An often cited negative about gold is the inability for investors to value it, unlike traditional investments such as stocks and bonds.
A company’s revenues and earnings can be forecast to arrive at a valuation multiple. A bond’s cash flows can be discounted to come up with a present value. But since gold bullion does not produce either, investors often struggle with assigning a fair value.
Some will look at technical analysis, others fundamentals, interest rates, or expected inflation—but unfortunately there’s no correct answer, and attempting to time the market when choosing an entry point is extremely difficult.
There is one long-term indicator an investor can monitor when reviewing portfolio allocations and initiating a position in physical gold bullion.
It’s the S&P 500 to gold ratio.
This is simply the amount of gold, expressed in ounces, equal to the level of the S&P 500. Below is the ratio and real gold price since 1968.
As you can see, the ratio has varied widely with a low of .17 in 1980, when gold reached an inflation adjusted high of $2100/oz., to over 5 at the height of the tech boom in late 1990s, when gold was trading around $400/oz. Currently the ratio is 1.90, 21% above its historical average of 1.57.
Since 1970, each time the ratio has been around 2, gold turned out to be a very good investment. There have been two such instances since 1970 and each time resulted in large gains. We’re potentially facing a third right now.
Since market timing is very difficult, it’s generally more advantageous to risk being early and leaving some profit on the table than trying to squeeze every percentage return from an investment.
Whether it’s financial risks from a fracturing European Union, slowing China, an emerging market, political uncertainty in the US, or excessive market valuations, now is the time to examine your portfolio and consider adding the insurance only physical gold bullion can offer.
Investors who think the current eight-year bull market has room to run may benefit by waiting for the ratio to rise above two—but keep in mind PE of the S&P 500 in 1999–2000 was near 30, about twice its historical average of 16. Currently around 23 (depending on the growth rate you assign to earnings) it appears stocks are fully valued.
While the S&P 500/gold ratio is not excessive (as it was in the late 1990s), it is at a 10-year high, and we’re in a different market environment and economic climate.
Investors concerned about principal and purchasing power preservation should consider this longer-term trend when examining their portfolios and the diversification benefits of gold.
If you’re considering an initial allocation to precious metals or want to add to your holdings, please review our SmartMetals Action Kit or call 1-888-993-2207 to speak with me directly about the Hard Assets Alliance precious metal services.
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