Is $6,300 Fair Value for Gold?

Ambrose Evans-Pritchard Daily Telegraph November 19, 2009

Thursday 19 November 2009 | Blog Feed | All feeds

By Ambrose Evans-Pritchard Economics Last updated: November 19th, 2009

4 Comments Comment on this article

The last parabolic spike in gold took off when central banks joined the fray in the 1970s, hoarding bullion with the same enthusiasm as gold bugs.

Dylan Grice from Société Générale says it smells much the same today.

He sees an eery similarity between the decision of India’s central bank to buy half the IMF’s entire sale of gold, and the move by France’s central bank to start converting dollars into gold in 1965 — which was, of course, the start of the slippery slope leading to the collapse of Bretton Woods and the closure of the US gold window under Nixon.

In the gold mania that followed, the price rose to levels that matched the US dollar monetary base (it reached 140pc at the peak). If that were to occur today after Ben Bernanke’s go at the printing press, gold would have to reach $6,300 an ounce. The US owns 263m ounces of gold while the Fed’s monetary base is $1.7 trillion. Simple equation.

Gold has had its ups and downs, of course. It is trading today at roughly the same real price as in the mid-13th Century — when an ounce bought a light suit of chain mail.

It doubled in the late Medieval bubble, before crashing 90pc over the next 500 years after the Spanish gold discoveries by Cortes and Pizarro in the New World, and then the finds in California, Australia, and South Africa — bottoming around 1930.

“Gold isn’t intrinsically safer than any other asset. There is nothing mystical about it either,” said Mr Grice.

However, precisely because gold is almost useless, it makes the perfect currency, and that is the role it is playing right now as flight from fiat paper leads to fresh records each day ($1150 yesterday).

Almost all western governments are insolvent. The total net liabilities of the US and France are both over 500pc of GDP. The UK and Germany are over 400pc.

We are bust. To make matters worse — says Mr Grice — central bank credibility has been “permanently ruptured” by their collective failure to see the 2008 crash coming. (He is too polite: they caused the crisis by holding real rates too low for a decade, creating a debt bubble).

Given that central bankers have been exposed as mortals/charlatans (ie pretending to command an exact science, when economics is merely a descriptive branch of anthropology), who can have much faith that they will manage the exit from emergency stimulus with skill?

Markets fear that central bankers will try to satisfy political masters by inflating away our debt. (Here too, I have my doubts: my concern is that they do not yet understand the deflationary dynamic underway, and will stay too tight, for too long, until we are in the Japanese abyss. Look at the 7pc annualized contraction of the M3 money supply {not the same thing as the monetary base, at all} in the US over the last three months, which Bernanke refuses to look at because he regards M3 as a barbarous Friedmanite relic.)

Mr Grice’s method is an odd way to calculate fair value of gold, but as good as any in a mania — and certainly no worse than ARPU ratios and “market cap to clicks” in the dotcom bubble. So perhaps gold is cheap.

Personally, I take no view on this. As a contrarian, I never like an asset that is in fashion. I loved gold at $252 eight years ago. The higher it goes, the less I love it.

Now, what asset today is as underpriced relative to the rest of the market as gold was in the depths of bear market in 2001?

The Harare stock exchange looks a good place to start.

Any other thoughts?

COMMENTS

“The Harare stock exchange looks a good place to start. Any other thoughts?” That your clearly insane :p

I’m still expecting a mass default across the debtor world, theres just no appetite for paying these debts or meeting these retirement and healthcare obligations, or ability to even if there was. Golds as good a thing as any to own to avoid that.

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Default by printing, assets down, energy and food up, de leveraging on a grand scale,private debt default, a big fall in equities and a continuing flight from paper. Thats my guess.

I did not know of the central banks hoarding in the seventies, hard to imagine the herd rushing to buy Krugerrands and sovereigns again at these prices. If the common man gets on board big time then look out.

Contrarian well the vast majority have not bought gold at all. How many portfolios have say ten percent exposure? The lunatic fringe (gold bugs) are being joined by central banks and a few funds oh and the big miners. If 10% of Europeans did so the price would rocket.

The “contarians” I think underestimate just how serious the dependence on printing really is and do not recognize that the policy is a symptom of insolvency for the states that indulge. Could end up with delirium t soon. Society General are correct to give their warnings. If this is not the big one gold will fall, if it is meltdown it will go up and up.

Harare, phew now that is contrarian.

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How about shares in Icelandic banks while you’re at it? The theory being that when you’re flat on your back, the only way is up.

I do regard inflation as the danger for a very simple reason: people are starting to question the actual value of their money. Money is based on trust more than anything else, and who trusts anything the central bankers do? We then have potential situation in which money which is worth less is chasing goods which retain their value, ergo, inflationary spiral.

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Who knows – at least it’s egg on Brown’s face everytime the price goes up!

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