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Whither Gold?

April 25, 2012 | About:

At today's price of $1,642 an ounce gold has risen 5% since the start of the year. But the trend now seems to be downward with the price below the 200-day moving average of 1,670.

Is gold overvalued?

The easiest way to value gold is to compare it to other precious metals, and by this criteria gold is overvalued. It is more expensive than platinum which is $1,551 an ounce. Platinum is about 15 times rarer than gold and historically has been as much as twice as expensive.Compared to rhodium gold is even more overpriced. Rhodium is currently $1,350 an ounce. Rhodium has historically been as much as ten times as expensive as gold.

The price of a man's suit is a famous metric for valuing gold. Ever since biblical times, a high-quality man's suit has supposedly cost about 1 ounce of gold. This is a difficult metric to apply as the price of a man's suit can vary enormously. Today, you can buy a quality man's suit for as little as $128 which would make gold 13 times overpriced. On the other hand you could spend $3,000 or more on a man's suit if you wanted to. It seems doubtful that many ordinary folks would spend more than $1,000 on a suit.

Another well-known metric is the price of 300 loaves of bread which historically have cost 1 ounce of gold. Admittedly loaves of bread in the past were much larger than today, but even so gold would seem expensive.

With oil at $104/barrel the gold/oil ratio is currently 16. The gold oil ratio has exceeded 20 in the past but rarely remains at this level for long. The ratio has fallen below 10 in the past. Gold is therefore approaching the upper end of this range.

A look at other commodities make the same point: Gold is expensive in historical terms relative to most essentials such as sugar, cotton, coffee, electricity, housing, wages etc.

There is one important exception: Gold is still cheap relative to the monetary base. In the U.S. the monetary base is currently $2.691 trillion and gold reserves are 8133.5 tonnes or 261.527 million troy ounces. 2,691,000,000,000/261,527,000.00 = $10,289/ounce. This was how the price of gold was calculated at the time of the Bretton Woods agreement. The price could go ever higher. In 1980 the money supply amounted to a mere $133.425 billion. A full gold backing would have required a gold price of some $500. However, gold shot up to $850. A comparable overshoot would give a gold price of $17,000/ounce today.

In other words, gold is expensive compared to other commodities, but very cheap relative to the money supply. Hyperinflation could be on the way.

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