The fundamentals of the gold market have changed as the Federal Reserve continues to ease its bond purchases. The Fed's bond purchases had been one the major reasons behind gold's rally in the last few years. However, the gold market will be driven mainly by physical demand going forward; the largest driver will be demand from Asia. A recent report from the World Gold Council (WGC) has confirmed this.
The Fed's first quantitative easing program began shortly after the financial crisis of 2009. The Fed has launched two more programs since then, with the last one in the process of being wound up. These bond purchases had sparked a huge rally in gold, with the precious metal crossing $1,900 an ounce in September 2012.
Gold's rally ended last year as the precious metal dropped nearly 30%. Gold came under pressure last year after the Fed hinted that it would start easing its bond purchases and look to exit quantitative easing by the end of 2014. The outlook for gold had been bearish at the beginning of this year. Even as the Fed has begun its bond purchase program, however, gold prices have held their ground.
Gold has been supported partly by the geopolitical tensions in Ukraine. Gold prices, however, have mainly found support due to strong physical demand, especially from China. In fact, China surpassed India as the largest global market for gold last year. Chinese demand grew as consumers took advantage of weaker gold prices. This has changed the fundamental of the gold market. While the Fed's easing of bond purchases means that gold will not see significant price appreciation, strong physical demand has provided a floor for prices. A report from the WGC has shown that the trend from last year continued in the first quarter of 2014.
The WGC, in its report on gold demand trends, said that gold demand in the first quarter of 2014 was 1,074 tons, almost unchanged compared to the same period in 2013. According to the WGC, this clearly demonstrates that the fundamentals of the gold market remain robust.
Worldwide demand for jewelry totaled 571 tons in the first quarter, up 3% on a year-over-year basis. According to the WGC, this represents the strongest start to the year for jewelry since 2005. More importantly, China saw a 10% rise in demand for jewelry. This is encouraging for gold miners such as Goldcorp (NYSE:GG), Barrick Gold (NYSE:ABX), and Newmont Mining (NYSE:NEM) as strong demand from China will continue to provide a floor for gold prices.
The WGC report also shows that central banks continued to be strong buyers in the first quarter of 2014, purchasing 122 tons. Although central banks' purchases were down 6% on a year-over-year basis, it was the 13th straight quarter in which central banks were net purchasers of gold. Central banks are likely to remain committed to keeping an exposure to gold. In fact, earlier this week, central banks in Europe renewed a five-year agreement by committing not to sell significant amounts of the precious metal.
The only area of weakness is investment demand, which is understandable as the Fed's easing of bond purchases has had a negative impact on gold as an investment. Still, outflows from gold-backed exchange-traded funds (ETFs) slowed in the first quarter, which is again an encouraging sign for the gold market and miners.
The demand trends for the first quarter of 2014 are encouraging for gold miners. The key for gold miners is now to adapt to the new pricing environment. The first quarter results of major gold mining firms indicate that they are already doing so.
Last month, Goldcorp reported that its all-in sustaining costs for the first quarter of 2014 were just $840 an ounce. Going forward, the company expects its all-in sustaining costs to be between $950 an ounce and $1,000 an ounce. Barrick Gold expects its all-in sustaining costs for 2014 to be between $920 an ounce and $980 an ounce.
The outlook for gold mining companies has improved as they continue their cost-cutting measures. The encouraging demand trends for the first quarter have further improved the outlook for gold miners.
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.