Gold’s Downside Risk Is Limited, The Upside Potential Is Substantial

In his latest Gold Investment Letter, John Hathaway, Portfolio Manager and Senior Managing Director at Tocqueville Asset Management, concluded that the downside risk in gold is limited but the upside potential is substantial.

Despite the painful decline in gold and gold shares that persisted throughout the entire year, we believe that the fundamental case for both remains strong. It seems to us that the correction has left the entire sector sold out and friendless. As contrarians, our experience has been that attractive investment returns arise out of such circumstances. We therefore encourage investors to maintain their commitment and wherever possible to add to positions.

Hathaway points out that gold’s new supply is facing a significant threat (good for the gold price) as the gold price is at or below the cost of production. Therefore, the construction of new mines in most cases does not make sense. “Future mine supply is jeopardized without a substantial and sustained rise in the gold price.” The mining industry has reduced costs. Cash on their balance sheets should build rise and acquisitions should be expected.

The letter touches on the major disconnect between the physical demand and the paper market where the price decrease does not reflect supply/demand factors:

The bullion market has been pressured all year by an artificial supply of paper gold with little or no connection to the underlying physical. We wrote about this more extensively in our website article “Let’s Get Physical.”

We believe that the resolution of the disconnect between paper and physical gold will be a dramatic upside repricing of the real thing.  Most important is the steady migration of physical gold bars held in Western vaults to China and other parts of Asia, where they seem unlikely to be returned, other than for exorbitant ransom.

Along with the letter, Hathaway distributes 50 charts which are directly or indirectly linked to the gold sector: the “Gold Monitor.” We have selected four charts which have not been circulating on the internet in 2013 but which speak for themselves.

Total open interest in COMEX gold is at 2009 and pre-2007 levels, indicating a lack in interest in gold investment. At the same time, it appears that gold’s decline is highly correlated to the commodity sector.


Central banks continue piling gold:


The total value of gold investments compared to total US financial assets is at an extreme low (no bubble to see here).



The gold mining sector (in terms of the gold price) is trading at extremes:




Gold Monitor – 50 charts in 2013 related to gold

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