INSIDE INVESTOR: Why gold prices are strengthening

The yellow metal is mellow no more. Gold prices have been in recovery for the past two months, as a supply contraction and demand increases from central banks and investors push up prices.

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Remember the gold crash earlier this year?

From predictions it was on the cusp of bursting through $US2000 an ounce, it suddenly collapsed to $US1200 – the single biggest collapse in history.

Pretty much everyone wrote off the yellow metal as a store of value. But like all crashes, and booms for that matter, it was overcooked.

Gold prices have been in recovery now for the past two months, particularly in recent weeks where it has been pushing back towards US1400 an ounce.

The initial slump was sparked by the head of America’s central bank, Ben Bernanke, when he mentioned that the time soon would come when the US would have to be weaned off its economic stimulus package.

It was always assumed the stimulus would lead to an inflation problem, which is when gold comes into its own. But it didn’t happen. And to be cutting the stimulus when inflation wasn’t a problem caused gold prices to crash.

That caused a world of pain for gold miners as anyone who owned shares in them could attest. Australia’s own Newcrest recently racked up a $6 billion loss.

That pain, however, has changed the gold dynamics. It forced a lot of mines out of business. High-cost miners shut down uneconomic operations while others scaled back production.

Just as supply was contracting, retail buyers right through to central banks took advantage of the slump to increase demand. Even the speculators – most of whom were betting on even bigger falls – have been forced to buy back in so they could close out their positions.

That is what has pushed prices higher recently.

While we are unlikely to see a return to the boom levels any time soon, it would be reasonable to expect gold prices to push higher in the short to medium term as the market adjusts to the new demand-supply dynamic. Only if inflation begins to rear its head will there be a sustained move higher.

If you don’t want to have a horde of gold bars under the house, the easiest way to capitalise on this is to buy exchange traded fund product that specialises in gold on the stock exchange.

The other alternative is to buy shares in a gold miner. But beware: many failed to make money in the boom, so their prospects are not great during a slump.

If you do want to go down that path, look for a gold miner with low operating costs and good management rather than one with problems that need to be fixed.

Remember the gold crash earlier this year?

From predictions it was on the cusp of bursting through $US2000 an ounce, it suddenly collapsed to $US1200 – the single biggest collapse in history.

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