Physical Demand Will Support Gold Prices

Gold prices have limited upside due to waning investor demand in the west. However, prices should be supported at around $1,200 an ounce due to Chinese physical demand.

Apr 21, 2014 at 3:26PM

A recent report from Thomson Reuters GFMS has forecast an average gold price of $1,225 an ounce for 2014. The report has a bearish view on gold due to waning demand from investors. While this will put pressure on prices, gold prices should find support at around $1,200 an ounce due to physical demand. In fact, a stronger price floor is one of the reasons for recent uptick in M&A activity in the gold mining sector.

Bearish outlook on gold
In its annual gold survey, Thomson Reuters GFMS said that there was consensus that gold prices would continue to decline over the coming month and years. The report noted that appetite for gold as an asset class was expected to be dampened by the tapering of the Federal Reserve's bond purchases, the rise in treasury yields and equities, and a stronger dollar.

Indeed, as I have noted in previous articles, with the Fed out of the equation, there is not likely to be significant upside to gold prices. However, that doesn't mean that prices would collapse. Weaker prices boost physical demand in countries such as China and India. And this will continue to provide a strong floor for gold prices.

In fact, this was even noted by Thomson Reuters GFMS in its report. The report said that its base case view is that as Western investor support continues to fall away from gold, physical buying will see prices supported.

The report forecasts that gold prices will average $1,225 an ounce for 2014. That would represent a drop of around 13% from the average price last year. The good news for gold miners, though, is that prices are not expected to fall below $1,100 an ounce if physical demand remains strong. A new report from the World Gold Council (WGC) suggests that physical demand in China will remain robust.

WGC report
WGC said in a recent report that it expects 2014 to be a year of consolidation for Chinese gold demand. According to the report, a sharp drop in prices last year prompted Chinese consumers to bring forward jewelry and bar purchases, and this may limit growth in demand in 2014. However, the WGC notes that lower domestic gold price should support purchases by consumers, especially of 24 carat jewelry. In addition, the WGC expects medium-term physical gold demand in China to see further growth driven by a range of factors, including rising real incomes and the vast pool of private savings.

Also, physical demand from India, the other major consumer of physical gold, could pick up after the country's elections next month.

The WGC and the Thomson Reuters GFMS report confirm that gold prices will find support due to physical buying. The support level seems to be at around $1,200 an ounce. While gold prices have limited upside, a strong support level gives miners some certainty over the future cash flows. It is also encouraging miners to explore merger and acquisition opportunities.

Uptick in M&A
The gold mining sector has seen a number of deals so far this year. Goldcorp (NYSE:GG) has been pursuing Osisko Mining since the start of this year. Last week, Osisko struck a deal with Yamana Gold and Agnico-Eagle. For now, it looks likely that the Yamana and Agnico-Eagle deal will prevail, however Goldcorp is likely to explore more such opportunities since acquisitions are the best possible way for major gold miners to grow given the outlook for gold prices.

In fact, major gold miners are not just looking at acquisitions of smaller rivals but even exploring mergers. A report in the Wall Street Journal last Friday said that Barrick Gold Corp. (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM) had been in merger talks, which eventually broke down. The Wall Street Journal, citing people with knowledge of the situation, said that two companies were planning to announce a deal as early as Tuesday before talks broke down. Barrick Gold and Newmont have a combined market capitalization of $30 billion. A merger between the two would have created a gold mining giant.

Gold miners are certainly adapting to the new pricing environment, and recent developments suggest that they look at mergers and acquisitions as the best way to grow.

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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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