After gaining nearly 500 percent in the decade between 2002 and last year, gold finally fell out of favor in 2013. Thanks to both the stabilizing effects of global quantitative easing and slow but steady economic improvement in both the US and Europe, so far this year the price of gold has fallen by nearly 25 percent.

Not only has that decline hit holders of physical gold hard, it’s weighed heavily on gold miners, many of whom overinvested in the boom years and were slow in responding to falling gold prices.

Global mine output is set to hit a record high this year of about 2,900 tons as many miners—including our portfolio holding Goldcorp (NYSE: GG)—have boosted production in an attempt to offset lower prices. To see the difficult path Goldcorp has been forced to travel, take a look at the chart below, which shows Goldcorp’s returns vis a vis those of gold during the last four months, ending Nov. 29:

The Golden Fall



Source: Bloomberg

High all-in production costs have also hurt the miners, with the average cost last year running at $1,228 per gold-equivalent ounce, cutting deeply into profit margins per ounce mined.

But there are reasons for optimism going forward and, as usual, China figures into the equation.

Even as China’s domestic gold production grew 6.8 percent in the first nine months of this year to reach 307.9 tons, it hasn’t come anywhere close to meeting gold demand in the country. Over that period it is estimated that China shipped in 855 tons of the metal from Hong Kong and its purchases this year are expected to be in excess of 1,000 metric tons, a 29 percent increase over last year’s purchases.

Analysts estimate that at least 300 tons of the gold purchased so far were on the central bank’s account. That puts China’s gold imports ahead of India and now makes China the largest gold consumer in the world.

Additionally, the People’s Bank of China (PBOC) has said that it is looking at granting additional import-export licenses. Currently, just nine banks are allowed to import or export gold. But the PBOC has that in the future, all bank members of the Shanghai Gold Exchange as well as gold producers with annual output of at least 10 metric tons will be allowed to apply for import and export licenses.

Individuals will be allowed to bring up to 7 ounces of gold into China from overseas without having to report to customs or pay tax. The government also permitted trade in gold swaps to begin in China’s interbank market last month, allowing banks to more effectively hedge their bullion exposures.

While gold jewelry has long been a status symbol in China, investment demand has been surging as the Chinese look for safe haven assets against economic volatility and inflation. In addition, rising incomes have also driven investment demand even as China’s equity market has underperformed this year and access to investment products such as mutual funds is still relatively scarce. That is especially true in rural areas which are underpenetrated by banks and where tighter controls on real estate transactions have been put into place, leaving many savers to turn to gold and silver.

On top of that, there remains the uncertainty of how the great quantitative easing experiment will end.

Although the Federal Reserve will begin tapering sometime in 2014, Credit Suisse estimates that central bank balance sheets will continue to grow next year, up by another 20 percent. Global easing on this scale has never been attempted, which means central bankers are continuing to compound a risk that even they can’t fully understand.

And given how accustomed the markets have become to central bank support, I expect a pull back in the markets when the banks tighten and perceived safe haven assets come back into favor.

As a result, I look for gold prices to stabilize and rebound somewhat next year, likely somewhere in the $1,250 per ounce range, both as a result of more robust demand and the likely decline in production next year. Many smaller and higher cost miners are continuing to get shaken out of the market, reducing production to cut costs, further contributing to price stabilization.

One of the reasons that I added Goldcorp to the portfolio is the fact that it is one of the lowest-cost gold producers. In the third quarter, the company’s all-in sustaining costs fell to $992 per ounce while its realized price was $1,339.

The company also has attractive, low-cost development projects coming online over the next few years.

While the company’s Cerro Negro operation in Argentina can’t be lumped in with low-cost development projects given its delays, production there is expected to begin someone in mid-2014 with an annual yield of between 130,000 and 180,000 ounces. From there, production is expected to rise to 525,000 ounces.

The company’s Eleonore and Cochenour operations will also be coming online soon, with production at the former expected to begin late next year and at the latter in early 2015. Between the two mines, more than 900,000 ounces of annual production will be added to Goldcorp’s output.

The company has consistently managed to keep its production costs well below its realized prices, even with its ongoing capital expenditures at new properties. Consequently, it has managed to remain profitable whereas many other gold miners have not. Added production will help boost profits, even as gold prices are likely to firm in the coming year.

Thanks to its low-cost advantage, Goldcorp remains a buy.