Price of Gold A Reprint From February 2013
With the present turmoil in the gold market, I thought a revisit of the problem might be in order. Nothing much has changed.
J.P. Morgan is reputed to have said, “A thing is worth what it will fetch.” That seems objective. Nonetheless, there are two fundamental premises that underlie the statement. Those premises may alter the statement’s “meaning” for you.
- “What it will fetch” is a synonym for price and it purports to represent worth objectively. Worth or value typically have meaning in terms of usability. On the other hand, price may include emotion, fashion, speculation, urgency and other less measurable factors.
- The statement is only true for the instant in which the transaction occurs. It is not necessarily connected to a continuum because the price is only valid within the conditions present at the time of the transaction. There is no guarantee that they will be present in the future. Price is always situationally dependent.
If you reword Morgan’s statement, you will get this, “A thing is valued at its price.” Most of us would not accept that without adding qualifiers. A better version, “At this time, with these participants, and for this particular transaction, this thing is worth this price.”
As to the title, I would rather ask what is the value of gold, but I have no idea how to address that. Gold seems to be an asset whose price, as opposed to value in use, depends on fashion, fear, greed, celebrity shills, group think and bubble mentality.
I have trouble with those backgrounds when I am thinking about a concept like value.
My thoughts on gold are:
- Historically gold is a store of value. It is recognized, measurable and nearly indestructible. There are some non-decorative uses, but those are not a large share.
- People have used it as a medium of exchange. They traded what they had for gold and then some other time traded gold for what they wanted. It was a “medium of exchange.” It made trading easier by taking away immediacy. In terms of this use, gold has become a relic. The medium of exchange is now fiat money. More convenient and unfortunately more easily manipulated.
- Some people want to own gold because the fiat money medium has become unpredictable. Governments are making the trade of goods and services harder because no one can be sure what they will be able to buy (trade their money for) using the wealth that they have stored.
- Gold tends to always be worth, proportionally, the same as the goods it trades for and the paper currency price is unimportant. If a cow was worth an ounce of gold one day then it should be worth an ounce of gold some other day. The paper currency price could have doubled or halved and yet the gold exchange rate should be unchanged.
- Some people own gold to hedge inflation. In this case, they don’t know how many pieces of paper money are needed to make a fair trade for an ounce of gold. Good question that. But, gold is an uncorrelated inflation hedge. If you bought it in 1974 for $125 per ounce you would have outperformed inflation by at least double today. If you bought it in 1980 for $800 you have lost a third of your purchasing power. I want my hedges to improve predictability. I can’t get that with gold. For periods ending prior to 2006, it is an inflation hedge that works if you ignore the spike in 1980. After 2006 there are other factors affecting its price. Not many of them are measurable.
- It may have some short-term value as a safe place in case of currency devaluation in the United States, but I doubt it. The old wisdom is “Buy on rumor, sell on news.” That means that things have a tendency to trade up in anticipation of the news (rumor) and trade down once a degree of certainty appears (news.) RIM and the announcement of BB10 in 2013, is a representative example. As to the value of the $US, we are in the rumor phase just now. If the Americans devalued by 50% tomorrow, would the price of gold be higher or lower in 90 days?
Sell on the news, right? Selling makes prices fall. Gold would likely go down once the announcement was made. How likely is a 50% devaluation, anyway? You would need an 80% devaluation to make gold worth more than it sells for now.
- In terms of exchange value for other goods, gold is radically overpriced. Gold is almost 30 times its 1972 price. But notice that commodities of all types define the marketplace. For example, gasoline, a premium hamburger, and the price of admission to a movie theater, are each about 13 times as expensive in dollars as they were 40 years ago. Crude oil is about 30 times as expensive versus 1972 and about 9 times versus 1974. Crude is a political tool and some of that shows up in its price.
Base metals are usually a good indicator of price level change. Nickel prices today are around 6 times higher, copper 7 times higher, zinc 4 times, aluminum 4 times. American household income, house prices, and the price of imported food are 5 to 6 times higher. The price of domestic food like eggs, milk, beef, and pork are about 4 times higher. Published price level change is around 6 times. As a “medium of exchange” for the all inclusive world marketplace, gold should be about $390. The rest of the price derives from the other factors.
- There are other possibilities I suppose. Maybe gold will become a reserve to back some, as yet absent, currency. When gold is money, as it has been for most of recorded history, its value in exchange is based on price levels in the marketplace. If tomorrow, someone wants to make it worth $5,000 per ounce, then they will make gold irrelevant to the people, because they will have to confiscate all of it to maintain that level. If I were such a powerful person, I would wait for the price to fall before confiscating it. Assuming I intended to pay anyone for it.
- There could be worldwide economic chaos. In that case, all the bets are off. It could have any price, but only for a short time. In the interim, you will have trouble finding anyone to make change.
What could happen to the price?
If we assume
- Price levels are now higher by 6 times (US Inflation) compared to 1972, and
- The $US will some day fall by half from its current value, (price levels then at 12 times)
Gold will likely sell for no more than $750 per ounce once the news appears. BUT. The price could go up before it goes down. Just because the price is crazy does not mean that it cannot become crazier.
When the people stop wanting to own it because the crisis has passed or has been accepted, the price will fall. That is the risk of dealing in things that are priced based on what everyone fears or “knows” to be true. Notice that owning gold is non-economic. It earns nothing and costs to store.
For perspective, you might enjoy a well-respected book published in 1841 by Scottish journalist Charles MacKay. Extraordinary Popular Delusions and the Madness of Crowds. The Kindle edition is $1.00.
Some, the ones who understand market psychology far better than I and who are far braver than I, will make a lot of money over the next few years. Like the people who shorted mortgage backed securities in 2005 through 2007. There are three conditions for success. You must be brave, very disciplined, and very well financed. There will be turbulent times in the interim.
Think it through. The information is there.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario. firstname.lastname@example.org