Revisiting Gold's Valuation 21 comments
an article to
-
Font Size:
-
Print
- TweetThis
The other day, I asked how should one value gold. Specifically, what metrics should you follow to see if gold is overpriced or underpriced? My post was reposted at Seeking Alpha. As I expected, nearly all the comments were completely useless rants from gold bugs. Yes, I know why gold is used, but that doesn’t tell me anything about the current price.
One comment, however, stood out and I felt I should acknowledge this from silveraxis who blogs here.
The proper way to value gold is based on its monetary qualities, or in other words what it could purchase. Many people use inflation rates such as CPI as a proxy for fair value of gold but this is not very sophisticated for several reasons, the most significant of which include accuracy issues as well as the fact that the aboveground stockpile of gold grows every year. I prefer to use a ratio of gold to the global economy, stock markets, U.S. Treasury debt and/or global asset base.
Global economy is reasonably estimated using global nominal GDP (currently around $55 trillion). There are also available figures for Treasuries and stock markets (an effective if rudimentary approach is simply to use the S&P 500 as it is already market cap weighted).
Global assets are much harder to estimate but this is probably the most relevant ratio because it reflects gold's relative purchasing power. Clearly it wouldn't make sense for all of the world's gold to be worth more than every asset that could be purchased! Indeed, gold could only be realistically worth some fraction of total assets which throws some of the wilder (Jason Hommel, Ted Butler, etc.) gold price predictions right out the window. In any case, you basically add global stock market capitalization, real estate, private equity, debt collateral, fiat money in circulation, etc. but exclude all credit-based money, derivatives and other financial products that are zero sum (offsetting asset and liability). Let's say the current number for the global asset base is $150 trillion (probably a bit high but not that far off).
Now calculate the global market cap of gold: 5 billion ounces times $900 = $4.5 trillion. Thus the gold to global economy ratio is roughly 12 ($55T/$4.5T) whereas the gold to global asset ratio is currently around 33. Similar ratios can be computed for stock markets and U.S. Treasuries.
To determine if these ratios and thus the gold price is fair, too high or too low, you need to come up with similar ratios for various points in time, such as the 1980 high in gold, the 2001 low, under Bretton Woods (pre-1971), etc. as well as an average over time. If you do the math it basically says that gold is currently comparable to where it stood in the mid-1970's after the 1974 high and before the 1980 high. At the 1980 peak, the ratios were anywhere from 3 to 7 times lower. That implies if gold were to reach a similar extreme today, it could rise 3-7 times from current levels assuming the denominator (GDP, stocks markets, etc.) stays the same.
Alternatively, the average gold ratios over the past 40 years or so imply that fair value lies in the range between $500 and $1000. If we strip out most of the 1990's when the novelty of gold mine hedging and central bank leasing were at their peaks, these fair values become $600 to $1200. I believe at least several of the analysts that predict $1200 gold are basing their numbers on a similar model to the one I am describing.
Finally, my own studies indicate that the historical ratio of global asset values to gold may have been approximately 5 under the gold standard. In other words, gold might have typically represented approx. 10-20% of the world's material wealth in the past. Perhaps this could be viewed as the ultimate fair value of gold. If so, assuming a global asset base of $150 trillion would mean gold has a fair value of $3000 to $6000/oz. ($150T/5/5 billion ounces). Such a price assumes the adoption of a worldwide gold standard and no consequent deflation in asset prices, which may not be realistic. Perhaps $75T might be a better number given the already ongoing global asset meltdown in which case the fair value gold price under a gold standard could be $1500 to $3000.
Keep in mind all of the above gold prices are real and therefore don't need to be further adjusted for inflation because the ratios' denominators already account for changes in price over time.
This is a thoughtful answer and he’s clearly given the topic serious consideration. My major objection is that the variables needed seem to be very hard to come by and there must be very large room for error.
My view is still the same. I think the safest way to look at gold is to consider its price to be wholly irrational.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
David Fry
-
2
TraderMark
-
3
Don Dion
-
4
Cliff Wachtel
-
5
Mike Havrilla
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
Assuming $10T of US debt and 5B ounces of gold gives a value of $2000 per ounce of gold, just to "extinguish" US debt! Adding government debt of Europe, Asia, and Africa, and private debt, the value of gold approaches 5 digits.
On Apr 08 07:55 PM RickenAxer wrote:
> I don't get gold as an investment. It's practically useless and
> has little intrinsic value. In contrast, iron, lead or aluminum
> offer the owner a substantial array of practical uses. So, why gold?
in the real world (neo) barter is taking place... but if one does not have the commodity to barter - he gives his gold instead. this way the barterer can then use this gold to barter the commodity he desires.
This is the value of gold.. there is no credit behind it - it is what it is.. a hunk of metal - that is rare and shiny and makes the females happy and gives the males more sex....
this is a lot more valuable then paper with some old mans picture, latin letters, and "in god we trust"
everything is relative.. although gold is practically worthless.. paper money will be worth so much less.. in a nuclear war, or global disaster .. so this is where gold gets its value from
when the probability of such an events ticks up even a little bit , it causes large movements in the current price of gold.
its a risk reward thing... or insurance.. "i am willling to risk holding an asset that payes no paper interest and is currently useless... for the reward of surviving", during above mentioned events.
get with the program! if gold was worth $10,000, would you sell it? No way! but you would probably barter it; for maybe food, guns, bullets or a boat....
the point is - the more gold rises, the harder it is to buy. because people r hoarders. in the end the gold bugs will win... but it will never be to late to jump on that train... the last one holding the bag of paper wont be anyone of us...
so everyone chill!! we all know the squeeze is coming.. its just a mater of time.
disclosure: long silver calls
out of berg
As for the value of gold being wholly irrational, I just tried to show a small gold nugget to my dog and after she sniffed it and decided it was inedible, she wanted me to throw it so she could play fetch. That should be telling me something but I'm not sure what.
nicely put - slightly different angle - i really like it.
I'm a little bit more simplistic: My son likes smooth shiny quartz crystals from the beach. So do his friends. He trades 'em for Legos.
I like gold. My friends do too. Someday we may trade...
--ikk
Then take into account supply and demand of gold in your calculation.
There, you'll find the value of gold.
On Apr 08 07:55 PM RickenAxer wrote:
> I don't get gold as an investment. It's practically useless and has
> little intrinsic value. In contrast, iron, lead or aluminum offer
> the owner a substantial array of practical uses. So, why gold?
Again, the study concept has merit but just not sure about the numbers.
I was playing with a study that assumed China decided to engage in an economic war with the USA by buying gold recognizing that the dollar would be trashed. Today they could buy 2.2B oz with their $2T of USA dollars. Of course that won't happen because the price of gold would skyrocket as soon as the world recognizes the war has begun. Lets assume the Chinese slowly starts buying so as not to get attention. If they could accululate 0.2B oz (6,200 tons), then they would come out even if gold would rise to $10,000 per oz. Can they find that much gold? Unlikely. Would they settle for a big loss? Is it fesible gold could go to $20,000 per oz which would give them a more realistic target of 3,100 tons? GLD has 1,100 tons in their vault and it wouldn't take long to accumulate it all if you were serious. Ya, this is a crazy doomsday scenario but it is just as interesting as the scenario above. AND, remember; long term for us is the next quarter - for the Chinese, its next century.
It seems like you have much more luck getting groceries with lead if it's in the form of ammunition in a loaded gun. Of course, that might cause you to have certain legal problems, among other things.
Most of the things we assign value to in the modern world have a somewhat arbitrary value. When civilization was young, it was obvious what things had value. Seeds to grow crops with. Materials to make tools and weapons with. Materials to make clothing and shelter out of. Everything since that point has been a march up the abstraction ladder.
Anything that enough people agree has value then has value. It's not intrinsic, it's faith based. But when people stop believing, watch out!
I'm sorry you just got useless rants from goldbugs. Let's discount what they have to say and listen to the smart guys on TV who didn't predict the economic crash and don't know what's coming next.
www.hardassetsinvestor...
From looking at a chart, I'd say that what was support around $885 now seems to be resistance.
The rest of this "what's gold worth" discussion can't be quantified beyond that, for today. Until we know whether this rally has legs, if the dollar firms ( in which case gold will trend down for awhile) or greater uncertainty regarding the financial markets and equities in general take another leg down 20% ( in which case gold will trend higher), I personally wouldn't change my allocation--do nothing.
If you have never personally lived through a time when you had to barter for survival, I hope you never need to.
It's interesting the dollar didn't suffer during this rally, but gold seemed to suffer on demand for equities. Bond yields are in the green, that outta make China happy.
That's the kind of rally I like.