The Intrinsic Value of Gold

It is said that gold is precious because it doesn't oxidize, it is relatively scarce, it is beautiful, and it is the only thing proven to hold its value over long periods. If gold is a good store of value, maintaining its purchasing power relative to other things over time (e.g., one ounce of gold buys about 20 barrels of oil on average), then it must have some intrinsic value around which its actual value fluctuates.

This chart is a crude attempt to find that intrinsic value, which I'm guessing is about $400/oz. give or take a bit. My rule of thumb for interpreting gold prices (which I don't try to predict) is that when gold trades above its intrinsic value, as it is now, that means that people are willing to pay a premium for its qualities. It's trading at a premium today because monetary policy is accommodative, and because geopolitical tensions (e.g., India/Pakistan, Israel/Hamas) are elevated. Gold tends to trade below its intrinsic value (e.g., in the 1950s and 60s) when monetary policy is tight and inflation risk and geopolitical risk is relatively low.

So if you are considering buying gold these days, you need to keep in mind that it is somewhat expensive. That's not to say it can't pay off, but there is a hurdle that needs to be overcome (i.e., fears of rising inflation and geopolitical disasters need to be realized) before gold prices can move higher. In addition, there is the issue of timing: over the next 10-20 years I would predict that gold will tend to drift back to its intrinsic value, thus rendering it a very poor investment—and don't forget that gold is one of the very few things that doesn't offer any yield. But that doesn't rule out gold going to $1500 should the Fed fail to withdraw in a timely fashion the massive amount of money it has supplied to the market in recent months.

Something to think about.

Comments

[silverwood:]

Gold is money, it is inversely correlated to the $US because the $ is the world's reserve currency. True, Gold pays no interest, but interest received is not a gain unless you can get a real return, that is interest rate minus inflation rate. That has been almost impossible in recent times. Calculating inflation rates has been blurred and compromised making it hard to see clearly. So holding paper in interest bearing investments could be quite the losing proposition, if in fact the Fed can't withdraw all the liquidity. Based on the Fed historical results you can bet they won't be successful.
Oil and gold relation cannot be used to determine whether gold is expensive or not but better stated, if oil is expensive or cheap.

2008 Dec 31 08:38 AM

[Scalpulator:]

Quite amusing how you've attempted to price gold in terms of dollars, with nothing more than a government supplied guess value! By choosing 2007 dollars you've ignored the massive devaluation of the USD since this years fallout!

Fiat currencies and their controllers are in direct psychological warfare with the perceived value of gold. Anything that questions the value of their fiat currency is a direct threat to their ability to deeply manipulate the cost and wealth structure. Who would trust these statistics? Perhaps you might 'guess' price gold in terms of M3?

2008 Dec 31 09:23 AM

[SW Richmond:]

Another backward look at gold. I think the author should reexamine the strawman basis of his argument.

If you look at the chart you posted, you can see what happened to gold's price in dollars in 1971. Something happened in 1971: Nixon closed the gold window, and paper fiat currencies floated free. Did gold go up in value, or did the dollar fall precipitously? Was gold more desirable, especially starting in 1971, for exactly the reasons that so many have posted here so often: it is no one's liability, carries no counterparty risk, cannot be defaulted, is internationally recognized as valuable, and cannot be debased?

Fast forward to 2008. Is gold now much more highly desired for those same reasons? Could it be that capital seeks the safety of gold because central banks worldwide have publicly declared their intentions to debase their currencies, and governments worldwide have publicly declared their intentions of running massive deficits? Does the author know what "quantitative easing" means?

I truly wish we had a stable currency. I would gladly invest my capital in some productive endeavor where it could both benefit me and help to make something useful. But the fact is we don't, and a look at any FOREX chart will show this clearly. My capital has taken flight to gold, and it will stay there until it is safe for it to be used productively again.

I also find somewhat incredulous the author's faith in the Fed's ability to mop up dollars after the economy restarts but before inflation explodes. This is classic B school ideology, the same ideology that made AIG think it was OK for them to follow their 99.85% model. The men who are now literally running the economy are cut from the same cloth as the men who got us into this mess; in fact, they went to the same schools and work(ed) in the same places. They are not infallible Gods, they are fallible men.

2008 Dec 31 09:49 AM

[seven42:]

let's see. gold's intrinsic value is 400, but watch out, it can go to 1500. thanks ... for nothing.

2008 Dec 31 10:04 AM

[MellowGuy:]

Look at the production costs of gold which now average over $400 with marginal producers at $700. $400 is the floor for the price of gold and if demand is normal, gold should be trading at over $700.

2008 Dec 31 10:36 AM

[GMiki1:]

"Pundit, noun, a person who knows a lot about a particular subject and is therefore often asked to give an opinion about it." Cambridge online dictionary

I think you need to change your handle. Or learn about gold.

2008 Dec 31 11:58 AM

[bricki:]

intrinsic: Of or relating to the essential nature of a thing; inherent.

Gold has no value inherent to itself or because of its essential nature. The only value gold has is because people are willing to exchange other goods and services that have utility in their lives; food, energy, etc. These other goods do have intrinsic value; oil can be used as a raw material or source of energy. Food can be used to keep one's body going.

Gold though has no use. If all the gold in the world were to vanish overnight there would be no effect on humanity's ability to conduct daily life.

I wish people would stop writing about the intrinsic value of gold. There is no such thing.

2008 Dec 31 01:22 PM

[Smarty_Pants:]

""Pundit, noun, a person who knows a lot about a particular subject and is therefore often asked to give an opinion about it." " - GMiki

Maybe he knows a lot about Califia Beach and the article is just off topic.


"intrinsic: Of or relating to the essential nature of a thing; inherent.
Gold has no value inherent to itself or because of its essential nature." - bricki

The Austrian school view of economics is that no object has an intrinsic value. All value is imputed to an object by a person based on its perceived value to that person.

The same object will have different values to different people. If not, then there would never be any voluntary trade between people. Voluntary trade only occurs when people each agree to exchange something they value less for something they value more (ie. the parties hold opposing views on the value of objects exchanged).

If I grow 400 bananas a year and only consume 200 of them in that time, the remaining 400 bananas are only useful to me in exchange. In a worst case scenario I NEED to grow 200 bananas to survive, if I grow more than that I can hope to trade the excess for other items I would rather have, but it's unlikely I would trade any of the first 200 for something I couldn't eat.

The 201st banana has less value to me than the 200th banana because if I don't trade for something non-perishable it will spoil.

If someone else digs up minerals for a living, he would probably be willing to trade some of that mineral ore for my excess bananas because he can't eat the ore. He needs to survive and so would be willing to trade ore for something edible.

My excess 200 bananas have a much higher value to him than they do to me. He values my excess bananas more than his ore and I value his ore more than my bananas so we trade and both feel we are better off.

I may not have any immediate use for his ore, but it is worth more to me than spoiled bananas. The ore is non-perishible and I would be able to exchange it for something I value even more later on.

Same objects, different perceived values for two different people. No "intrinsic" value to either set of objects, all valuations are based on personal judgements.

2008 Dec 31 03:04 PM

[bearfund:]

The interesting part isn't what happens when something trades above or below its intrinsic value but how one determines that intrinsic value. I'd love to read a serious attempt to determine the discounted present value of the US dollar. Unfortunately while you've offered a number, you haven't shown how it was derived. In fact, even your chart is incomplete: it suggests that the "real value" of gold has changed (or maybe the "real price?") but doesn't say how that was computed other than "2007 dollars". How were those "2007 dollars" computed relative to dollar values (or prices) at other dates?

I could quite reasonably argue that the real value of gold looks like a flat line, but the units on the Y axis would have to be "goods and services" - and now I'm on my way toward computing the value of the units in which the sizes of various good and service markets are usually quoted by sources like Bloomberg and the BLS; i.e., a serious article. More trivially, I could simply decide to graph the market price of the US dollar, in ounces, adjusted such that the value of an ounce of gold never changes. But I'd still have to work out the value of the dollar at each point in time.

That's fantastically hard to do. I know you haven't done it, not only by reading your article but simply because you wrote it. If you had a reliable formula for determining the value of the dollar at a point in time, two things would occur:

1. You would be so wealthy that you'd hire someone else to write a much more detailed - but subtly wrong - article for you, and

2. Your enormous wealth combined with your constant arbitrage profits would make the market price of the dollar dramatically less volatile than it is.

Keep trying, please.

2008 Dec 31 07:31 PM

[Rakesh V:]

I beleive that the intrinsic value of gold is not US$400/OZ, i see the value at US$460/OZ...........yo... would like to know why US$469/OZ.... please have a look at this.

whenever considering the I.V(intrinsic value ) one has to keep in mind the prodcution cost/cost of accounting. which i beleive that depends on each countries export/import mangament. E.G South Africa has production cost of US$460, Whereas Australia has production cost of US$480. if you will see the differce of US$20 indicates that countries financial managment also. Now i beleive China the real player in Gold production is coming with US$420 which is exceptional down,also indicates that they can produced more and more gold in coming years.

No doubt that it take times from exploration to sell its is big process and hurdles are many specially political intervention. ........

Yes i do agree with your view that position can short Sell at US$-890/920, for Buy target of US$750/590, upside resistance we found at US$1030/US$1080.......... i will sell at strenth only if i enough margin to hold the position even if it goes up US$150- from my prices. so please specualators should be away from this call, i will welcome the commercial and Gold stock (Equities Traders.) and Hedge funds.

Jan 01 04:27 AM

[ndallasj:]

Bearfund is right on. I was hoping this article would delve into how the supposed intrinsic value of $400 was derived. Furthermore, there is now way the intrinsic value of gold is static as shown in the chart, although I hope that this is just reflective of how the chart was drawn rather than the author's belief.
The marginal cost of producing gold has little bearing on it's intrinsic value either, at least in the near term.
All in all, a very disappointing piece.

Jan 01 10:07 AM

[User 30121:]

SWRichmond, Gmiki, bearfund:

Amen!

Jan 01 11:42 AM

[Burticus:]

Measuring the intrinsic value of any commodity (particularly the ultimate historic monetary commodity of gold) against paper currency is inherently preposterous, which explains the piling-on by the readers. To help him understand this concept, the author should research and write an article on the intrinsic value of paper currency issued at whim by central bankers, backed only by fiat of corrupt gubmints. Oh, don't bother...this was addressed long ago:

"Paper money eventually returns to its intrinsic value: zero." - Voltaire (1694-1778)

Jan 01 12:34 PM

[secmaven:]

Technical analysis can prove anything if you select your data, not inflation adjusted in this case, and put the ruler in the "right " place. Need I say that technical patterns abort more often than they complete? The horizontal line pattern this blogger has traced on paper is no different.

Jan 01 12:45 PM

[Gedankonomist:]

Gold compounds, which accumulate slowly in the body and, over time, reduce inflammation, especially related to rheumatoid arthritis, inflammatory bowel disease, psoriatic arthritis, membranous nephritis, lupus erythematosus and, infrequently, juvenile rheumatoid arthritis (JRA). (From "gold salts" in wikipedia)


On Dec 31 01:22 PM bricki wrote:

> intrinsic: Of or relating to the essential nature of a thing; inherent.
>
>
> Gold has no value inherent to itself or because of its essential
> nature. The only value gold has is because people are willing to
> exchange other goods and services that have utility in their lives;
> food, energy, etc. These other goods do have intrinsic value; oil
> can be used as a raw material or source of energy. Food can be used
> to keep one's body going.
>
> Gold though has no use. If all the gold in the world were to vanish
> overnight there would be no effect on humanity's ability to conduct
> daily life.
>
> I wish people would stop writing about the intrinsic value of gold.
> There is no such thing.

Jan 01 04:13 PM

[surferonice:]

I like the one about gold and banana's.LOL. However I did not see anyone mention here that the amount of gold in the USA is never determined in these monatary to gold calculations. Rather it is the amount of gold in the world that someone wants to enter as relevant to calculating a nation's currancy value. 4.4 to 5 billion ozs of gold in the world and only half known to be in any kind of money form for exchange. Mines shutting down.Exploration shutting down.As far as I know there is only about 250 million ozs of gold in the USA .Maybe a little more outside the USA in different accounts here and there.

Jan 01 10:27 PM

[auto44:]

Gold has a lot of important uses in electronics. and other metalurgical areas. If it were not so expensive a lot more of it would be used. It is expensive because it is rare and because paper is not.

Jan 02 01:48 AM

[Anon Emous:]

Throw out all the above comments defining value using the word "cost". Intrinsic qualities define intrinsic value. Gold is scarce, dense, persistent, etc. These qualities "lend" (of God, I'm so funny) themselves to the definition, hence function, of "money". Liking to keep it simple, money is a:

- Unit of account . . . the ounce.
- Medium of exchange . . . a little volume packs a lot of those units.
- Store of value . . . an ounce is an ounce.

Darn! I thought I was doing so well but a term can not be used to define itself. So, I can't get to the definition of value using the definition of money. What is that elusive "value" thingy? Let's drift back to those dreamy moments in Econ 101 and recall those fun terms like widgets and . . . yes, here it comes . . . "Utils". Is utility the definition of value? That depends on what you can do with those widgets. So, we come full circle to how many uitls and widgets. Let's try another route.

Being a computer type, I set values all the time when writing code. That's it! Value is just a number! Humm, well it can be a character also. But those characters, ultimately, are one's and zero's . . . you know, the binary basis of computing. Can we safely say the definition of value involves a number?

I've seen many times the examples of gold's value function . . . for 6000 years an ounce of gold has (pretty much) equaled 400 loaves of bread or a descent suit of clothes for a man . . . or a woman I guess also. So, value involves a number of something . . . more accurately, a consistent number of something . . . that does something for one's self . . . keeps one alive or covers the body per the examples. Consistent? Why must it be consistent? Why are things not consistent?

Just why are things not consistent . . . in the value context? Apparently, we agree in principle value should be consistent. Like a standard I suppose. Is that it? We can not actually put our hand on value so we at least want agree on something to represent it. An "analog" . . . that's it! We are trying to agree not on the definition of value but the definition of something analogous to value. Value is, after all, an opinion. Are we trying to form a collective opinion to represent the sum of our individual opinions?

So, in spite of all our opinions, we still need to have something we agree upon as a representation of value . . . a number of something consistent . . . if we want to live in a civilized manner.

I don't know . . . I'm too busy living to redefine the world's opinions. Hold on . . . how much could I get paid for doing that? Never mind. So, I'm going with the winning record of gold. It's not perfect . . . but it has held up better than anything else. And, that is in the face of recent history with our super sophisticated financial system . . . you know . . . the one which recently gave us all those fancy investment products which have how much "value" these days. Come to think of it, those fancy products are often liabilities (unless the government buys them) these days. For years now the financial sophisticates ( I call them salesmen ) have called gold a "primitive relic" . . . which means anyone holding gold is a dummy who, nonetheless, still has something of "value" . . . in their dummy opinion.

What I really want to know is how does the "value" of my post compare to the value of the original authors article? Please post your opinion in terms of ounces of gold . . .

Jan 02 09:39 AM

[AuAgPt:]

Hello and thank you for this informative writing. I was wondering if you have a similar analysis for historical silver prices in 2007 US$ ? and a resulting intrinsic value for silver?

Jan 13 08:20 PM