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Gold: How does a falling price impact you?

April 24, 2013 by Editor, InvestingForMe

When gold prices fall like they have, it doesn’t matter whether you have invested in gold or not. Price changes will have an impact on all of us – on the Canadian economy, our governments, and on us as individuals. How much of an impact will depend on your own personal relationship to gold:

Remember those recent headlines predicting gold reaching $2,000, $3000 and, even, $10,000 per ounce in the coming months?

Well, today with gold priced down 27% (peaking in September 2011 at $1,920.30), and tentatively hovering around $1,400, what are the investment headlines saying now? Uh, not so much … In fact, the crystal-ball gazing headlines now have turned downright negative predicting that gold will continue to decline reaching $1,200, $1,000 and, even, $800 per ounce in the coming future.

But no matter which factors have changed to alter investment expectations, gold’s recent price decline does have an impact on our economy and our lives. To what degree? That depends on your relationship to it.

Note: As I have confessed previously in Gold: Should You or Shouldn’t You?, I’ve never understood how the market determines the true value of gold and why investors place such importance in having a portion of their savings allocated to owning it. So, the debate about the true value of gold etc. will continue to befuddle us all. But back to the present discussion …

Gold mining industry and its employees

A lot of Canadians depend on the gold mining industry for their jobs, so for those people the decline in the price of gold will have a very real and meaningful impact on their lives where their jobs and life-savings may depend on it.

Not a lot of Canadians realize just how much money the mining industry contributes to our economy. Take a look at just some of these mining industry numbers and facts:

  • $42 billion per year - The total overall contribution to Canada’s economy from the Canadian mining, mineral-processing, and metal producing industries
  • 60 – Canada is one of the largest mining nations in the world, producing more than 60 different minerals and metals
  • 115 – The number of communities across Canada that are dependent on the mining industry
  • 5% - Over the past five years, the minerals and metals sector contribution to Canadian Gross Domestic Product (GDP) has averaged nearly 5%
  • 55% - Mining product shipments represent approximately 55% of Canada's rail freight revenues and 60 to 75% of Canadian port tonnage
  • $8 billion - The Canadian mining industry contributes more than $8 billion a year in taxes to federal and provincial/territorial governments
  • 363,000 people - The Canadian mining industry employed 363,000 in 2007. This includes 51,000 workers in mineral extraction, 79,000 in primary metal manufacturing, 55,000 in non-metallic mineral product manufacturing, and 179,000 in fabricated metal product manufacturing
  • 1 in every 46 Canadian jobs - The mining industry accounts for approximately 1 in every 46 Canadian jobs. In the goods producing sector, mining accounts for one in every ten jobs

Example: Let’s say it costs a mining company $1,300 to produce one ounce of gold and they can sell it for $1,920.30. At those prices they can make a nice healthy profit of $620.30 or 47.7%. And healthy profits can be used to buy new gold properties, develop new gold mines, buy new equipment/machinery, pay employee salaries, pay shareholder dividends and hopefully support higher share prices. (All good things for our economy!)

But what if the mining company can only get $1,400 for each ounce of gold? The company’s profit would fall to a mere $100 or 7.7%. That’s not a whole lot of profit to work with. Instead of investing in their business, rewarding investors and paying employees, they face harder decisions on how best to use their meager dollars of profit:

  • Can they afford to develop that new mine?
  • Can they afford to replace the old equipment/machinery with new ones?
  • Can they afford to keep paying their shareholder dividends?
  • Can they afford to keep paying the same number of employees?

Remember: Investors demand that a company’s management constantly grow sales, profits and dividends. Often when management is unable to grow its profits through a growth in sales, investors will demand management achieve the profit goal by cutting expenses (often jobs). And so the impact of declining gold prices begins on the Canadian economy.

But the mining companies are not alone in this impact scenario.

Just like when a pebble is dropped into water it sends out multiple, spreading ripples, the same ripple affect happens when gold prices drop. Sales and profits also decline for companies providing goods and services to the gold mining industry – forcing those supporting companies to debate the same difficult business decisions, as gold companies.

Gold and investors

When it comes to investing and gold, you are either a Believer (often called gold-bugs) or a Non-believer. But either way, we’re all affected:

  • If you’re a Believer and have invested some of your hard earned savings in gold, then you understand first-hand how gold’s big decline has hurt the value of your savings.
  • If you’re a Non-believer, well, don’t feel too smug just yet! While you may not have invested in gold personally, chances are your pension plan or the mutual funds and exchange-traded-funds (ETFs) you hold in your RRSPs are also feeling some pressure from gold’s price decline. Even if your investment manager were a Non-believer, peer pressure and market competition would make it extremely difficult to resist investing some of your savings in gold - forcing them to be reluctant Believers. So, in the end even Non-believers are negatively impacted by the decline in gold’s price.

Note: As I have stated before, it is my personal belief that no one has a clear understanding of how gold should be valued. But simply put, the gold investment debate between the Believers and the Non-believers goes something like this:

  • Gold-bugs believe the fundamentals for owning gold (money printing, risk of inflation, financial and political turmoil, etc.) have not changed and support the gold price moving higher.
  • Non-believers believe the price decline is due to improving world economies, greater financial stability created by central bank actions and an overall improvement in the past 18 months. Non-believers say gold’s price decline simply reflects reluctant Believers shifting back to Non-believers, selling their gold investments, as world economies improve.
  • For me a third possible explanation exists. It’s also possible that gold had simply become a saturated trade with a number of investors deciding to reduce their investment to secure profits and this in turn triggered margin calls for some investors who borrowed to buy their gold investments.

Gold and producers

When we talk about gold producers, we often only think of the big boys – the Barricks and Newmonts – the largest gold producers in the world and have a hard time imagining them feeling too much pain from falling gold prices. But there are also hundreds of smaller Canadian producers and gold exploration companies and it’s these guys that are often hurt most when the gold price falls.

Unlike the previous gold price cycle (1970-1980), smaller companies have been struggling for years to raise money from investors to fund their exploration and mine development activities. In the past cycle, a rising gold price virtually guaranteed these smaller players a healthy supply of money from investors. But not this time around! In this current cycle, gold investors have bypassed small mining and exploration company shares and simply bought any of the dozens of gold ETFs. Gold-based ETFs provide investors with the ability to speculate on the price of gold without the risks associated with investments in the smaller mining/exploration companies. While easier for investors, the boom in the number of gold ETFs has starved the gold mining industry of vital investor capital.

Now with gold price expectations dropping, these companies may have hit-the-wall when it comes to raising money to fund their future activities. So, once again a falling gold price not only hurts the sales and profits of gold producers, it also cripples the ability of all companies to raise money from investors. And if gold prices continue to decline, we can sadly look forward to new headlines announcing company closures and bankruptcies.

Gold fun fact #1: Did you know that it may now be more profitable to mine our old cellphones than it is to dig and process ore from a gold mine? It’s estimated that recycling a ton of iPhones (8,101 iPhone 5s) will recover 9.72 ounces of gold or $13,608.00. Compare this figure to processing a ton of gold ore from the famous Yanacocha Mine in Peru that recovers 0.03 ounces of gold or $42.00 for every ton of gold ore.

Gold and consumers

While falling gold prices hurts all of us in the big picture, it does have its advantages, however, closer to home.

Have an anniversary or special birthday coming up? Well, you’ll be happy to know that that special gold necklace and set of earrings just got cheaper – 27% cheaper in the past 18 months. If you haven’t seen the reductions yet near you, just hang on. While the jewelers might be a little slow in sharing the price reductions with you as they work off their older (more expensive) gold jewelry, the savings will eventually make their way to your purchase.

Another place we’ll all see some savings as consumers thanks to falling gold prices is in the world of electronics. One of the biggest uses for gold is in the manufacturing of electronics – cell phones, flat screen televisions, etc. So in theory, a decline in the price of gold should make electronics cheaper. Or if the manufacturer decides to keep the savings for themselves, the gold price decline should help them to generate more profits.

And finally, have you been postponing that gold crown your dentist has been recommending? Well, you might want to go ahead now because it’s on sale – 27% off the old price.

Gold fun fact #2: According to the World Gold Council’s 2012 gold demand statistics, out of a total of 4,405 tons of gold used in 2012, here’s how it gets used:

  • jewelry used 1,908.1 tonnes
  • investments used 1,534.6 tonnes
  • central banks purchased 534.6 tonnes
  • electronics used 302.7 tonnes
  • industrial use was 85.7 tonnes and
  • dentistry used 39.9 tonnes

Gold and governments

Finally, when it comes to falling gold prices, we have to wonder about the biggest gold-holders of all – our governments. Through their Central Banks they hold hundreds and thousands of tons of gold.

Gold forms a part of a Central Bank’s reserve assets. Just like any investor, they buy gold to help diversify their assets. Central Banks, typically, invest their reserves in foreign and domestic currencies, bonds and gold. And just as with any investor, when their investments increase in value they gain financial strength and flexibility, and when their investments decline in value they are poorer and not as financially sound.

After three decades of net selling, government Central Banks began buying gold in 2010 – buying over 534 tons in 2012. Which countries are the largest holders of gold? Below is a list of the top 10 countries as of April 2013:

 

CountryGold Held (tonnes)**Decline in value since gold's price peak (billions $)
   
United States8,133.5$149.273
Germany3,391.3$62.240
International Monetary Fund (IMF)2,814.3$51.650

Italy

2,451.8$44.997
France2,435.4$44.697
China1,054.1$19.346
Switzerland1,040.1$19.089
Russia976.9$17.929
Japan765.2$14.044
Netherlands312.5$5.735
Top 10 Total:23,375.1$429.000
   
Canada, 86th place3.2 tonnes$58.729 million
**A metric tonne equals 2,204.6 pounds or 35,273.6 ouncees

Translation: As the chart above clearly illustrates, the 10 largest holders of gold lost $429 billion dollars in the past 18 months! Ouch, that’s gotta hurt!

Conclusion

When gold prices fall like they have, it doesn’t matter whether you have invested in gold or not. Price changes will have an impact on all of us – on the Canadian economy, our governments, and on us as individuals. How much of an impact will depend on your own personal relationship to gold:

  • If your income and savings (employment, pensions, investments) are dependent on gold’s price, then a decline will certainly be more worrisome for you.
  • If, on the other hand, you’re simply a consumer with no ties to gold, then a declining price should be welcome.

 

(Published by RateSupermarket.ca)

 

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