Why Gold Is Overpriced

After I used the historical data for home prices for my previous article in January, in which I concluded that home prices will stabilize or recover this year, I tried to study gold prices.

(By the way, a month after that article was published, we saw positive news in the housing market this year).

Gold, unlike home prices, has seen extreme swings since the 70s, where the price per ounce moved from $40 in 1970 to $850 in 1980 and thereafter collapsed to under $300 in 2001.

Due to limited usage of gold, it is obvious that there are only two factors influencing gold prices: emotional and speculative.

As speculators have limited capability to keep prices high for a long time, I would just focus on emotional factor of masses.

As we witnessed during the housing cycle, people increase the demand of a product when emotions are running high (“let us buy it today or else we might never be able to afford it ever !”), but start thinking with a cool-headed mind when prices go above affordability.

When that level is reached, the demand falls and the prices decline.

Most of the market experts fail to recognize when this point has arrived, since they are unaware of the ‘affordability’ of the product from the point of masses.

India has been the largest importer of gold in the world for many years now. It imported 800 tonnes of gold in 2007 and 450 tonnes in 2008.

However, in the past two months of 2009, India’s gold imports have been almost negligible. Ignoring forex changes, it is obvious to me that the “affordability” level has been breached, and therefore the prices should now fall dramatically.

The dollar has been rising against most currencies, so the argument that gold prices will go up since they are inversely proportional to dollar does not work.

Comments

[AlphaDude:]

You say : "Due to limited usage of gold, it is obvious that there are only two factors influencing gold prices: emotional and speculative."

What about investment demand ? Investment is differant to speculation and Gold is differant to other commodities in that it can be and has been used as money for 1000's of years.

I believe the biggest driver in gold prices at the moment is investor demand and that is unlikely to change while the financial crisis persists.

Apr 01 06:24 AM

[robert99:]

Wow, what a terrible article. I was looking forward to reading a decent bearish argument for gold (since I'm long), but I was very disappointed.

Apr 01 07:37 AM

[RG2009:]

I'm definitely not impressed by this sort of analysis. Gold is nowhere near underpriced, and being bearish about it seems like outright nonsense to me. Then again, its just my opinion...and that of many other blogs and articles i've read...but then, we could be all wrong! What are the odds? Time will tell.

Apr 01 08:08 AM

[RG2009:]

Sorry, i meant overpriced. Sorry, my mistake.

Apr 01 08:09 AM

[DONE_SONZ:]

Your kidding right?? Do you know what golds main role is? I guess anybody can post on Seeking Alpha.

Apr 01 08:55 AM

[Vuke:]

A well presented argument, missing however all fundamentals and therefore leading to the wrong conclusion.

Apr 01 09:16 AM

[Cesato:]

RG2009

The price of Gold has not even been able to test the USD 988 level so far, this level was the one which triggered a major sell-off last year. I do really expect a try up to USD 988 within the next 2 months but also I still believe that the massive double top being identified in the chars will take the price down to the USD 800/700 level; some may consider it further consolidation of the 1 year-long trading range, which I would agree with, others will become bears, goldbugs will suffer a lot but in the end it will be the last run down prior to a strong 2 year long uptrend. We will be short-term buyers in June 2009, then strongly bearish from July to September 2009 and then will make every attempt to find a bottom between September 2009 and January 2010 for a 2 year bull run, provided that the price never goes below USD 500 before the end of the year. The bull run will take the price at least to USD 2.000 by 2011. Of course traders and scalpers will play the volalitibilty, long term goldbugs will make money but probably much less than they could have if they weren't that stubborn as far as not selling these days. The strategy through the end of the year is to buy short-term, take profit on a daily/weekly basis then sell short strong rallies, take profit on a fortnightly basis and buy it all at the USD 700/600 level for a continuation of the multiyear bull trend until sometime between 2011 and 2013. Sell following Gold fundamentals, as I believe you understand them very well, unless you don't care about 50% price swings then you are ok for next 3 years, as far as maintaining your purchasing power long-term. If you still want to hold your physical Gold, play paper Gold to hedge your investment and make good money. There is no point on having your vault full of coins/bars if you can't cash out and make a life out of it.


On Apr 01 08:08 AM RG2009 wrote:

> I'm definitely not impressed by this sort of analysis. Gold is nowhere
> near underpriced, and being bearish about it seems like outright
> nonsense to me. Then again, its just my opinion...and that of many
> other blogs and articles i've read...but then, we could be all wrong!
> What are the odds? Time will tell.

Apr 01 09:22 AM

[Tony Daltorio:]

I can't believe how some articles don't make the "cut" at Seeking Alpha, but poorly researched trash like this does.

Apr 01 09:32 AM

[stanbo:]

If the dollar crashes we all would love to have all the gold we could afford at this price,but better yet to have silver at its price today.

Apr 01 09:35 AM

[billyboy54:]

AUTHOR: "(By the way, a month after that article was published, we saw positive news in the housing market this year)."

If you mean by "positive news" the "news" that Feb homes sales were up over Jan home sales, that happens EVERY year. And Mar homes sales will be up over Feb, as Apr will be up over Mar.

It's a seasonal thing, happens every year.

If those things don't happen, we'll be in really serious trouble.

Apr 01 09:38 AM

[Jingle-Jangle:]

Because homes rebounded when he and others thought they never would means to him that gold will pull back because many think it never will.
Well, maybe in India. I know they have not been buying gold but that is an indicator of the Indian currency strength (which has tanked). While it may not be a bad idea for those in India to keep their powder dry until gold makes a downturn, they better be ready to pounce when it does.
Gold seems also the only way east Indians know how to make money and therefore the writer of this article likens it to over priced homes and does not take into consideration that all nations are diluting their currencies (which makes gold more expensive along with everything else you may wish to purchase).
Let's wait and see, indeed. The economic storm is coming. Have some gold and silver in your pockets to weigh you down so you won't blow away.

Apr 01 09:51 AM

[blog.kerdos...:]

It is amazing how every time somebody writes something even slightly negative on gold the response is huge , and venomous.
Mr. Sharma is correct and we might add that there is no nation that understands gold better than India.

Apr 01 10:00 AM

[haysys:]

Have a look at the this recenly published book that explains why Gold is going to massively increase in price.

The little book of bull moves in bear markets
by Peter Schiff

p.s. I am not related to the author. I just found this book at my local library here in the UK.

Apr 01 10:06 AM

[RG2009:]

Cesato:

Interesting analysis, although some of my beliefs differ a tad from yours, especially towards the end of 2009. I do not believe gold will get lower than the 850. However, preparing for such a possible event is beneficial and is a good advice to take into consideration. In the end, i am bullish as well for gold for the next 3 years. Once it starts to pick up, it will not be looking back. As far as i am concerned, i mostly concentrate on mining production and exploration. It has produced a 50% year-to-date yield for me so far, and what i thought was initially a short run will extend for the next years.

Thank you all for your comments, with our heads combined we can achieve miracles.

Apr 01 11:43 AM

[Bruce Pile:]

Even though most of the use of gold is for jewelry, the major price moving "use" of gold is as a stable source of money when the world's paper money mechanics are fooling with the long term viability of currencies. You can't value the price of gold like you can soybeans. But if you simply compare gold pricing now with the last time it was being used as a safety shield against currency problems (the 70s) you see that it's now trading at only about 20% of its inflation adjusted price from 30 years ago. There are very few things trading at 20% of their inflation adjusted price from 30 years ago. And the fooling around they are now doing with currencies makes the 70s version look like a minor annoyance by comparison.

Apr 01 12:08 PM

[pungent:]

I too was disappointed in this article. Hoping for a well-reasoned argument, all I found was a lot of "let me tell you how I feel". So let me tell you how I feel. I like gold -- it's shiny! But there's something more. Remember Einstein's Theory of Relativity and e=mc^2 ? The 'c' is an changeless constant. Gold is like that except that its value is _always_ growing slightly. The trick is: how do you measure the value of gold? I suggest using the number of loaves of bread that an oz will buy. An oz of gold will buy 500 loaves of bread today, just like it did back in 1920 (gold = $25/oz, bread = $0.05/loaf). Gold appreciates slightly over time because it is consumed (used up) by industry and in limited supply. Gold is relativistic that way. It doesn't really matter what its value is in Zimbabwean dollars (or its cousin the US dollar). And that's why, as the US dollar plummets in actual value, gold will only _seem_ to be expensive at $2000/oz. That would mean that bread would be $5/loaf and that, of course, will never happen!!

Apr 01 01:16 PM

[Mark Anthony:]

I agree that gold is now over-priced relative to other commodities. The much better precious metal to buy is palladium, thanks to latest news from Russia, and a Gigantic Science Breaking News last week that will re-write the course of the 21st century, no exageration.

Read this, and pass it to your Congressman:

tinyurl.com/ddfdvy

For a detailed analysis of precious metals supply and demand read this:
seekingalpha.com/artic...

I am not a gold bear. I believe gold price will go much higher in dollar terms. But there are simply much better buys than gold.

Apr 01 01:28 PM

[Allan Frain:]

"Due to limited usage of gold, it is obvious that there are only two factors influencing gold prices: emotional and speculative."

So would you consider the massive concentrated short positions in the face of financial instability and unprecedented fiat creation emotional or speculative ?

Apr 01 01:38 PM

[Drew Arnold:]

This post isn't even close... The analysis gives me the impression that the author just started following the markets a week ago and wrote an article.

I would be very nervous about shorting gold here. The reflation argument is a strong one and is not outweighed by India's lack of imported gold.

Apr 01 02:05 PM

[thearizona5:]

Rofl, I stopped reading when he said "we saw positive news in the housing market". I hope everyone else did as well.

Apr 01 02:12 PM

[No Eye Deer:]

Sorry Sanjeev, like another poster commented I was looking forward to reading a bearish outlook on gold.I have a bit of gold. I have sold all my equities. I am now sitting on the sidelines. I will not invest in equities as I think the full political and social impact of this downturn has not kicked in. I think the full impact will kick in when they stop borrowing.

This is why I am always seeking out the opinion of others.

Apr 01 02:30 PM

[zepheri:]

Oh yea, and they have cars to buy now that are much neater than a hunk of metal. The golden quadrangle is the indian version of the German autobahn or US interstate. What happened to our gold standard after the Model T? The sweet nostalgia of the deuce coupe, although I am partial to the 63 Impala but I guess the nano will be more bugish

Apr 01 02:43 PM

[Alex Filonov:]

Agree with article. Well, almost. Gold so far ignored fundamentals. My response to everyone saying that gold is investment: Wrong! Gold is not an investment, it's a way of money storage. Current insane investment demand can't keep for a long time. When buyer of 30% of gold removed itself from the market and jewelry demand for gold is now negative (more sold for scrap than bought), it's a bubble. And yellow bubble isn't any different from black one which burst last year.

Disclosure: short gold by holding DGZ.

Apr 01 03:06 PM

[Mad Hedge F...:]

This is why. More than $19 billion has poured into commodity funds since January 1, $4 billion more than was seen during all of last year. This explains why my beloved copper soared 35%, while gold jumped 9%. Buy hard assets, sell paper ones.

Apr 01 04:21 PM

[@TexasER:]

My view is that gold will be volatile to upside, but not the downside. In other words, it could spike up but don't count on the floor dropping.

Gold is the ultimate doomsday trade. A single negative headline could send it rocketing up.

But short of the headline "Financial Crisis Just a Rounding Error", gold prices will not collapse.

Apr 01 04:27 PM

[physicist:]

If you ever had any experience in a high school, you will realize that gold is actually not overpriced. A simple arithmetic will reveal that:
1. In 1998 (where the gold bull has not started, the market is unknown to most people) the gold price was around $300/oz.
2. In 1998, the M3 of US dollars is around 5 trillion.
3. Now, in 2009, the M3 of US dollars is estimated to be 15 trillion (by shadowstatistics.com, Fed has stopped reporting this data since 2006)

So if we assume the demand/supply is not changed, the fair gold price should be:

300*15/5=900

which is about the price we are having now.
Actually, due to the current monetary crisis, I believe the demand side of the gold has increased significantly compared with that in year 1998 and the supply side probably has not increased that much. Of course, central banks in U. S. may have significantly increased the number of future contracts on the paper market. This is interpreted by some gold experts as price manipulation. So a $900/oz price is really a bottom for gold unless the money supply is reduced significantly or central banks print more paper gold for sale on future market.

The money supply does not seem to be able to contract since Fed is running the printing press as fast as possible. The shortage of physical gold probably will prevent central banks from printing more paper gold since margin calls may destroy them.

So what will be the gold price in the future? think about it again.

Apr 01 05:36 PM

[capt Brian:]

duh h h h h h----- okay listen to this guy, the economy is okay now, all the problems have been fixed, so you fools out there better unload ur gold and silver real quick. Geez thanx for warning everyone you wonderful guru you. What to do. Simple, the insane person I am will be good to the public one more time. Sell me all your gold and silver at spot price and you will not have to worry anymore.
Call BR-549 or write com.post.com and I will mail u all my money and u send me your silver and gold. Geez is this guy for real?

Apr 01 08:09 PM

[The Geoffster:]

The NBA players make up for any loss of sales from India.

Apr 01 08:50 PM

[12345:]

The Creditors of this world are now done playing the Fiat game. Good luck with your paper wealth....it's going to burn

Apr 01 10:41 PM

[Spartacuss:]

This guy is obviously disconnected from reality. Doesn't anyone connect the dots anymore. We're screwed at McGruders. The US dollar is now trashed by the government and the FED. There is NOTHING left to hang on to. Now we have a rally in stocks, a rally for fools or those clever enough to know when to dump the rally for some quick gains.

Never in the history of the world has there been such a massive bubble in currency. Sure, in the ordinary sense the author is correct. Just look though while everything else has tanked, the metals have held. You can use whatever metric you want but those who wish to safeguard will always buy gold.

Apr 02 12:34 AM

[Erick Tippett:]

Mr.

Your data give an entirely wrong impression. Gold has been in a
steadily inclining bull pattern over that last several years. The
dollar is holding up only because it is the world reserve currency
and that may not last much longer. A great majority of the world's
holdings are in the dollar and the Euro is having problems because
of the economic conditions in Europe. All of China, Japan, and
Russian ownership of American debt involve the dollar.

Gold being imported or exported in India does not change the fact that for over several thousand years gold has been both an intrinsic value and medium of exchange. Nations that have devalued their
currency and followed the fiat path have collapsed without exception
except perhaps this country, so far that is!

Go to Google and check out Mr. Alan Greenspan's paper on "The
Gold Standard and Freedom" you might learn something!

EDT
Chicago, Illinois

Apr 02 02:06 AM

[Fighting Yoda:]

Demand/supply determines price for everything. If prices go up demand goes down from the consumers - 60% of total worldwide gold demand is from jewelry - end consumers. About 30-40% of total gold demand comes from India. If India is not buying, demand is falling. Actually lots of Indians are selling gold.

The speculative/investor buying has not been able to offset the loss of consumer demand - gold bugs do not seem to comprehend this very simple fact. Speculators have their reasons to buy, consumer have their own - affordability.

Gold historically has underperformed everything for last 20/30 years - inflation, S&P, and even the treasuries. All please do your homework before jumping with two feet into gold.

Apr 02 02:36 AM

[Sanjeev Sharma:]

Since most people have made rude comments while not been able to refute my main argument or deny that data about India’s imports, they do not deserve any response. I think the editors need to monitor the quality of comments, such nasty comments would dissuade many people from writing in seekingalpha.

Thank you Alex Filonov and Mad Hedge fund trader for providing additional data supporting my article, in a sea of emotional commentators.

Here are some of my responses:
- If Dollar has no more value left, then why are we witnessing deflation, instead of inflation ?

- If all nations are devaluing their currency, and not just the US, why should dollar alone become toast ? In fact, dollar has gone up in the last 1 year against all other currencies.

Check out the prices in an year's time..

Besides my article about housing market in Jan this year, I wrote in Aug 2008 that dollar would go up (seekingalpha.com/artic...), it has done so against most currencies since then.

Also, had written in July 2008 (seekingalpha.com/artic...), that the proposed fed policy at that time of reducing principle for home owners would not work in lifting homeprices.

Apr 02 02:44 AM

[Fighting Yoda:]

Disclosure:
Do not have long or short position in gold or gold miners.
Overall bearish


On Apr 02 02:36 AM SB-tiger wrote:

> Demand/supply determines price for everything. If prices go up demand
> goes down from the consumers - 60% of total worldwide gold demand
> is from jewelry - end consumers. About 30-40% of total gold demand
> comes from India. If India is not buying, demand is falling. Actually
> lots of Indians are selling gold.
>
> The speculative/investor buying has not been able to offset the loss
> of consumer demand - gold bugs do not seem to comprehend this very
> simple fact. Speculators have their reasons to buy, consumer have
> their own - affordability.
>
> Gold historically has underperformed everything for last 20/30 years
> - inflation, S&P, and even the treasuries. All please do your
> homework before jumping with two feet into gold.

Apr 02 03:05 AM

[Sanjeev Sharma:]

BTW, if somebody who has done more "research" has a financial model explaining the price movement of gold from $40 in 1970 to $850 in 1980 to $290 in 2001 to the current prices, I would be grateful to have a glimpse of it.

Apr 02 03:13 AM

[billyboy54:]

On Apr 01 01:16 PM pungent wrote:

"That would mean that bread would be $5/loaf and that, of course, will never happen!!"

LOL, yes, when I was growing up in the 50s here in the US, it was unthinkable that a loaf of bread would ever cost even ONE DOLLAR.

I agree with all that you said.........

Apr 02 07:23 AM

[WetCoast Re...:]

That is one of the worst articles I've read and even the reference to housing data is incorrect. He referred to the February housing sales statistic that's improved... What he forgets is that it's compared to January and isn't seasonally adjusted... No one buys a house in January and since data's been gathered FEB has always had higher sales since JAN.

Very shoddy and surprising anyone would post this type of dribble.

Apr 02 10:29 AM

[Sanjeev Sharma:]

Housing data jump of Feb was not a routine one, but a very unusual and unexpected one:

For those who decided to comment but have either not read the news or forgotten it:

www.livemint.com/2009/...

online.wsj.com/article...

Apr 02 10:59 AM

[GMaximus:]

You say: "Due to limited usage of gold, it is obvious that there are only two factors influencing gold prices: emotional and speculative."

I disagree. There is one more very important factor: the value of the currency in which you consider "price". Remember, when you say "price", you imply a price denominated in some good or currency. Price of gold in Big Macs? Oil? US Dollars? If the value of the USD declines significantly, the price of gold in USD will rise. That does not mean the intrinsic value of gold increases, but the price does. When people predict that the price of gold will go up it is really less of a statement about the value of the yellow metal going up and more of a statement on currencies losing purchasing power.

Apr 02 12:50 PM

[Fighting Yoda:]

Sanjeev:
This is gold bug forum; no one wants to listen to a bearish forecast on Gold.
I agree with your views, more importantly the facts speak for itself.



On Apr 02 03:13 AM Sanjeev Sharma wrote:

> BTW, if somebody who has done more "research" has a financial model
> explaining the price movement of gold from $40 in 1970 to $850 in
> 1980 to $290 in 2001 to the current prices, I would be grateful to
> have a glimpse of it.

Apr 02 02:05 PM