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Is This Year’s Plunge in Gold Prices Just the Beginning?

gold coins money grab

Coming into 2013, investors in gold had enjoyed 12 straight years of gains, giving them high expectations for the future of the yellow metal. Yet the price of gold in 2013 plunged by more than 25%, losing US$475 per ounce and remaining just barely above the US$1,200 mark in recent times.

In hindsight, it’s important to understand what precipitated the big decline in the price of gold in 2013 and to figure out what investors can learn from their mistaken optimism.

What caused gold prices to decline in 2013?

In looking at what happened to the price of gold in 2013, it’s easy to forget that the gold market had actually been setting the stage for a substantial pullback for several years. Gold hit all-time record highs around US$1,900 per ounce in August 2011 before a substantial correction throughout the remainder of the year.

Subsequent moves higher in 2012 fell short of that US$1,900 high-water mark, leaving those who use various technical-analysis methods somewhat nervous about the yellow metal’s prospects entering the year.

gold chart

Source: Gold Return data by YCharts

But the real problems for gold became evident to mainstream investors in April, when gold prices plunged US$200 in a two-day span to their lowest levels in two years. With the banking crisis in Cyprus going on at the time, gold investors feared that the island nation’s central bank would have to liquidate its gold reserves in order to shore up its financial system. That change in sentiment reversed the conventional thinking that central-bank purchases would continue to support the price of gold through 2013.

From there, further gold-price declines stemmed from increasing worries about an imminent shift in the US Federal Reserve’s monetary policy.

For years, one of the underpinnings of the bull-market move in gold had been the Federal Reserve’s aggressive moves to keep interest rates low. Yet in June, the Federal Reserve first signalled that it would consider pulling back on its latest round of quantitative easing, and even the possibility of such a move sent gold still lower, touching the US$1,200 level.

An investor exodus?

After the initial drop in prices, two things happened.

One was that gold miners’ shares got hit even harder, as the decline in the price of gold had an even more dramatic impact on their profit margins. Many small producers suddenly found themselves unprofitable, and even major players such as Newmont Mining and Goldcorp (both listed on the New York Stock Exchange in the USA) took big hits.

Specifically, the fall in gold prices led to major decisions to mothball even some of the most promising gold exploration projects. Barrick Gold, another NYSE-listed gold miner, decided to suspend its exploration at its Pascua-Lama site in Chile, threatening not only its own profits but also those of publicly-listed silver-streamer Silver Wheaton, which had taken a stake in the potential silver production from the mine.

In other cases, loss of economic viability made decisions from other producers to suspend exploration efforts easier to make but more painful for shareholders.

Second, investors started pulling out of once-popular ways to play the gold market. SPDR Gold Shares (SGX: O87), an exchange traded fund that allows investors to buy shares that aim to track the price of gold, saw a dramatic drop in the number of shares outstanding.

As investors sold off their ETF holdings, market specialists redeemed blocks of ETF shares in exchange for bullion, reducing the amount of gold that SPDR Gold Shares owned. Coming into 2013, the gold ETF had more than 43 million ounces of gold in its reserves, with a value of US$72 billion. Now, the ETF holds about 26 million ounces of gold, down 40% from its year-end 2012 levels, and the drop in gold prices has made that bullion worth just around US$31 billion.

All told, the SPDR Gold Shares ETF has lost 29% of its value since the start of 2013, a very painful result for local investors, especially considering how Singapore’s stock market benchmark, the Straits Times Index (SGX: ^STI), is down just 1.7% in the same time period.

What’s ahead for gold?

Looking to 2014, gold prices could easily remain under pressure for some time. With the Federal Reserve’s decision last week to start reducing its bond-buying activity, interest rates could continue to move higher in the coming months, putting more pressure on gold investors to liquidate their holdings in favor of income-producing assets.

If the moves in the price of gold in 2013 are any indication, sentiment has never been weaker, and whether that will produce a contrarian rally in 2014 or a continuation of the downward trend remains to be seen.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. This article was written by Dan Caplinger and first published on fool.com. It has been edited for fool.sg