How To Value Gold
Have you seen this video that mocks gold owners? It shows how it's easy to twist reality 180 degrees and make it funny at the same time. Congratulations to the author (director?) on a nice piece of verbal sleight of hand.
The video is illustrative of the fact that many people hold a negative opinion on gold without having done any research on it. I’ve seen stories in the Wall Street Journal saying gold has had a tremendous run up and it’s becoming more mainstream, so it’s probably overvalued, etcetera, etcetera. This is the laziest form of analysis and in fact, isn’t analysis at all. You can’t make an informed conclusion on a subject unless you have examined the evidence thoroughly, which clearly the WSJ and others haven’t. An opinion on gold that doesn’t examine drivers of gold demand is like an opinion on a company without knowing its products – fun, but useless.
I'm a bit surprised people think gold has little or no intrinsic value when it is plainly obvious it does. One argument I hear is that in the commodity realm, gold isn’t as good as oil because oil has industrial uses. But what is the goal of industrial activity? To fulfill human desires – for products, transportation, warmth, etc. Oil performs that role admirably. Yet humans also desire a safe place for wealth and gold performs that role extremely well over time. Both commodities fulfill human desires. Both fluctuate. So I’m not sure if I see the difference. Additionally, the marginal-cost approach deflects attention from the real driver of value – demand.
I’m not surprised people are flummoxed over how to value gold – it’s fairly complex – but saying it can’t be valued is presumptive without deep knowledge of the subject.
What people and even the WSJ miss is they start their valuation with gold and its price, a strategy akin to predicting how high a corn stalk will grow by looking at the seed. Sun, water, and nutrients determine how high corn will grow. Likewise for gold. Gold’s price is the effect, the result, not the cause. Other forces drive gold’s price including its supply, amount of dollars are outstanding, popularity of equities, bonds, cash, real estate, confidence in government & authorities, confidence in the economy, & many other factors. We must examine these forces to value gold.
It’s obvious there are no cash flows to ground a traditional valuation, but that doesn’t mean gold has no value. Even cursory thoughts on gold or other commodities would come to that conclusion. With knowledge of the future anything can be valued, gold included. The question is how well we can forecast the future. And based on analysis of the drivers above, I believe we can determine a range of prices for gold – both an anchor price and a range of likely future prices.
First, it’s obvious that gold is nowhere near its prior highs in relation to inflation, equities, or money supply. This provides context. Second, lack of confidence, fragility and inflationary structure of the world’s financial system, poor economic growth prospects, and demand from central banks all point toward much higher prices for gold.
Like with companies – we can only make our best prediction as to their future worth. At this point I have a near term anchor price of $1,000/oz for gold and I think it could go to $8,000/oz in certain situations.
Valuing gold is complex, sometimes excruciatingly so, and might be open to claims that it can’t be done, but I’ve yet to hear informed opinions as to a) why it can’t be valued or b) why its value is lower than $1,000/oz.
At certain points gold can be valued correctly and one of them is now. It’s everyone’s right whether or not to accept that value, but I’d caution on relying on broad judgments made by people that haven’t examined the situation in the requisite amount of detail.