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|Includes: GLD, Barrick Gold Corporation (GOLD), SLV


Keyword:  GLD, SLV, Inflation,


Is gold overpriced?

Some folks relate the current price for gold against the growth in M1, M2, U.S. Federal debt, GDP, and so many other things.

Some use dollars to measure if gold is properly priced (like Ben did in June) while others are simultaneously using gold to decide if the dollar is falling in value.  It is a circular debate.  We also cannot even use other currencies to measure if the dollar is properly being valued because they also are moving for a dozen similar and disparate reasons.

So is the gold/dollar exchange rate correct currently?  Can CPI be used to compare gold price variations over the years?  Was the gold peak in 1980 irrational or ($612 year's average and $800 peak)?

The Palm Steak Index:  I read once where a guy from Europe visited New York 2-3 times per year and had plotted the price of a certain 12-ounce Prime Rib steak at the 4-star Palm Steakhouse in New York for over 30 years.  He used this as an index of the cumulative costs of beef, feed, agricultural land, water, transportation, salaries and other overhead, like insurance, furniture, etc.  The competition for steak eaters in New York is efficient to avoid over-pricing or under-pricing.  The product stayed the same.  That is of critical importance because so many other products do not.  Cars and airplanes evolve technologically, in manufacturing automation, materials consumed, and cost of importation of rubber from third-world countries, etc.  Medicine moves on its own dynamics, including price pressures from the federal government and insurance companies.  But, Mr. Palm-lover reasoned, he could measure inflation on many component items of a brick & mortar product that cannot evolve.  It was very insightful.  A 12-ounce steak is not a victim of shrinkage -- as with a candy bar or hamburger and is not helped by technological paradigm shifts.  In a 12 ounce steak,  the material is genetically identical.  The method of production (saws and cleavers) is the same, transportation is still done by the same trucks as 50-80 years ago, and it is cooked using the same number of BTUs from the grill or oven.  It was an index of an unchanging cross-section of the whole economy.

His index told him that inflation varied between 5.5% and 11.9% from 1980 to 2005….while the CPI was reporting a rise in costs of less than half of that number on an annual basis.  So, no surprise, CPI is a manipulated number.

So, we cannot use CPI as a rule as to whether gold is properly valued compared to earlier values - as so many are want to do and make these claims that gold should be at $2,400.  Using the weighted average “Prime Rib Index” inflation of 7.8% per year starting with 1970-74 (just before the end of the "anti-hoarding" laws of FDR), if gold were correctly valued in 1974-76 as a base year, gold should be between $882 and $1,257 today.  Not too far off.

But, let’s look for further verification of the “steak index”.

In 1936, you could buy a VERY nice suit with two pairs of pants and a vest made out of the best wool-silk blend – not the best suit you could buy, but VERY nice – for $36.  Gold was selling for $36 and the Great Depression was still dragging on, although gold prices had been controlled by FDR for 3 years at that point.  In 1955, gold was still at $35 per ounce because it was still price controlled and removed from circulation from 1933 to 1974.  But, it was selling for $50 per ounce in other countries.  That suit was up to about $60-75.  In 1975, that suit would cost you about $160 and gold was selling for…….$160 year's average.  But, by 1980, gold sold for an average of $615 and that suit was only $395.  Suit prices were lagging.  Or…was gold too high due to the fear of continuing high inflation for years?  The following 10-12 years were soft for gold prices while the cost of that suit rose to meet the price of gold.  I bought a very nice suit for interviewing in 1992 for $425 suit – one of the best, but there were better ones for sure – mine was 90 on a scale of 100.  Gold was then selling for $383 average.

The suit/gold ratio has been over and under parity many times, sometimes as much as 30%.  But, today, you can buy a very nice suit for about $1,249.  Not the best, which go for $1500-2000, but a VERY nice suit - suitable for any interview at Goldman Sachs.

If you’d lost that $35 in cash money in your suit pocket in 1936, today you’d have $35 and you could buy a nice tie to go with your $1,249 suit.

Another measure: My dad made $250 per month as a newly-graduated chemical engineer from Carnegie Tech in 1949….his grandson, a 2011 UCLA newly-graduate chemical engineer will be making up to 27-30 times this amount in starting salaries graduating with the same degree in 2011.  Let’s see.  $50 gold in 1949 times 27 equals…..$1,350-1,500 gold in 2010-2011.

The point is that we are not talking about the same paper dollar at all.  Each year, it is a different dollar.  But, although the suit is the same quality with the same material and components and the same number of man-hours invested in it’s manufacture – – an ounce of gold will still buy you one – very nice - interviewing suit.

So, gold has not gone up or down.  It is not "too high".  Gold is what it has always been, the only material on earth that cannot degrade and cannot produce compounds with other elements.  Throw it in the ocean in a stone urn and 2000 years later, it will come out as it went in....pure gold.

It is OTHER CURRENCIES that are changing around it.  Their prices change -- but the value of gold -- relative to suits or chemical engineers or steaks -- does not.  Gold should be exchanged today for $882 to $1,500.  At current prices, it is right in the mid-range.

Disclosure: Long GLD, gold, SLV.