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The gold price continues to suffer… When is it going to end?

by , 20 November 2014

Recently, the gold price has perked up slightly.

Looking at gold at the moment, there could be a short-term buying opportunity, but what about over the long-term? Where is gold heading?

Well if hedging is anything to go by, the price may have further to fall.

Let's take a closer look…

The volatile life of the gold price

From 1971 to 1980, gold stormed from $35 to $850 an ounce. Yet on that journey higher, the gold price had a 50% correction between 1975 and 1976.

There are many gold bugs hoping that the gold price is currently in the midst of a correction in a long-term uptrend. It’s down 40% from its 2011 high.

But look back to between 1980 and 2001, Dominic Frisby in Money Morning UK explains. Along with some small rallies, the gold price fell from $850 to $250 an ounce.

What if we’re in the middle of something similar at the moment?

The role of hedging in gold

The reality is when the gold price plummets, mines shut down, development ceases and investment into exploration dries up.

But some gold producers survive. One way to do this is to sell gold they haven’t mined yet. This is called hedging.

For example, say the gold is in a bear market. Gold is trading at $500 an ounce after trading at $600 an ounce last year. It costs gold producer Company ABC $450 an ounce to produce.

Company ABC can go to the futures market and sell next year’s production now. That means the company knows it will make $50 an ounce next year. As will the market and its shareholders.

If by the next year, the gold price drops to $400 an ounce, the company knows it’s already sold its production at a profit.

This is one way for a gold producer to survive. And a huge proportion of gold producers did hedge during the last gold bear market.

When the gold price is low, gold producers will also take steps to cut costs and streamline its processes. All in a bid to cut its cost to produce an ounce of gold.

During bear markets, hedging and cost cutting measures saved many a gold producer.

As the gold price peaked in 2011, in the run up to that many gold producer had stopped hedging their future production because they were losing money as the gold price continued to rise.

What going on now with gold producers hedging?

Most gold companies haven’t started to hedge now when perhaps they should be. They’re taking this fall in the gold price as a blip, not a certain bear market.

At the moment, gold producers have only hedged 2% of annual supply. That is a miniscule amount. By the end of the 1990s, some 125% of annual supply had been hedged when gold was trading at $250 an ounce.

If gold is in a bear market, gold producers are going to suffer.

Only time will tell if the gold price is just experiencing a stumble in a long-term uptrend or if it is a bear market for gold.

If it’s a bear market we’re looking at, if the lack of hedging going on at the moment is anything to go by, it’s going to be a while before the price starts to rise again.

The bear market might not end until hedging exceeds global production once again.

So there you have it. As the gold price continues to suffer, the end could still be far from over.

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The gold price continues to suffer… When is it going to end?
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