Updated on 02/07/17
You’re thinking of buying some gold bullion—smart move!
With all the craziness in the world—high and rising debt levels, record low interest rates, countries still printing money, and none of the G-20 with a balanced budget—owning some gold coins and gold bars right now makes a lot of sense.
After all, from kings to pirates, gold has been a good store of wealth and crisis hedge throughout history.
So, how much is gold worth? Buyers want to know if the gold price is cheap or fair at any given time. Is there a way to tell if the current price is a good or poor value?
The answer is, you can’t. At least not in the usual sense. Gold is not a company that reports sales and profits. It’s not a currency where we can judge the balance sheet of the issuing country.
Gold’s chief uses are as a store of value, an alternate currency, and a shield against crisis and inflation. That makes the valuation question tough—you just can’t put an exact price on that.
But tough does not mean impossible. There are other signs that give us clues about gold’s value. This article looks at the seven methods to determine how much gold is worth, plus the secret way to value gold for yourself…
One of the first clues has little to do with gold.
Many pundits warn that gold will suffer when the Fed raises rates. But they overlook a key influence on gold’s overall worth: the real interest rate.
The real rate is simply the nominal rate minus inflation. If you earn 3% on an investment and inflation is 1%, your real return is +2%. On the other hand, if your investment earns 1% but inflation is 3%, your real return is -2%.
It is this real rate that has bearing on whether gold is undervalued or overvalued.
This chart shows the gold price and the real interest rate (10-year Treasury rate minus inflation rate) since 1970.
Notice that when the real rate was below zero—for example, the mid and late 1970s—gold was in a bull market.
And when the real rate was positive, gold tends to perform poorly.
Gold technically entered a bear market in 2013—and you see that’s when the real rate rose above zero. Though the relationship is not precise, generally speaking as long as the real rate remains positive, gold could be viewed as overvalued.
When the real rate shifts to negative, that will increase the value of gold. Be careful about waiting for that shift, though—sometimes gold has already entered a new bull market by the time real rates turn negative.
Valuation Hint: The real interest rate is currently positive, meaning gold is in a bear market. When it shifts to negative, the value of gold will increase. Investors should accumulate gold during bear markets, however, not bull markets.
Another way to judge gold’s value is to adjust for inflation. If gold’s inflation-adjusted price is near its highs, it is probably overvalued. On the other hand, if the price is near its lows, it could be seen as undervalued.
This chart shows the nominal and inflation-adjusted (in 1975 dollars) price of gold.
You can see that today’s gold price, in inflation adjusted dollars, is nearly 50% below its 2011 high. It’s also a whopping 78% below its previous 1980 high and near 1983 levels.
Prices were lower for prolonged periods of time in the 1980s, 1990s, and early 2000s, so they could fall further. By this measure, however, gold is far off both its highs and lows, and thus represents fair value.
Valuation Hint: In inflation-adjusted dollars, gold looks fairly valued. Although prices could go lower, the risk for buying now is low.
The gold market is notorious for running in cycles. And the start, end, or size of a cycle is hard to predict from the data. However, history shows that we must pay attention to our position within the gold cycle.
This chart traces gold’s many cycles since 1975, when gold again became legal to own in the US.
Gold has completed seven major price cycles since 1975. Some are brief with shallow price action, while others are big, lengthy moves. The average decline that caps a cycle is 41%.
The 8th cycle is now in progress. After a near 40% decline in gold, it’s hard not to conclude that the price is near a cycle low.
Valuation Hint: Gold has run in cycles for decades. It is currently at or near this cycle’s low. For investors, the next major cycle for gold will be up.
This valuation technique—ratio analysis—isn’t perfect. An investment could be undervalued and its ratio continue to fall if the comparison asset climbs. And vice versa.
But ratios give us insight into relative values. Here, we compare the price of gold to the broad stock market using the S&P 500 Index.
Why bother? Because gold is a non-correlated asset to the stock market. In other words, when stocks are hot, gold tends to be tepid or cold. But when stocks hit the ice, gold usually does well. And that makes sense. Investors’ interest in gold is low when stocks are doing well, but they change their tune when there’s fear in the marketplace.
Here’s the Gold/S&P ratio since 1975.
The S&P near an all-time high and gold well off its highs is clearly reflected in today’s low ratio. It means that gold is deeply undervalued relative to the S&P.
To calculate this ratio, simply divide the gold price by the S&P:
Gold/S&P Ratio = Gold Price ÷ S&P
Then compare the number to this chart to see if it’s high or low.
Valuation Hint: Anything below 1.0 represents excellent long-term value.
The Gold/S&P ratio shows that gold now offers much better value relative to the stock market.
This valuation guide looks at gold as a portion of all financial assets. If the percentage is high, gold might be viewed as overvalued. If the percentage is low, gold is likely undervalued.
This chart from consultancy CPM Group shows gold’s current share of global financial assets (2015 is a projection).
Gold’s share is above its level in the early 2000s, but significantly lower than it was in 1980. In other words, the current reading makes gold fairly valued.
However, the lows seen last decade aren’t likely to return. We just don’t see gold prices falling into low triple-digit figures for that to happen. And its share of financial assets now is four times smaller than it was in 1980.
Valuation Hint: The recent trend in gold’s share of global financial assets has been down due to the fall in gold’s price, but gold is currently undervalued when compared to historical highs. If the measure were to approach 2006/07 levels, we’d see that as a signal gold is dramatically undervalued.
We can also survey what gold is worth by comparing it to another tangible asset: real estate.
You can figure this ratio by dividing the price of gold by the Case-Shiller US National Home Price Index.
Gold/Real Estate Ratio = Gold Price ÷ US National Home Price Index
Here’s the 40-year history of the ratio:
Remember when home prices soared from 2000 to the peak in 2006? The gold price was climbing then, too, but home prices were rising faster. That caused the ratio to dip to very low levels.
You know what happened next. In 2007, home prices crashed. It was the biggest real estate bust in modern history. It’s doubtful we’ll see a repeat of a real estate boom like that anytime soon. If that’s the case, the current ratio is much closer to a bottom than a top.
Valuation Hint: Since 1975, the average reading for this ratio is 5.8. The current ratio is approaching that level, so relative to home prices gold is fairly valued.
All the above valuation clues combined don’t equal this one...
Gold isn’t a dividend-paying asset or an earnings-producing company. As such, its real worth is judged by how it will guard your wealth and protect your family when things go haywire in the economy.
So the question to ask is…
How much is gold worth to YOUR future?
Gold is like no other asset class. Gold has…
These advantages give you power. So when you ask, how much is gold worth?... ask yourself, what is this power worth to me?
Consider how empowering gold will be in any of these scenarios…
Deflation. Debt is already slowing global growth and could easily tip us into recession. Many analysts believe it could be worse than a recession, since most of the developed world is deep in debt with no viable way to pay it off.
Inflation. We have low inflation now—but the US has printed more money than ever before. When that money makes its way into the economy—or if the Fed prints more money—we’ll get inflation. And it won’t be mild. This risk is not immediate, but it is inevitable.
Bear market in stocks. As an uncorrelated asset, gold will outperform stocks in the next bear market. As Valuation Clue #4 shows, gold is a much better value right now than stocks.
Negative real rates. As Valuation Clue #1 shows, when real rates turn negative gold tends to enter a new bull market. This shift between positive and negative real rates has happened regularly throughout US history—it will happen again.
Another financial crisis. In virtually every recorded crisis, the gold price has risen. Gold is the primary asset that will protect your portfolio in all types of nasty scenarios. (Gold fell in 2008 when the financial crisis hit, but it rebounded sharply in 2009 and surpassed the high for 2008).
Personal emergency. You save for a rainy day—and if part of your savings is denominated in gold, its purchasing power won’t get washed away. Cash savings are slowly losing value… at just 5% inflation, your dollars lose half their value in less than 15 years. If we return to 13.5% inflation like in 1980, your money would lose half its purchasing power in under 5 years! You can avoid this insidious “inflation theft” by owning gold.
In virtually every crisis mankind has faced, gold has done what it’s supposed to do: insure against calamity, whether it’s worldwide or personal. Gold is the only asset that can do this. So how much is gold worth to you? Your lifestyle is worth insuring with gold, even if the price isn’t a “bargain.”
Valuation Hint: It’s less about buying at the exact bottom for the gold price and more about how well insured you are against risk. If you don’t own gold, buy some now. If you don’t own a meaningful amount—enough to make a difference to your portfolio when things go sour—buy more now.
Here’s a recap of the 7 ways to value gold…
|Real Interest Rates||Gold is likely to shift to a new bull market when real rates go negative (interest rate minus inflation).|
|Inflation-Adjusted Price||Gold’s highs and lows adjusted for inflation can tell us if the current price is a good bargain. Based on this measure, gold is neither overvalued nor undervalued.|
|Gold’s Cycles||The gold price historically runs in cycles, and is currently at a cycle low. The next major cycle for gold will be up.|
|Gold/S&P Ratio||Gold is undervalued relative to the general stock market. Gold is currently a much better value than the stock market.|
|Gold’s Share of Global Financial Assets||Gold’s share of global financial assets is four times smaller than it was in 1980. Though currently fairly valued, gold is undervalued when this metric is compared to historical highs.|
|Gold/Real Estate Ratio||Relative to home prices, gold is fairly valued. The ratio suggests that investors are not overpaying for gold at this time.|
|Valuing Gold For Yourself||How much is gold worth to you if we get deflation, inflation, a stock market crash, negative real interest rates, another financial crisis, or a personal/family emergency? It’s worth insuring your portfolio with gold since it has no counterparty risk, has never been defaulted on, has never gone to zero, and maintains long-term purchasing power.|
If you’re looking to buy gold, check out our recent article on how to buy gold bars.
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