when gold prices fall further, says gold bull Peter Spina, president of GoldSeek.com in Littleton, Colo.

"Central banks are not chasing the price higher. They are likely to be more aggressive accumulators on pullbacks," said Spina. "I believe that is one of the big supports under the market and gives us a solid price floor at $1,600 (an ounce)."

Secondly, the gold bugs scream central banks around the world are printing money in their so-called quantitative easing programs to support the economy. But such efforts at some point are seen igniting inflation and sending gold prices soaring. So far, U.S. inflation has been mild despite three rounds of quantitative easing -- QE1, QE2 and QE3 -- which has boosted the Federal Reserve's balance sheet to $2.8 trillion. The newly printed money is just sitting on banks' books and isn't being loaned out to consumers or corporations, which are already hoarding cash.

"The U.S. is saturated with consumer and corporate debt," said van Eeden.

As a result, gold is very overpriced and the gold bulls are buying for no reason, he said. Gold may be a safe haven or hedge against inflation, but there isn't enough inflation to warrant high demand.

"Gold has already gone up a lot in price, so it is akin to buying very expensive insurance," said Gerard Mihalick, a portfolio manager at Wilkes Barre, Pa.-based Berkshire Asset Management, with $700 million in assets under management. "In the late 1970s early 1980s, gold actually declined nearly 70% in real terms until it bottomed in the early 2000s.

"Investors who bought at the peak in the early 1980s are just getting back to even in terms of purchasing power. Over a long period of time, stocks have done a better job at generating real returns than gold."

Gold Miners' Misfortune

Market Vectors Gold Miners ETF ( GDX ), a basket of large-cap global gold producers, fell 2.6% to 45.98.

Market Vectors Junior Gold Miners ETF ( GDXJ ), a basket of small-cap global producers, plunged 4.2% to 21.15. Both fell deeper below their 200-day moving averages, which is very bearish.

Investors are most likely selling the gold miners stocks to harvest tax losses, said Adrian Day, founder of Adrian Day Asset Management in Annapolis, Md. "There has been lots of tax-loss selling going on the last several weeks," Day said.

Gold miners will likely bottom at their lows from May 2012, says David Morgan, publisher of The Morgan Report, which specializes in gold.

"We think those lows will hold and if the gold stocks get into that range it will be quite a buying opportunity," said Morgan.

"Once the May lows are tested, we expect to see a divergence where the gold stocks gain strength and trend upward (following gold), while the general equity market continues to suffer because of the constraints presented in the upcoming fiscal revisions presently to take place at year-end."

A correction to the May lows would make for a 15% drop from GDX's current price and an 18% drop for GDXJ.

Follow Trang Ho on Twitter @TrangHoETFs

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , ETFs
Referenced Symbols: GDX , GDXJ , GLD , UUP

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