Why Gold Is Not Overpriced

Apr. 1.11 | About: SPDR Gold (GLD)

Yesterday, yet again, another author wrote a very long and circuitous expose on why gold is “in a bubble” that will end like some Greek tragedy.

Sorry, but I have given up trying to convince some people who still use CPI as a measure of “inflation”. So, read here on that issue.

But, that being a given, this article also argues that gold is overpriced because, among other reasons, it has risen X% in Y time periods. In so doing, he digs himself into the traditional hole of measuring gold with the USD rather than the other way around. The exchange rate between the USD and gold is what should be discussed, not the value of only one relative to the other. This will become painfully clear if and when the USD loses its status as world reserve currency.

This “gold’s price is too high” argument is too much like someone who gets on a scale after gaining 50 pounds and stating “this scale is obviously inaccurate based on the fact that the weight could not be that high or get that high that fast”. No, another possibility is that you have eaten too many Ding Dongs in too short a time or that the U.S. Govt has - in too short a time - printed too much money, taken on too much debt (for which it has shown repeatedly that it will pay off by printing still more paper money), and has shown absolutely no interest in reducing spending.

This USD reserve currency loss result, by the way, is not likely to occur in one black swan event, as some have warned. Due to the fact that so many financial institutions base their laws, financial rules, and contracts on the USD, and that so many countries hold USD “in reserve” in order to do world financial transactions, etc. – the loss of world reserve status is likely to occur in slow motion. Like some Hollywood action movie, gravity will be held in abeyance, the laws of “bodies in motion” will be dampened, bullets will move so slowly that you can see them spinning as they fly to their targets. The result will be a “meltdown” more than an implosion or collapse. And, my argument is that the meltdown is well underway – hence the reason for most of the last $400-600 rise in gold’s USD-denominated "exchange rate".

And, THAT brings us to the point. Both gold and the USD are currencies, mediums of exchange, claimed stores of value with which you can barter between 3-5-15 people simultaneously without having them all in the same room at the same time agreeing on the barter terms of each item being bartered. If you have a measuring stick (say the USD) and you use it to measure the length of an ounce of gold (i.e. establish the value in USDs) and you measure $1000 in May, 2009, you cannot simply remeasure in March, 2011 and declare “this gold has grown too long" (i.e. too high in USD units of measure). If the measuring stick (the USD) is rubber and has shrunk in length (i.e. value) due to too many of them being printed from here to the moon, then, yes, the length of that gold can appear too “long” (i.e. high as measured in USDs).

But, as any weights and measures guy or civil engineer can tell you, you need to first calibrate the measuring stick. You need to know the actual unaltered length of the measuring rod – in this case -- what it will buy. And, nobody with eyes to see or ears to hear can argue that the USD will not buy what it used to buy. What world commodities (i.e. not real estate which is ONLY local in nature, usefulness, and hence value) have not changed in price relative to the USD at a rate of 1% per month or higher in the last 3 years? Corn, oranges, wheat, oil, gasoline, coffee - the list goes on endlessly. CPI doesn’t measure this accurately – CPI is a government contrivance meant to talk down fears of inflation and to control government increases in entitlement programs like social security, Medicare, welfare, etc which are all keyed to CPI for their annual revisions.

The “price” of gold is merely an exchange rate between gold and the USD. And as I stated in Sept of 2010 when gold was priced at $1330:

M1 has risen from about $1360 BB in March 2008, when gold was at $1000, to $1720 BB recently. That is an increase in M1 of 26.4%. That accounts for nearly ALL of the increase in the price of gold, which, at $1300 is now 30% higher than the $1000 price of March-June of 2008. So, if gold is "too high" now, it has been "too high" for 2-1/2 years now, consistently tracking money supply…..not based on “speculation” or "bubble building" as so many have argued.

Gold is not "overpriced" – or, if it is, then nearly every other worldwide commodity from alfalfa to zebra meat is also "overpriced".

Disclosure: I am long GLD, DIG.