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Valuing Gold

Part II of the V Part Series,Why Gold?

Brett K. Rentmeester, CFA ®, CAIA ®, MBA – This email address is being protected from spambots. You need JavaScript enabled to view it.


The value of gold is hard for many to grasp.  Critics point to its lack of cash flow and argue it is impossible to value.  Others say its value is a sort of greater fool's theory where it only has value to the extent someone will buy it at a higher price.  However, these arguments completely ignore the scarcity of gold.  In fact, all the gold ever mined throughout history can fit into two Olympic-size swimming pools.  Second, some level of understanding of human psychology is required to comprehend gold, a skill largely absent from the armies of investment intellects today.  There are many items that people assign value to that could otherwise be junk at a garage sale to an unknowing seller - a Babe Ruth baseball card, the Mona Lisa painting, or even the Hope diamond.  However, no one would be so foolish as to argue that these items do not represent true value simply because they lack cash flow and need another buyer who appreciates their value.  In fact, paper currency itself is only valuable because people believe in its value.  What is a $100 bill really?  As the Austrian school of economics established, all value is subjective.

Gold has value because it is scarce, is valued for its beauty, and most importantly - has been viewed as money throughout history.  Given its increase in value during the last decade, some critics have suggested that gold is in a "bubble" – a sort of psychological ascent where price becomes disconnected from reality.  We would suggest they have it completely backwards.  It is the amount of paper money being printed that is the bubble.  Gold is simply stable purchasing power.  While giving the appearance of rising, gold has actually stayed stable while paper currencies have depreciated against it.  The more they depreciate, the more it appears as if gold is rising.

In our minds, there is one simple measure to value the price of gold – its quantity relative to the amount of paper money in the system.  The more paper money in the system, the more gold will be worth.  As illustrated below, the ascent of gold has mirrored the growth of paper money on central bank balance sheets.

Gold vs. Central Bank Balance Sheets[1]


Another way to think of the value of gold is to ask what its value might be if it was used again in the official monetary system.  If we returned to a gold-standard backing of the US dollar similar to the levels of the 1930s, gold could exceed $8,000 per ounce under certain conditions.[2]


When viewed in the context of the rise in gold in the 1970s, today's increase looks fairly mild with much more potential upside if we followed a similar pattern.


With the amount of paper money in the system multiplying at dangerous levels, we believe the value of gold is poised to rise in the years ahead.  In our view, policy makers will continue to print money and knowingly risk inflation as the lessor of evil strategy versus the alternative of presiding over a crash of our overleveraged system.  This means higher prices for precious metals and other hard assets that cannot be printed from thin air.  However, this will not be a straight path.  Expect volatility as continued economic weakness prompts occasional deflation fears that give pause to gold's rise.  However, we fully expect periods of sustained economic weakness to be met with even more aggressive money printing, which will lift gold higher. Gold experienced almost a 50% correction in the 1970's (December 1974 through August 1976) before rising over 700% (January 1980).  During these periods, investors need to resist being shaken out of their positions and should increase exposure during any sustained weakness.  Our diagnosis of inflation is secular and one we expect to persist for years ahead.


 

Brett K. Rentmeester, CFA ®, CAIA ®, MBA is the President and Chief Investment Officer of WindRock Wealth Management (www.windrockwealth.com).  Mr. Rentmeester founded WindRock Wealth Management to bring tailored investment solutions to investors seeking an edge in an increasingly uncertain world.  Mr. Rentmeester can be reached at 312-650-9593 or at This email address is being protected from spambots. You need JavaScript enabled to view it..

All written content in this article is for information purposes only.  Opinions expressed herein are solely those of WindRock Wealth Management LLC and our editorial staff.  Material presented is believed to be from reliable sources; however, we make no representations as to its accuracy or completeness.  All information and ideas should be discussed in detail with your individual adviser prior to implementation.

[1]       Timmer, Jurrien.  "Boxing Match: Central Banks vs. the Economy".   Fidelity Viewpoints.(https://www.fidelity.com/viewpoints/market-and-economic-insights/timmer-september-market-commentary). September 16, 2012.

[2]       Dundee Wealth (http://www.dundeewealth.com/)