The Gold Price Compared to Various Yardsticks

Our friend Ronald Stoeferle from Erstebank in Vienna  has sent us a few charts that we think are well worth considering (readers may recall his widely read and excellent series of reports entitled  'In Gold We Trust' – for those who have missed it, a pdf file of the most recent report can be downloaded at the bottom of this previous missive).

Many people insist on referring to the gold bull market as a 'bubble', to which we always retort, 'one day it may well become one, but it's not there yet'.

Most prominent among the gold bears who have been deriding the advance in vain over the past several years has been Nouriel Roubini, who has referred to the gold market as a bubble for quite some time, but there are many others who agree with his view. Roubini apparently simply hates gold, presumably because its rise stands as a constant reminder that the money printing and deficit spending policies he supports are seen in a rather dim light by the markets.

It is only natural though that people are worried about the possibility of a bubble having formed. After all, the gold price has now advanced a good bit from its lows 11 years ago and it has done so unwaveringly year after year. Since gold is difficult to evaluate, one must go about the exercise in roundabout ways.  Gold is not consumed and the market treats it as a currency rather than a commodity, so it can not be analyzed by the supply-demand type analysis applied in e.g. analyzing industrial commodities prices. Since it has no yield it is also not possible to calculate its present value by discounting a future stream of earnings, such as one can e.g. do with stocks and bonds.

However, it is possible to compare gold to alternative investment assets as well as to various monetary aggregates.

For an in-depth discussion of the  major fundamental drivers of the gold price, we refer you to a previous article, 'Precious Metals, An Update'. Although the article is slightly dated by now, the principles discussed in it remain of course valid.

 


 

Gold, 1974 to today, via the Privateer. It has gone up a lot, so it must be a bubble, right? Not so fast – click chart for better resolution.

 


 

Below are the charts Ronald sent us – they compare gold's price to the monetary aggregates M2 and MZM (money of zero maturity), as well as the S&P 500 index. These are very long term ratio charts (beginning in 1968), which brings the situation into proper historical perspective.

 


 

The ratio of gold to M2 , 1968 to today – click chart for better resolution.

 


 

The ratio of gold to MZM, 1968 to today – click chart for better resolution.

 


 

The Gold-S&P 500 ratio , 1968 to today – click chart for better resolution.

 


 

A note to the charts: for the M2 and MZM ratio charts, the gold price was divided by the amount of these aggregates in millions. E.g. M2 amounts to $9.763 billion as at December 2011, so the ratio depicted above as of today is 1,740/9,763 = 0.178.

For the Gold- S&P 500 ratio chart, the usual method of dividing the gold price through the SPX in points was used.

As can be seen, in terms of these ratios gold is merely closing in on the levels first achieved in 1974. This certainly indicates that gold is no longer a bargain – it was a bargain ten years ago, and even five years ago, but not today.

However, it is difficult to argue that it is overpriced. As QB Partners are fond of pointing out,  the gold price level that would be required so that the value the official US gold reserves would 'cover' the amount of US base money outstanding amounts to approximately $9,000/oz.

None of this is to say that the extremes in the ratios seen in 1979-1980 will be reached again this time around – we simply don't know. All that these charts are telling us is that gold is not yet in what can be deemed 'bubble territory'. It could well be argued however that the significant global monetary inflation of recent years could eventually help to produce an even bigger move in the gold price than during the last bull market.

Usually long term bull markets don't end before a blow-off rally occurs that produces significant overvaluation. While it is unknowable how and when we will get to that point, it seems fairly certain that we will get there sometime in the next few years.

 

 

Charts by: The Privateer, Ronald Stoeferle


 

 

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10 Responses to “The ‘Gold Bubble’ In Perspective”

  • Hi Rafael, thanks for the kind words – could you post a link to your site?

  • Mikesmarket:

    Looking at the gold/money supply charts, one can’t help wondering if margin selling in the next global financial crisis won’t complete a 4th wave correction (the 2nd started in 2008Q1), before an extended 5th wave that reaches for the old ratio highs. The lowest point around 2000 looks like a major degree low, prior to the current impulse wave. This fits with Austrian expectations of the dollar destruction by the few very evil central planners who call themselves government or the Fed.

  • hettygreen:

    Gold may not be in bubble by definition but a lot of the commentary seems hyperbolic (ZH constantly and with absolute ‘certainty’ harping about the inevitable Fed quantitative easing equaling Gold to the moon Alice! nonsense) or just plain nut jobbish when it involves armageddon like scenarios. Forget about a reasonable conversation: stridency thy name is Gold Bug. Anyway I just don’t see having a stash of gold as a priority if banks fail and countries collapse, or even if the central banks continue with their absurd and ultimately fruitless machinations. I’d rather have food and the means to produce it, my health and/or a marketable skill. Gold buys nothing in my grocery store unless I go to the bank and exchange it for currency. It also draws the attention of folks with guns. A lot of people planning to get rich off gold will live to see it taken at gun point by their neighbor or their government. Either that or the price plummets when the stock market implodes and they take a shellacking along with equity investors (again). Finally most people are having trouble paying the bills let alone acquiring a gold stash so if the precious does go all Nasdaq 2000 I will take comfort knowing the stupidly wealthy, the only ones who can afford it, are finally about to be clipped like all the rest of us.

    • rodney:

      Hi hettygreen,

      Don’t look to ZH for reasonable market analysis. They provide more ‘opinion’ than analysis of the facts.

      I would say nothing is 100% safe, neither gold nor your preferred play (land, livestock, etc.)

      However, gold is safer. A point you are overlooking is the fact that gold can be easily stored in a safe vault controlled by yourself and the thieves don’t need to know where it’s located.

      You need to live through confiscatory deflation (eg. Argentina) to really know your risks. In the times of Argentinian ‘corralito’, it is precisely those with farmland and cattle that were robbed at gunpoint. Thieves had exactly the same thought you did: Food, not gold, is the priority when you are hungry.

      As regards gold going down together with the markets, it may not happen if the reason is a complete breakdown of the monetary system.

    • rodney:

      On second reading, you really blew it with that last sentence. You will never grasp the facts or come up with a proper analysis with all that bias. Get rid of it if you want success, not just in the markets, but in any endeavor.

      If gold does go parabolic, lots of smart investors who purchased five or ten years ago will notice and realize their large profits by selling their positions.

      ‘Stupidly wealthy’: Do not assume that everyone who is wealthy just inherited a fortune and doesn’t know what to do with it. The majority of wealthy people are successful entrepreneurs (yes, capitalists) who were smart enough to discover an unsatisfied need or want they could supply.

      ‘all the rest of us’: I, together with a lot of other people with a different view of life, don’t belong to your group. Please leave me out of it.

      • jimmyjames:

        Good job rodney-

        People like hettygreen do not understand that public participation in the gold market is almost nil-
        They have never been a factor in determining the gold price and likely never will be-
        I find it odd that those who have no exposure to gold always make the most noise about it-
        Is this akin to “whistling past a graveyard”?

        http://www.acting-man.com/blog/media/2010/10/Gold-percentage-of-financial-assets.png

      • hettygreen:

        Whoa there Rod, for starters I’m not in a ‘group’ and I have no interest in attracting any followers. Otherwise why would I commit the heresy of even remotely questioning the wisdom of gold for all. Those smart investors you speak of have probably taken ‘notice’ of the price along with profits ages ago. Who is buying gold now apart from the rubes who always show up late in the game? Why, the biggest,richest and stupidest rubes of all, central banks of course! You remember, the big sellers from ten years ago when anyone buying was viewed to be from another planet. Where were the bugs then? Oh I forgot, that crowd was totally enamored with the Nasdaq. What was I saying about stridency? Sheesh…stop living in the nineteenth century.

    • It is true that a number of gold bugs are very strident and some are in fact at times sounding a bit nutty and are unwittingly giving the ‘gold bug community’ a bad name.
      But you must not forget that in the bigger picture, they remain a tiny minority. Mainstream investors still have only a minimal allocation to gold and gold related investments. I would guess the ‘gold bubble’ is approximately where the Nasdaq bubble was in the late 1980’s – still in its infancy compared with what is to come (of course this is just a personal opinion and subject to change should new evidence emerge)
      Regarding the usefulness of gold in case of a financial collapse or even worse, a collapse of civilization as we now know it, i.e. in the event of a vast retrogression in the global division of labor, I would point out the following:
      There is nothing that says that gold must ‘fall in price’ in such an eventuality. This presupposes that fiat currencies remain a valid means of payment. That may not be the case.
      True, food may be a bigger priority if everything goes to hell. However, gold has always been the money of the free market and I do not expect that to change. Not everybody can become an autarkic producer of his own food.
      Let me give you an example from fairly recent history: in the final years of World War 2 as well as in the inter-war period, food and basic necessities became scarce in the major German and Austrian cities. The only way to obtain food was by getting it from the farmers. In the interwar period, mobs set out from the cities and robbed the farmers. It was a common sight in the post WW1 hyper-inflation period in Austria and Germany. The police were powerless to stop it, and sometimes even took part in the robberies. So growing one’s own food did not keep the people with guns and knives from showing up and simply taking it.
      How could one obtain food from the farmers in a peaceful manner? They refused to accept the collapsing fiat currency. One either had to barter or pay with gold. Those in possession of gold in fact were among the few who saw the purchasing power of their assets protected and were able to fairly easily survive during the hard times. The farmers weren’t easily convinced to take an artwork in exchange for a cow, but they sure did take a piece of gold.

      • hettygreen:

        P I’m not a farmer or large landholder but I am in a position to feed myself in a pinch and I can fix things and make things other people need. What percentage of the population are vulnerable small farmers these days? Apart from the AgriBusiness operators, who I’m sure have the means to take care of any of those pesky mobs who roamed post war Europe, they seem to present a much smaller (and therefor less exposed) cohort. I’m not anti gold, just somewhat agnostic given the tone of a lot of the commentary; if the world I live in starts to look like Germany and Austria in 1945 it might be a tool for survival, but then again so would possession of a supply of lead and the means of distributing it rapidly and accurately. Personally I prefer to peaceably go about my business and live and let live as far one’s choice of ‘investments’ or ‘insurance’ are concerned. Damn fine blog by the way.

  • rafaelhotz:

    Hi, I’d like to compliment you on your website. I discovered it a few weeks ago and now it’s a must read, just as Zero Hedge.

    It’s nice to see fellow Austrians working and commenting the financial markets – it’s tough to work only with the biased info from mainstream media. I myself work for an asset and write reports for an explicitly “Austrian” financial consulting here in Brazil (“The Vienna Club”).

    Check out my website, it’s full of free Austro-libertarian literature.

    Keep up the good work.

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