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By Simon Avery

The price of gold topped $1,590 (U.S.) on Friday. Is that too high, or too low?

Julian Jessop, chief international economist at Capital Economics in London, offers several long-standing metrics for assessing the value of bullion (GC-FT1,590.801.500.09%). Some of them suggest gold is still a smart buy. Others say it’s fairly valued. Take your pick.

1) Buy

  • In inflation-adjusted dollars, gold is still off its high reached in January 1980, the equivalent of $2,400 today. The world was arguably even more chaotic then, with double-digit inflation, the U.S.-Iran hostage crisis and the Soviet invasion of Afghanistan. Prices didn’t hold, but they did average about $1,900 that month in today’s terms.
  • The ratio of the price of an ounce of gold to a barrel of Brent crude oil is just 13.5 today. In 1970 it was 16. If you apply a 16 multiple to today’s $117 price for oil, you get a gold target of $1,870. At times, the ratio has ranged between 25 and 30, implying a valuation of $3,000 or more.

2) Sell

  • Gold is above its historical average when compared with equity values. Since 1900, the Dow Jones Industrial Average has been about 10 times the price of an ounce of gold. At the moment the Dow is about eight times the value. However, the ratio has fallen as low as 1 to 2 during the Great Depression and the early 1980s.
  • The ratios of gold prices to the U.S. money supply M2 and nominal GDP are above their long-run averages.
  • A return to the gold standard is “inconceivable.” One assumption is that a return to the standard would increase demand for gold, especially from the central banks.

But as the euro-zone crisis shows, using a fixed exchange rate system removes policymakers’ ability to set the appropriate interest rates for their own economies.

Conclusion:

Mr. Jessop’s own forecast calls for $2,000 an ounce by next year. But he adds: “we would not be surprised to see prices reach this level sooner and then rise significantly further.”

Source: Gold May Be Worth More Than You Think