Possible Price for Gold?

User Forum Topic
Submitted by jg on December 1, 2006 - 1:55pm

Please correct my reasoning/logic:

5 billion ounces of gold in existence, today, growing at 2% annually (source: 10-K for StreetTracks GLD ETF).

U.S. share of world GDP is 28-43% (entire world vs. developed world) (sources: Federal Reserve and World Bank).

M2 is $6.9 trillion dollars (source: Federal Reserve).

Ignore fact that, today, 64% of gold is used for jewelry and industrial purposes (source: 10-K for StreetTracks GLD ETF); assume that in inflationary times, it will be used 100% for money.

$6.9T / (5B ounces * 43% to back U.S. economic activity) = ~$3,000 per ounce.

If all other countries go to gold to back their economic activity (i.e., use denominator of 5B * 28%), price could reach ~$5,000 per ounce.

Where have I gone wrong on my assumptions/calculations?

Submitted by jg on December 1, 2006 - 4:31pm.

Is gold at ~$650 per ounce rationally priced?

Replicating the above calculations using M1 (currency, checking accounts, and traveler's checks) instead of broader M2:

M1 is $1.4T

$1.4T / (5B ounces * 43% to back U.S. economic activity) = $637 per ounce.

Using 28%, instead, in denominator --> $978 per ounce.

Is there some 'method to the madness' in gold pricing? Or, is this just 'happy coincidence'?

Submitted by LookoutBelow on December 1, 2006 - 4:44pm.

It STILL only costs around 150-170 bucks to mine the stuff.......its hideously overpriced.

A few pounds of that stuff with a healthy slice of XOM stock and you got the makings of a 44 magnum headache......CD's...4.85%, sleep like a baby

Submitted by brian_in_la on December 1, 2006 - 4:56pm.

"If all other countries go to gold to back their economic activity (i.e., use denominator of 5B * 28%), price could reach ~$5,000 per ounce."


Well, at least that (ex) wedding ring I never got around to hurling with rage into the sea will have some value...I can use it to buy a wheel-barrow to take my greenbacks to the 7-11.

Submitted by technovelist on December 1, 2006 - 7:59pm.

I don't think you have gone wrong at all, except for possibly neglecting the fact that the actual intrinsic value of a "dollar" is zero. So any number of "dollars" per ounce of gold could (and probably will) end up being too low.

Submitted by sjk on December 1, 2006 - 8:57pm.

"It STILL only costs around 150-170 bucks to mine the stuff.......its hideously overpriced.

A few pounds of that stuff with a healthy slice of XOM stock and you got the makings of a 44 magnum headache......CD's...4.85%, sleep like a baby"

With all do respect, you don’t know what you’re talking about!

Submitted by masayako on December 1, 2006 - 10:12pm.

"It STILL only costs around 150-170 bucks to mine the stuff.......its hideously overpriced.

A few pounds of that stuff with a healthy slice of XOM stock and you got the makings of a 44 magnum headache......CD's...4.85%, sleep like a baby"

Your 4.85% CD can't even beat inflation. Hope you sleep like a baby 'cos you are in la-la land.

In my humble opinion, Gold is going to reach $700 by Q1 or Q2 in 2007.

Submitted by powayseller on December 2, 2006 - 7:13am.

I don't know so much about gold. I know its value is affected by the value of the dollar and US inflation, but didn't know it's affected by our GDP. But even with regard to the money supply, I have a question: since the Federal Reserve is just printing more money constantly, how is the price of gold affected? M3 has been growing at a faster rate in the last year, right?

Gold investors like Eric Janszen and Peter Schiff think gold will rise to thousands of dollars per ounce when the US dollar finally collapses.

Besides your method jg, is there any way to measure the value of gold? Or is it just set by supply/demand of jewelers, industrial companies, and investors?

Submitted by Wiley on December 2, 2006 - 8:43am.

from a man a lot smarter then I...

"Gold as it becomes a commodity becomes less valuable. As it becomes a currency gold becomes infinitely more valuable, seeking to balance the Balance Sheet of the USA Inc. in terms of externally held dollar instruments vs. the value of the nation’s holdings of gold. This value was $900 in 1980 and now stands close to $1,650." Jim Sinclair

Submitted by masayako on December 2, 2006 - 10:08am.

I personally agree that Gold the Most Undervalued precious metal in the Market right now. For those who want to know more about the facts about the value of gold vs dollars, here are the links. Just facts, no speculations.

Also, read "The Generational Storm - What You Need to Know about America's Economic Future" by Kotlikoff and Burns.

Currency in Circulation:

Gold at Fort Knox:

To quote from the "Generational Storm"(pg 224):

"Today, U.S. interest rates are near historic lows, real return are low to negative, and we are exporting record quantities of dollars. Our trade deficit is running 500 billion annual rate. We have a trade deficit with the European Union that's running at a 100 billion rate. 150 billion rate with China, 77 billion rate with Japan. All three areas import the bulk of their energy, which is priced in dollars.

In the late 1970s, as petrodollaRs piled up in Saudis Arabia and inflation headed for double-digit rates in the U.S., the Saudis made noises about seeking a more secure currency. Nothing happened because there was no place to go. The euro didn't exist. The yen was seen as not quite big enough to replace the dollar. China was still communist... Basically, there was no alternative to the dollar. That's one of the reasons the price of gold soared, peaking at $800 per ounce in 1980. Gold is the currency without a government. Given the dismal history of government aroundthe world, many think this quality makes gold superior to any paper currency. Others simply wish for a government willing to backits paper with something more substantial than... more paper.

Divide the amount of U.S. currency in circulation in 1980 by U.S. gold reserves, and you will find that a gold-backed dollar would require gold to be priced at $800 per ounce.

Do the same math today,and U.S. gold reserve would have to be worth about $4,600 per ounce for us to have gold-backed currency. That's nearly 12 times the current market price of gold.

Is that the true value of gold? We don't know. Besides that's the wrong question. The important question is the reverse: WHAT IS THE TRUE OF THE DOLLAR?"


Submitted by powayseller on December 2, 2006 - 1:49pm.

So gold soared in the 1980s because the Saudis bought it with their dollars, instead of buying Treasuries?

I think Roubini is against gold, but he has never explained what else people will flock to once they want to divest from the dollar. What are the choices? Equities, bonds, euros, swiss francs, sterling, yen, renminbi? Gold, silver? All that money will go somewhere else, pushing up the value of that "something else".

Submitted by rseiser on December 2, 2006 - 2:02pm.

Yes, jg, your method makes sense, and I came to a similar result when I calculated how much of our liquid dollar assets (cash, CDs, bonds) one would put into gold. That is exactly the most important variable, and that can be anywhere between 0% and 100%. Are we totally trusting paper money and hold 0% gold. Probably not since there is clear precedent to the contrary. Are we totally losing faith in politicians to manage paper money honestly, then we will want to hold towards 100% in gold and demand a gold standard.

I think a number of 20% is reasonable (again, just talking about dollars we own, not our other assets) which would put gold much higher than it is now. It is very realistic that in times of rising inflationary fear that this ratio trends continuously up, e.g. from estimated (?) 5% to 30%. That's one of the major reasons why gold can easily go up a factor 6 from its bottom (plus of course another 7% annualy or whatever dollars are printed during this time frame). Can the ratio go towards 100% and give another factor 3 (making it a total of 18 times up)? Sure, who knows, if we regard nothing as valuable as gold, but then it clearly becomes more risky. I rather take the easy gain in the beginning than panic later and try to get in at a price of about 3 times ($2000) from now.

Everyone has to answer for himself how much he trusts the government and paper, and what the other (clueless?) participants will think in a few years.

By the way, the production cost is so low because there is presently not so much demand. If the demand multiplies due to the above factors, there won't be enough production at low prices, so the marginal price to meet this demand will come from additional mines at much lower grade, and then the production cost will be a muliple of now. (Think of some Saudi oil at <$5/bbl and the tar sands at $50/bbl total cost. That's why oil is $60 and not $6.)

Submitted by Wiley on December 2, 2006 - 2:41pm.

Gold is insurance. Better to buy insurance before you need it, especially when you think you might need it.

Money supply doubling in last 7 years
Incredible amount of leverage partly due to Yen carry trade
Entitlement spending now/future
Rolling over of economic indicators
Current Account deficit
Trade deficit
Budget deficit

Maybe I'm wrong but it sure feels like a good time to have insurance.

Submitted by jg on December 2, 2006 - 6:45pm.

Thanks for the observations, calculations, links, and forecasts, W-, m-, rs, and tn.

I'm in gold mining stocks 100%, and now I'm in on margin, too.

It would be great to be able to keep my money in interest-bearing accounts/the stock market, earning interest or appreciating until right before the stock market crash, but because I have no confidence in my ability to predict short-term market moves, I'm happy to be out prematurely. I miss my 5% interest income, but I sleep better, now, knowing that I don't have exposure to short-term unpredictable market psychology (i.e., the market dropping before I'm out).

Submitted by powayseller on December 2, 2006 - 7:40pm.

jg, which gold mining stocks do you own? Nemont Mining? Zeal recommended several in their most recent newsletters, and I could forward you a copy for review (I'm sure they won't mind if you could be a potential client).

I'm not very good at explaining this gold stuff to my husband. He is reluctant to invest more than a few grand in gold, and is more interested in inverse stock market funds. Do any of you have any compelling arguments or articles I can show him? He says gold can fall in value again, just as in the 1980's, and that the dollar's fall wouldn't really matter that much. And honestly, I don't know how to answer either question.

Submitted by jg on December 2, 2006 - 9:26pm.

I said 'gold mining stocks' when I should have said 'precious metals mutuals funds.'  We have all of our money in these:

Vanguard Precious Metals and Mining (VGPMX) -- mostly larger cap (median $6B) gold and other mining companies.

U.S. Global Investors Precious Metals (UNWPX) -- mostly smaller cap (median $2B) gold and other mining companies.

The PowerPoint presentations at PrudentBear -- "Is the Dollar at Risk?," "Why Gold?," and "The Case for a Secular Bear Market" -- were the ones that made the sale for me.  See what your husband thinks.


Submitted by jg on December 2, 2006 - 9:51pm.

Mostly, ps, you should tell your husband that he'll be killing your future website business, 'cause no one will take you seriously as a 'doom and gloomer' if you only have 'a few grand in gold'! Lever up, lady!

Roubini -- who has expressed disdain for gold -- will see the light, too, as the dollar continues its fall and the oft-mentioned alternative, the Euro, gets diluted, too: per Doug Noland's most recent Credit Bubble Bulletin at PrudentBear, Euro zone M3 was growing at 8.5% year-over-year in October.

Submitted by anxvariety on December 2, 2006 - 11:24pm.

jg, I enjoy reading the stuff you write. What do you do for work? Are you a San Diego resident?

Submitted by jg on December 3, 2006 - 10:00am.

Thanks for the compliment, av. I'm just a humble wage-slave (head of finance for a small medical device start-up) living in a rental home in La Jolla.

See you at the next meet-up.

Submitted by powayseller on December 3, 2006 - 10:41am.

I like his posts too. Thanks for the links, jg, good stuff. But I need somethign more, something that explains why gold will do well when the credit bubble pops.

Submitted by rseiser on December 3, 2006 - 7:39pm.

I think the only chart you can use is a plot of gold, inflation adjusted in today's dollars, using a reasonable rate of inflation (not some ridiculous 2% CPI number). There you will see that the window for gold is $300-$2400, and there is no reason to believe that gold should trade much outside this window, since it hasn't for 3000 years. Of course, this window will move up with inflation, so in 10 years it could be $600-$4800. Within the window gold will trade according to fear, investors expectations, loss of faith in currency, etc. So if investors will sell everything else, the money might go into gold, and therefore prices will gravitate towards the upper end. The only way money won't flow anywhere is if government lets our huge credit bubble collapse without printing money - highly unlikely. Even then, gold can move to the upper end of the window, but the window will move down.

Will gold go to $3000 in between and then crash again to $600? Who knows, why not. But sometimes you have to know what is cheap and what isn't. Since gold is $650, it is closer to the lower end than to the higher end, and chances are still in your favor. If gold goes to $1500 the reverse is true, and I wouldn't rush out to buy it. I might sell some and hopefully find better investments then.

It's like a 5 year old Toyota, that you can get for $2000-$8000. I would buy it for $3000, and I wouldn't worry that it can go to $2000. If you are afraid of things like that, you will never make money in investing.

So to summarize, these are the basic beliefs that you must have when buying gold:
-That gold will trade in the same range it has been for hundreds of years.
-That inflation is real, and that interest rates are not high enough to offset your loss of purchasing power. (including protection in a crisis)
-That other asset classes are overpriced and that this won't last forever.
-That you can only buy it when it is realtively cheap or not at all. After the price moves up and everyone rushes into gold, the risk/reward will not be as favorable anymore as it is now.

If you don't share these basic beliefs, then don't buy it. Nobody will ever be able to offer you a guarantee since nobody can predict the future.

Submitted by masayako on December 3, 2006 - 10:45pm.

Well said, rseiser.

Submitted by Wiley on December 3, 2006 - 11:18pm.

I second what rseiser said.

and add a quote...“Gold still represents the ultimate form of payment in the world… Fiat money in extremes is accepted by nobody. Gold is always accepted.”

Any guesses on who said it. No googling.

Submitted by powayseller on December 3, 2006 - 11:32pm.

One of our Federal Reserve Chairmen?

Submitted by Wiley on December 4, 2006 - 12:21am.

Very good. Greenspan 1999

Submitted by poorgradstudent on December 4, 2006 - 11:11am.

"assume that in inflationary times, it will be used 100% for money"

The price of gold will have to get a LOT higher before people stop using it for jewlery/industrial purposes.

Submitted by qcomer on December 5, 2006 - 3:30am.

JG, Gold is an asset and just like all assets, supply and demand drive its price. In future, I do see demand for gold picking up in view of the liquidity glut and so one should definitely have a certain portion of portfolio in gold. But your formulation assumes that all available money (M2) goes after gold (100% demand) which is very idealistic.

With a constant amount of gold around, a growing population,a growing prodution line and a globally linked world,a gold standard idea seems idealistic but quite difficlt practically. Honestly, I don't like gold as a commodity asset compared to more useful commodities like silver/copper/oil/houses. Reason is simply because if it comes to cut throat survival scenarios portended by true gold bugs, a shiny coin cannot really help me as much as oil(energy),food,copper(tools),guns,etc. But I do own gold because I believe in diversification.

Submitted by Wiley on December 5, 2006 - 9:50am.

Why does gold as a monetary standard seem idealistic when its been the most affective or maybe better said popular, monetary standard for the last 4000 years? As far as our short history (US) we've only not had some sort of gold standard for 35 years and look what the value of the thing we call money (frn's) has done.

Submitted by powayseller on December 5, 2006 - 10:31am.

We first went off the gold standard because there wasn't enough gold to buy all the stuff that we needed and were making. Our productivity jumped drastically with the industrial age, but the amount of gold in circulation just did not keep up. How is it even feasible that all the money in the world today could be replaced by gold? I guess if it happened, each oz of gold would cost tens of thousands of dollars? Then someone would need to make tiny slivers of gold to buy cheaper items like bread or shoes.

Submitted by qcomer on December 5, 2006 - 6:08pm.

The discussions about pros/cons of gold standard with gold bugs is a long,endless and tirring debate so I am not going to go there. The reason I called the gold standard 'idealistic' is because theoretically the gold standard theories rely on the freedom of action that is distributed between free movement of capital, and effective monetary and fiscal policy. However, one reason that most modern macro-economists do not support a return to gold is the fear that this remaining amount of freedom would be insufficient to combat large downturns or deflation.

This argument can also be termed as "controlled inflation" vs "controlled deflation" as goal of monetary policy. Most economists fear that gold standard creates deflation and people don't spend money and buy stuff in deflationary scenarios thus causing recessions. Also, gold standard doesn't necessarily guarantee fiscally responsible govts as we saw in WW1 when govts printed money without care for gold, hoping to return it after winning the war. I believe (like most) that there should be some form of hard currency. What we have on hand now is an inflationary extreme but a gold standard would be another extreme. If you have stats/data to show otherwise (since the industrial revolution) then I would love to hear.

Submitted by Wiley on December 5, 2006 - 6:49pm.

Without a means of controlling monetary infalation you always have corrupt system, as we do now. You cannot protect private property rights, and as such lack freedom. You can argue that all day long but thats reality.

Lack of some sort of standard also creates longer and more extreme cycles. Not the other way around.

The arguement that you have to have equal amounts of gold to back whatever value your giving the dollar is simple minded imho. All you need is some form of gold standard that controls the amount of increase monetary bases.

To argue that you don't want a gold standard because gov't can go off the standard and print madly is like saying why have an acoholic give up drinking because some of them go back to drinking.

So barring a gold standard what is the solution?

It's not the gold that bugs are so fanatic about gold, it's about how well it preforms the role of a standard.

Please give me the paper where a modern economist says a gold standard creates deflation. I think most austrian economists would insist it is the excess monetary creation which create the environment for deflation.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.