It has been very well documented in these pages how the demand from India and China for gold bullion is increasing. We have also seen central banks buying the precious metal to protect their reserves.

But when I look at other side of the equation, the supply side, the case for higher gold bullion prices becomes even stronger.

The biggest sources of gold bullion are obviously the gold producers—the companies that actually do the “dirty work,” digging the ground and extracting gold bullion. When the price of gold bullion declines, it gives them less incentive to produce at higher-cost mines as profitability is at stake.

In April of this year, and then later in June, we saw gold bullion prices decline significantly in value in the face of strong demand for the precious metal. That price action caused a new trend to start among gold producers—they’ve started to cut their exploration budgets.

Graham Ehm, Executive Vice President of South African-based AngloGold Ashanti Limited (NYSE/AU), one of the biggest gold producers in the global economy, stated the company is looking to save $500 million over the next 18 months, as capital expenditures will only be going towards their highest-quality assets. (Source: Mining Weekly, August 5, 2013.)

In its second-quarter corporate earnings report, Newmont Mining Corporation (NYSE/NEM), another massive gold producer, said the company reduced its exploration spending by $362 million from the same period in 2012. (Source: Newmont Mining Corporation, July 25, 2013.)

How does this all come into play with the gold bullion prices?

When gold producers invest less in exploring for new projects, the overarching effect is less future production, which leads to less supply. We’ve heard from senior gold producers about cutting costs; just imagine how severe the pain is for gold producers who have significantly higher costs!

If the prices of gold bullion remain suppressed, we could potentially see many gold producers shut down mines that produce the precious metal above the spot price, the end result of which will be an even smaller supply of gold bullion.

Where do I think gold bullion prices are going next? The “technical” damage done to gold bullion price charts in April and June was very significant. It can take some time for gold bullion prices to recover, especially as price manipulation continues, but if we continue to see supply decrease and demand increase, “regression to the mean” may happen a lot quicker than most expect.

What He Said:

“Over the past few weeks I’ve written about subprime lenders and how their demise will hurt the U.S. housing market, the economy and the stock market. There’s no escaping the carnage headed our way because the housing market and subprime business are falling apart. The worst of our problems, because of the easy money made available to borrowers, which fueled the housing boom that peaked in 2005, have yet to arrive.” Michael Lombardi in Profit Confidential, March 22, 2007. At the same time Michael wrote this, former Fed Chief Alan Greenspan was quoted as saying “the worst is over for the U.S. housing market and there will be no economic spillover effects from the poor housing market.”