12 years of the gold bull market have already passed – so is it possible that it’s still a good investment?
Here I’ll show you three simple and important charts that estimate the valuation investors are putting on gold right now. By the end of this piece you’ll have an objective understanding of the potential upside in an investment in gold right now.
Chart 1: What Percentage of Each Dollar Note is Backed By Gold?
The chart above plots the market value of the Federal Reserve’s gold as a percentage of the Fed’s total balance sheet. The result is the ‘% of the dollar covered by gold’. At the top of a gold bull market the consensus would be that we will see unlimited money printing and so gold would be one of the few stable reserve asset on the Fed’s balance sheet. In this scenario the % of the dollar covered by gold would be 50%+.
With the current gold price and Fed balance sheet size only ~15% of the dollar is ‘backed by gold’. This is far from the extremes that one would expect during the latter stages of a gold bull market. [Note: In the late-1970s / early-1980s the dollar was even 'over-backed' by gold (i.e. this metric was over 100%).]
Chart 2: What is Gold’s ‘Fair Value’?
The second chart shows the ‘fair value’ of gold against the market price. This ‘fair value’ is the price at which the dollar is fully backed by gold. The current price reflects the market’s faith in the integrity of the other assets on the Fed’s balance sheet, namely; Government bonds, Mortgage-backed securities, Federal-agency debt securities, the remnants of AIG & Lehman Brothers and so on… Currently the ‘fair value’ of gold stands at more than $11’000.
Chart 3: What’s the Potential Upside in Buying Gold Here?
This chart demonstrates the ‘potential percentage upside’ in investing in gold. At present the gold price would have to increase more than five times to reach ‘fair value’. This reveals the surprisingly large upside in gold given the age of the bull market.
What You Should Do About It:
Given the upside potential outlined above it’s prudent to own at least a small amount of gold. The data remains strongly in favor of a bull market if you expect the bull market to conclude when where most of the monetary base is ‘covered’ by gold (I believe this). I recommend using an allocated online service like Bullionvault. The reason is that it’s really convenient (all online), inexpensive (the cheapest I believe) and – most of all – the allocated nature of the gold storage agreement acts an inexpensive portfolio diversifier for the small to mid-sized investor.
If you’d like to know more about this type of analysis then I suggest you pick up Constantino Bresciani Turroni’s fantastic book; The Economics of Inflation – A Study of Currency Depreciation in Post War Germany. Great book.