The supply shortage in the gold pits no one is talking about

• A research paper by Canadian Imperial Bank of Commerce (NYSE/CM), known as CIBC for short, said “Gold has been dented in recent quarters by an absence of inflation, greenback strength and investors’ rotation into stocks to capitalize on an expected pick-up in growth… As implied by our 2014-end target of $1,000 per ounce, we nonetheless continue to feel the metal still has further to fall in the next year or so.” (Source: CIBC, “Commodities: Warmer Growth to Heat Up Resources Next Year,” December 2, 2013.) In other words, CIBC’s opinion is similar to that of analysts at Goldman Sachs Group Inc. (NYSE/GS), who also believe gold bullion prices will fall to near the $1,000 level this year.

• A forecast from Bank of America Merrill Lynch (NYSE/BAC) said, “Gold values will be hurt by Fed tapering, a resurgent U.S. dollar and a lack of investor interest in the metal. We expect gold to drop to $1,100 an ounce at some point in 2014…” (Source: Bank of America Merrill Lynch, “BofA Merrill Lynch Global Research 2014 Year Ahead Outlook,” December 10, 2013.)

• UBS AG (NYSE/UBS) cut its 2014 gold bullion forecast from $1,325 to $1,200 an ounce. The bank said, the “struggle for gold not only rests with the predominant selling, but with limited positive catalysts looking forward, gold is unlikely to regain its former appeal.” (Source: Market Watch, “UBS cuts 2014 forecast for gold and silver,” December 3, 2013.)

I believe these banks are way too bearish on the precious metal and are completely ignoring the fact that the demand for physical gold bullion is increasing. They also neglect to take into consideration that lower gold bullion prices temper supply.

As we move further into 2014, gold bullion buying in China is high. According to MKS (Switzerland) SA, a precious metals and financial services group of companies, gold bullion premiums in China have increased 100% to $20.00 an ounce from $10.00 a week ago. (Source: Kitco News, January 7, 2014.) It will be interesting to see what happens to gold bullion demand in China as we close in on Chinese New Year, a time when the precious metal is purchased for gifts and good luck.

The Indian government imposed three duty hikes in 2013 on the importation of gold bullion into the country; hence we saw news stories reporting an increase in “gold smuggling.” The premium on gold bullion rose to ridiculous levels in India in 2013 as the duties were imposed; $160.00 an ounce over London prices in early December. Now there is talk of cutting the duties, which, in my opinion, will push demand for gold bullion up in India once again. (Source: Reuters, January 6, 2014.)

The demand for gold bullion is extremely high in other parts of the world. In an e-mail statement, the U.K.’s Royal Mint said yesterday that it had run out of its 2014 Sovereign gold coins already “due to exceptional demand… Since the dip in the price of gold we have seen increased demand for our gold bullion coins from the major coin markets, and this presently shows no sign of abating.” (Source: Larkin, N., “U.K. Royal Mint Runs Out of Sovereign Gold Coins on Demand,” Bloomberg, January 8, 2014.)

Other mints around the world, such as the Perth Mint in Australia and the U.S. Mint, have reported massive increases in the sale of gold bullion coins in 2013.

When gold bullion prices started to decline in late spring of 2013, I predicted in these pages that consumers who missed out on buying the precious metal would now come in because prices were lower. This is exactly what happened; as gold prices fell in 2013, there was a “consumer gold rush.”

I see the negativity towards gold bullion prices as extreme. We have several factors working here to support gold prices: 1) consumers are buying gold-related items at a record pace; 2) world central banks are net buyers of gold bullion now; 3) the lower gold prices have resulted in marginally profitable gold mines being closed (hampering supply); and 4) pessimism reigns in the gold pits (the old adage has it that the market usually goes against what the majority expect, and right now the majority think gold bullion prices are headed lower).

From a long-term perspective, the reasons to be in gold bullion remain. I believe the opportunity with the best possible return will be in the senior gold miners, which are currently producing the precious metal at a profit. The miners saw their stock prices punished all of last year. They are trading at deep discounts to historical gold stock valuations. Look for gold bullion miners that have low mine operating costs, proven reserves, and properties in safe geographic areas.