What is
gold really worth?
Much of what the
gold-manipulation devotees come out with ranges from groundless to completely
nonsensical, although it is usually harmless. After all, it is true that
governments regularly attempt to manipulate the financial markets. The way we
see it, the question revolves around the methods, effectiveness and
investment implications of the manipulation. This is the area where we often
find ourselves at odds with GATA supporters.
The main reason
that a large chunk of our latest weekly commentary was assigned to debunking
a recent piece by GATA's Adrian Douglas is that in this case the
manipulation-related analysis was not only nonsensical, it was potentially
harmful. In particular, apart from painting a misleading picture about the
supply of gold and the nature of today's money, Douglas's conclusion that
gold is worth $54000 per ounce right now could cause some people to ignore a
major gold selling opportunity. By way of explanation, let's assume that
there is a massive escalation in the government debt crisis over the next 12
months, and in response the Dow Industrials Index plunges to 4000 while the
gold price surges to $4000/ounce. Based on 100 years of market history, the
drop in the Dow/gold ratio to 1 would represent a wonderful opportunity to
trade out of gold and into the stocks of high-quality US industrial
companies, but someone who had been swayed by Douglas's analysis would still
view gold as a strong buy on the belief that it was still trading at less
than 10% of its "true" value.
What, then, is
our assessment of gold's "true" value?
We see no good
reason to believe that gold is not fairly valued at today's price. Relative
to the CRB Index (CCI) gold tested its all-time high in February of 2009 and
is presently within 20% of its all-time high. This seems reasonable given the
economic and financial-market backdrop. Relative to the Dow, gold's value has
almost quintupled since its 1999 trough. We expect that it will eventually rise
a lot further, but the current level of the Dow/gold ratio looks about right
assuming that the long-term equity bear market is not yet close to being
over. Relative to the US money supply, Paul van
Eeden's work suggests that gold is over-valued at this time (van Eeden
calculated in October-2009 that if gold's price had risen in proportion to
the increase in the supply of US dollars then gold would have been fairly
valued at $815/ounce in 2009). Note that we don't think it's reasonable to
calculate a "fair value" for gold based on the assumption that the
gold price will, over time, simply move in proportion to the change in the US
money supply; we just wanted to point out that applying a simplistic
"quantity theory of money" calculation leads to a lower number than
today's gold price.
Which prompts the
question: Why are we intermediate- and long-term bullish on gold?
The reason we are
very bullish on gold's prospects beyond the short-term isn't that we think gold
is a screaming bargain based on the way things are today; we are bullish
because we don't think that today's gold price comes close to fully
discounting the adverse FUTURE effects of government and central bank
policies. Also of consideration is that we aren't aware of any long-term bull
market of the past 80 years that stopped once the investment in question had
become fully valued. In all historical examples that we can think of,
dramatic upward acceleration occurred some time after full value was reached.
Gold Market Sentiment
These days it is
popular and conventional to be a contrarian. It seems that almost everyone
tries to figure out what everyone else is thinking/doing so that they can
then do the opposite. Right now, for example, it seems that almost everyone
thinks that almost everyone else is bullish on gold, and, therefore, that
it's a good idea to lean the other way. Of course, if the majority is either
bearish or anticipating a major bull-market correction on the basis that too
many people are bullish, then most market participants are actually NOT
bullish.
Despite the fact
that gold is the only high-profile market to make a new all-time high over
the past few months, objective indicators of sentiment suggest that the
general level of gold-related optimism is relatively low. For example, the
results of the latest Market Vane survey show that only about 60% of traders
are bullish on gold. This bullish percentage is in the bottom quartile of the
three-year range. For another example, the premiums to net asset value for
Central Gold Trust (GTU) and Central Fund of Canada (CEF) dropped to 2.9% and
4.8%, respectively, on Tuesday 27th July, which is near their lows of the
past two years.
Now, sentiment is
just one piece of a large puzzle, so just because sentiment is not
particularly bullish -- contrary to the beliefs of many pseudo-contrarians --
doesn't guarantee that the gold price won't drop to much lower levels over
the months ahead. It simply means that sentiment is not a headwind for gold
at this time.
Steve Saville
www.speculative-investor.com
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