Even if gold could be worth $6,300 I’m not buying
Posted on December 9, 2009 by Richard Beddard
Filed Under Editor's choice, Markets |
Gold, it’s glittering
Everybody’s talking about gold. The financial Internet is yellowing by the day as pumped-up hedge fund managers, bloggers and analysts dream up reasons to buy gold bars, gold coins, gold ETFs, gold mining shares and, most probably, the gold fillings from dead people’s mouths.
Through a canny little site called bit.ly I can even measure this phenomenon. It tells me about three times as many people follow links I share on Twitter about gold than say, links to articles about attractively priced companies.
When prices go up, people get interested, especially if the price of a scarce, glittery commodity of limited practical use like gold.
Much of the commentary on the gold price doesn’t tell us much more than the fact that the price is rising, probably because investors are fearful that the price of other assets, shares, bonds, property and money even, will fall. Gold is a ‘hedge’ or an insurance policy against economic mismanagement.
Since gold isn’t used for much, its value isn’t dependent on the economy. Silver, and platinum prices suffer because industrial demand falls in a recession, but for gold, there is little industrial demand.
I received this insight from analyst Dylan Grice of Soc Gen who, in a note published in November, tried to put a value on gold of $6,3000. Since the current price is about $1,200 per troy ounce we should all be filling our vaults, right?
The $6,300 figure is the price at which the US dollar would be fully backed by gold since the US owns nearly 263m troy ounces, while the US Federal Reserve’s monetary base, a measure of the amount of money in the economy, is $1.7 trillion. This situation is not normal, says Grice, it’s happened once in the last fifty years (click the chart for a larger version):
But, in early 1980 the nation’s gold was, very briefly worth 40% more than the total value of all the dollars in issue and by Grice’s measure right now gold is less than 20% of its fair value. In spite of recent rises in the price of gold, its actually got cheaper in comparison to the value of all US dollars in circulation over the over the last year because the US has been printing money, increasing the size of its monetary base.
While I can see that one day gold might rise to the point at which its value equals that of all money in circulation, after all it did in 1980, I don’t see why it necessarily should.
Grice says:
To value gold it helps to understand that paper money was traditionally based on the stock of gold (and silver). Depositors of bullion would receive a receipt proving their holdings and it soon became easier to use those receipts for commerce than it did the physical gold. So while the use of paper money had become commonplace by the 18th century, that paper was always redeemable into gold or silver. The money supply was always gold-backed.
But since there has been no link between gold stocks and the quantity of paper money since the Bretton Woods system collapsed in 1971, its relevance today is questionable and Grice is indulging in wilful speculation, which he admits:
If my “valuation” of gold strikes you as a desperate attempt to value something which can’t be valued, it’s no different from metrics such as the “market cap to clicks” or “ARPU” ratios which were used in the late 1990s during the technology bubble when demand for bullish “valuation analysis” mushroomed. They seem crazy now but speculators bought into them during the tech craze. And there may well be a bubbly parallel…”
He uses the Minsky-Kindleberger anatomy of a bubble introduced to me by his predecessor at Soc Gen, James Montier, to draw parallels between now and the 1960s and 1970s.
Kindleberger’s anatomy of a bubble had five stages: displacement, boom, euphoria, crisis and revulsion and Grice thinks we’re at stage 2. Displacement in the 1970’s occurred when central banks hoarded gold instead of dollars because they distrusted inflationary US policies intended to ameliorate recession in successive oil crises. The displacement today is the credit crisis, and governments are following inflationary policies again while nagging doubts remain about their solvency. Lack of confidence in policymakers could once again trigger a new gold rush.
Central bankers are likely to be net gold purchasers in the second half of 2009 for the first time since 1988, he says. Last time they hoarded gold, in the 1970’s, this happened (click for a larger image):
Ahead lies euphoria, crisis and revulsion. The 1970’s bubble peaked, Grice says, when governments won mandates to take on unions and raise interest rates and they haven’t yet won mandates to tackle the problems that bedevil us today, the burgeoning cost of health, pensions, and climate change, say. When they do, gold will have had its day:
But that is a long way off. Governments only won such mandates because by the late 1970s, the “inflation fatigued” electorate was tired of lurching from one crisis to another. We’re several crises away from governments winning similar mandates. In the meantime, displacement has happened, liquidity is plentiful, and the compelling narrative is gaining traction.
It’s a great story, but one that brings to mind another framework for understanding markets. In Irrational Exuberance, Robert Shiller describes bubbles as naturally occurring Ponzi schemes in which stories, and the apparent success of early participants (i.e. the people making money out of gold now), encourage new ‘investors’.
The stories don’t just describe the factors that cause bubbles, they fuel bubbles. I reckon it’s worth remembering that when you see analysts inventing new methods of valuation and journalists and bloggers parroting them.
Couple a good story to rising prices (the gold price has tripled in five years) and incredible valuations and all the pieces are in place for a speculative bubble, but that doesn’t make gold a good investment any more than your average dot.com company was. Plausible speculation is, still, speculation.
Value investors try not to speculate, but that’s another story. One I’ve recorded in this podcast.
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23 Responses to “Even if gold could be worth $6,300 I’m not buying”
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Well, someone else will buy your gold and then everyone will be happy !
Sorry but I’ve forgot to mention that gold is NEVER a bubble, because gold is historically totally different from the other usual commodities, including silver and platinum…
The Bretton System didn’t collaspe, Nixon exited it to fund his war campaign. And once central banks stop (if ever) propping up their Fiat currency, then we’ll see then how big the gold “bubble” becomes……
The price of gold is only going up because the value of the dollar is falling, due to the Federal Reserve printing presses working overtime printing money.
As anyone with an ounce of sense will be able to tell you - the more dollars that are printed out of thin air (without being earned) then the more the dollars currently in existence are devalued.
China is a buyer of gold and it can be seen earlier this year when the price would rise then fall on a regular bases. The recent jump is due to speculators but that does not take away the chance that China and possibly other countries, are thinking towards a new reserve currency that would include gold as part of a new world currency. Then were would the USA, and the UK be?
Hi Richard,
Very interesting set of facts as always. Many thanks.
Perhaps it is better to not think of gold as a useless chunk of metal but to think of the dollar (or the pound) as a useless piece of paper. The value of gold, in dollars, is probably no more predictable than the value of the pound in dollars.
However, perhaps you could play a mind game to decide what you feel is more valuable. If you won a cash prize so that you can either have a 10oz gold bar (worth $11300) or the same amount in dollars, but you are not allowed to cash in either for 10 years, which would you prefer? The dollars would be invested in a fixed interest bank account earnings 3% per year.
Hi Robin, I like the mind game. If I couldn’t cash in for ten years then the comparison should be between gold and what I would invest my dollars in with a ten year payback in mind. That would of course be in companies of my choice, which is pretty much what I say in the podcast. But theere’s a caveat, that the end of the world isn’t nigh, which I’m going to (try) to talk about next week!
Maybe I should add gold to my list of benchmarks for the Thrifty 30. So far I’m planning to measure its performance compared to inflation, the ftse all-share, and companies I chose not to put in the portfolio!
Hi Richard, the mind game was to put you in mind of being a sovereign state who will always hold dollar reserves. Perhaps a better game would be to say you can either have all dollars, or hold half in gold and half in dollars.
I am sure that the Chinese would be happy to swap some of their dollars for the equivalent sum of gold from the vaults of the US
It’s an interesting speculation Robin!
Hi Richard,
I really enjoy reading your articles and blogs, well done for keeping them interesting.
I started investing by buying on tips and feelings (cost me a packet!) then buying good companies but at too high a price (another packet!) then I stumbled on your articles on value investing. I found that this approach makes sense to me and I feel comfortable following it. The returns are satisfactory so far, but better still is that I don’t feel so vulnerable if there is another downturn. I won’t worry that any of my recent purchases will follow woolies and rbs down the drain.
Anyway thanks for showing me a way I’m enjoying following and thanks for telling me about Ben Graham (I’m reading ‘the intelligent investor’) and sharelockhomes (earned its sub ages ago)
After all the flattery I have a question…how can I find out the PE’s for the FTSE100 and other indexes and sectors? Just so I can follow how the market as a whole is valued.
Keep up the good work.
Douglas
Hi Douglas, thanks for the compliment and good luck with the value investing. First of all I track the UK market’s long-term PE here: http://blog.iii.co.uk/state-of-the-market/
And one of the ways I do that is by exporting the 10 year PE’s of all the companies in sharelockholmes and taking the median, which of course you could do independently if you wish.
I imagine you could do the same thing for individual sectors and indexes (i.e. by including the index/sector information in your export and then taking the median for each one).
Alternatively at the bottom of the FT’s Markets Data page there’s a section called ‘Research Data Archive’. If you click on ‘Equities’ and then ‘FTSE Actuaries Share Indices’ and finally the most recent date on the calendar you get a file like this one: http://markets.ft.com/ft/markets/reports/FTReport.asp?dockey=FTUK-111209
Which includes PE ratios for the indices, and sectors.
This is the Markets Data page:
http://markets.ft.com/markets/overview.asp?ftauth=1260612808843
Hope that helps,
Also, while I’m convinced value investors do sleep easier at night there’s no way to be sure a company won’t ‘do a Woolies’. I lost a packet on SCS Upholstery, a company that had no debt and still went bust. It taught me a hard lesson about my own limitations, and is one of the reasons I diversify more now than I used to. I’m sure you appreciate this and don’t mean to lecture a fellow value investor but your comment about Woolies brought back a very nasty memory, and I thought I’d share it!
Richard.
Hi Richard
Great piece on the plight of gold per se, but shouldn’t we all hold some gold as part of a diversified portfolio?
Best
SDJ
Hi Pragmatist, nice to hear from you again. This is where I show my fundamentalist colours.
It depends what sort of investor you are. My personal view is that I’d never diversify for the sake of it, only if I thought I was diversifying into a good investment.
I realise there’s a whole ’science’ of diversification that would have people buying optimal portfolios but I buy it into the alternative theory that to beat the market you have to do something different.
That’s why I like value investing. Instead of allocating assets ‘top down’ based on what I think are generally pretty unknowable views of the the economy or mathematical models beyond the understanding of most people, you simply buy companies that look undervalued. In practice you’re cycling through cheap sectors.
I used to think you could stay fully invested that way but now I think its best to keep a cash reserve when shares are looking expensive generally - both for diversification (security) should the market blow up - and to buy undervalued stocks when it does blow up.
But then I only really understand two asset classes, cash and shares
If there is gold mania, why don’t I know anybody who owns gold? Not a single person I know owns gold coins or bullion. Many of them own stocks and all of them own cash. Where is this mania? Why buy gold?
Its not as if the government will continue to print more money, is it?
In a world creaking under unpayable debt it makes sense to park your wealth in an asset with no counter-party risk.
Money is what’s worthless, Gold has been used as a sign of wealth and power since the beginning of time. Read the book of Genesis when you the chance.
Hi Papermieche. Are you thinking about buying gold, are your friends talking about it? During the buy-to-let boom I didn’t personally know any buy-to-let investors but friends were talking enviously about the gains they’d heard about. If there is a bubble in gold we may still be at a relatively early stage, but people should at least consider what they might be getting into.
I love to hear talk frompeople that have no money. People that give investing advice generally are inept traders/investers. You don’t see Buffett or Soros posting 24 hour blogs to scheme money out of people. They earn it through smart investments not Ponzi advice schemes. As for myself I’m fortunate. I have gold and U.S. Dollars so I win either way. Let’s face it though the real money is in buying when the price is down and selling when it’s high. Value.. haha..Enron was a Value..GMAC was a Value worth ZERO today. Todays value specials…gold and the dollar. For a country only 200 years old we’re dooing good compared to the crybaby 5,000 year old nations. Sleep tight..tonight.
This may be the silliest article I’ve read on gold ever. The writer should stick with something they know something about. Obviously its not precious metals.
so If someone offered you a Gold buffalo $50 for $60 you would say no?
cause you might be out $10?
Seriously I think it’s silly to talk gold as being worthless. It’s not like anyone can make it so that means the amount currently in inventory and that will be mined til the end of time is all we got. You think that the government will only print a certain amount of money and call it a day?
I’m not saying run from the USD and buy as much gold as you can. But buying some here and there and silver too as a store of value is a pretty good idea. As it helps to keep said value that would normally evaporate from the government turning the printing presses on and leaving them on, to monitize the debt and pass it on to the public through inflation.
Also last I heard the Fed at least right now is busy with it seems anything else then keeping inflation down.
(quick note: a resession is meant to clean out all the bad or stupid investments made and put the stupid people out of business so the smart people (by smart I mean responsible with their investing) can make a good economy)
everyone flushes the toilet right? well except the people in washington…they just throw money at it to fix it and wonder why it still stinks…
I have a property in a hilltop village in the mountains of Tuscany- a place where there were never any “good times” until about 2 decades after the war.
In that area the gold sovereign is still king and is often used to grease the passage of major transactions such as real estate. Its a hold-over from harder times that are still in the memories of the older residents; memories of chaos, political and economic instability and war. Through times that the lira had a volatile stored value, little gold coins carried those mountain people through the famine years.
I don’t want to allow myself to accept as fact an apocalyptic outlook for our future but I also want to be awake and be aware of the events and trends affecting me today and I really don’t see a “light at the end of the tunnel,” what with the constantly-growing, already massive corruption in western governments, the corporatism that is tireless in its fight to create protected, public-funded monopolies, the widespread ignorance and illiteracy that makes it difficult for people to name and identify the institutional dangers to civilization (in the literal sense).
Society is no longer guided by any far sighted philosophy and I see and hear chaos stirring around me and I know that if we descend into it that gold will still be an acceptable medium of exchange between the rational and prudent.
I am sure I am not the only one who feels a period of chaos on the horizon and I also understand that maybe it is a product of mass (marketed) hysteria but having a physical gold stash does allow me to feel a little mental peace and security. Perhaps that is the effect the shiny yellowness gives and if I think consider the costs of a pharmaceutical option for feeling relaxed, there does not seem to be much of a price difference.
All that said, I do appreciate your analysis and read it thoughtfully.
Cheers!
John Epperson, I’m not scheming money at all. Please see the about pages of this blog: http://blog.iii.co.uk/about-us/
Keith Miles, the writer is sticking to what he knows. That was (partly) the point of the article.
Mr Jim, thanks for your comment, most of us share you’re fears at one time or another, but I think it’s dangerous to let fear determine investment decisions. I think fear is driving a lot of the hype around gold.
However, I think we have to consider the possibility that the general fears about the state of the economy/democracy/society are justified. I had a go (not one I’m tremendously happy with, but it’s a start), here: http://blog.iii.co.uk/the-new-dark-age/
Alex, I’m not talking about gold being worthless, I’m saying it’s very difficult to know what it’s worth.
it’s worth more and more dollars everyday because of the policies of this Government. When you have a Currency based on supply such as the U.S.
A commodity such as Gold can easily be worth alot! I’m not saying it’s going to stay up in price but it very well could.
I’m just saying when you have a government running the printing presses like they are and borrowing/spending as much as possible for their own politics then just monitize said debt. It’s not a great idea to keep your investment in the dollar as it willl continue to slide in value.
So when the dollar goes down gold goes up.
I just hope that the decline in the Dollar’s value stops and it rebounds, but until it starts doing that Gold and Silver are a god way of storing your value. Also you might end up making a few bucks along the way or at least be able to buy what you could buy now in 10 years.