Valuing Gold

We get a significant number of questions on gold and its intrinsic value. Gold is seen as a currency and store of value today, especially due to inflationary concerns. However, during its history gold has also been viewed as a collectible, and its value during that period has departed significantly from periods when it is viewed as a currency. In the chart below, even inflation adjusted price of gold has varied significantly over time, peaking when gold is more acceptable as a currency and troughing when it is viewed as a collectible.

Another way to view gold is through the U.S. gold coverage ratio, which measures the amount of gold on deposit at the Federal Reserve against the total money supply. That ratio has varied between 0.17 and 1, with an average of 0.4 (chart below).

During non-inflationary periods when gold is not viewed as a currency, the ratio drops to 0.17. When there are significant concerns about inflation and currency debasement, the ratio rises to 1. We find it interesting that the chart shows that even at the lowest historical coverage ratio of 0.17, gold looks significantly undervalued today and is certainly not predicting immediate and significant inflation. However, if the high inflation outcome does materialize due to competitive money printing across the world, gold has the potential to hit one of the higher price targets indicated in the chart.

Another way to look at gold is to look at the marginal cost of production. Currently, the highest marginal producer has a cost of about $1150/oz. Below these prices, that producer will likely take production off-line, thereby reducing supply and boosting prices (if demand remains the same). For that reason, absent a catastrophic event, gold prices could find support at the $1150 level.

As always, we caution investors to take this as one of the many data points out there. At the end of the day, the sentiment of gold buyers contributes as much to the price of gold as do fundamentals, and it is not surprising that the volatility in sentiment is being reflected in the volatile gold prices.

This material is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations. This is not an offer or solicitation with respect to the purchase or sale of any security.