bmichaud Posted June 9, 2013 Share Posted June 9, 2013 1. Gold peaked in 1980, averaging $615 per troy ounce. Assuming 2.5% inflation over the 31 years leading up to gold's 2011 peak, the "inflation-adjusted" 1980 average price in 2011 dollars was $1,322. This inflation-adjusted number is often cited as evidence that gold's secular bull market peaked in 2011, with an average price of $1,572. http://www.nma.org/pdf/gold/his_gold_prices.pdf 2. I would posit that Ray Dalio's definition of the fair value of gold, total units of currency outstanding divided by the global gold stock, is a reasonable guidepost for valuing the cash flow-less, and thus (supposed) intrinsic value-less shiny metal that is gold. As such, to properly compare gold's recent nominal peak average price of $1,572 to the 1980 peak, we need to instead look at growth in the global money supply since 1980, adjusted for growth in the gold stock. 3. According to the World Gold Council, the FYE 2011 estimated gold stock was 171,300 tonnes versus approximately 70,233 at FYE 1950. This equates to a 61-year CAGR of approximately 1.5% per annum. http://www.gold.org/investment/why_and_how/faqs/#q021 4. According to Ned Davis Research (see chart attached), global M2 was approximately $45T as of FYE 2011 versus $7.5T as of FYE 1986. The 25-year CAGR is approximately 7.4% per annum. Obviously the chart does not go back to the 1980 gold peak, but this rate of growth is likely a good proxy for 1980 to 2011. 5. So with 7.4% M2 growth and 1.5% gold stock growth, we have net monetary growth of 5.9% per annum. Inflated 5.9% per annum for 31 years, gold's peak average price of $615 is the equivalent of $3,636 in 2011. Gold's 2011 "peak" average price of $1,572 was 43% of the $3,636 1980 equivalent!! Hardly a peak I'd say.... 6. Gold averaged $460 in 1981 - inflated 5.9% per annum for 30 years, the 2011 equivalent is $2,568. The 2011 "peak" was 61% of the 1981 equivalent. 7. With Japan just now ramping up its printing press, the inevitable yet-to-be-initiated European QE program and a growing Chinese credit bubble, it appears there are plenty of global currency units yet to be printed. At around $1,383, I'd say the current gold price offers a rather attractive margin of safety. 8. Regarding Gold's decline from its all-time high of over $1,900, gold suffered three -20%+ declines in the years leading up to its 1980 peak, with one of the declines over -40% (see page 8 of the attached SSOL newsletter). Virtually every single precious metal sentiment indicator is at extremely depressed level, with the Hulbert newsletter index, for example, at levels not seen in the past 15 years (see attached). It appears few sellers remain.... 9. Lastly, Larry Edelson provides a good overview of gold here: http://www.swingtradingdaily.com/2013/05/27/golds-next-bull-market-the-real-forces-that-will-drive-it-2/. He has been bearish on gold since the 2011 peak and sees a bottom forming this year. He denounces money printing as the driving force behind gold's next run. I have no idea what will drive the next run, I just attempt to use the money supply as a valuation gauge. Disclosure: long precious metalsGlobal_M2SSOL_Issue_03.pdfHulbert_Gold_Sentiment Link to comment Share on other sites More sharing options...
vinod1 Posted June 10, 2013 Share Posted June 10, 2013 I would think a more reasonable approach to value gold would be to start with the reasonable assumption that the gold has zero real return. Then you can use an inflation measure like CPI to get a very rough estimate of the fair value of gold. You can start off with different starting years and calculate the fair value. So all you need is gold price at a particular point in time and the inflation rate since that time. There are a couple of papers that I read that have used this approach. I have seen fair values of around $500 to $800 when using a base years from 1900 to 1920. Obviously very sensitive to CPI rate. Gold bugs, of course, would believe that CPI is understated. The above approach seems more reasonable to me and on that basis I think gold is overvalued by 100% or more. I can recollect only one paper "The Golden Dilemma" by Harvey Campbell. Vinod Link to comment Share on other sites More sharing options...
vinod1 Posted June 10, 2013 Share Posted June 10, 2013 2. I would posit that Ray Dalio's definition of the fair value of gold, total units of currency outstanding divided by the global gold stock, is a reasonable guidepost for valuing the cash flow-less, and thus (supposed) intrinsic value-less shiny metal that is gold. As such, to properly compare gold's recent nominal peak average price of $1,572 to the 1980 peak, we need to instead look at growth in the global money supply since 1980, adjusted for growth in the gold stock. To me the idea of using the monetary base or some such currency measure to determine gold value is the equivalent of estimating a company's revenues by how much it has produced rather than how much it has sold. Vinod Link to comment Share on other sites More sharing options...
bmichaud Posted June 10, 2013 Author Share Posted June 10, 2013 All good points. Though I try to look at it from the perspective of if you were forced to convert the global monetary system to the gold standard. You'd probably start with some sort of currency outstanding analysis. Though if you believe gold has no monetary-based value, and should be looked at as just another commodity, likely the CPI route works well. Link to comment Share on other sites More sharing options...
dolce2think Posted June 10, 2013 Share Posted June 10, 2013 Currently gold is just a commodity. It was money, but it is not now. Some parts of the world use it as a store of value. The extraction costs are rising sharply, all in should be higher than 1000 USD. Also new projects wont get financed here. But, the stockpile is huge. Nobody knows how much was mined. A lot was mined and sold in black markets, hidden from officials, taxes and so on. In Europe the catholic church - the monasteries e.g. - own a lot of gold, I know this first hand. This gold has been accumulated over centuries, it will not come on the market, except in a mania stage. All said, its difficult to value, since the stockpile is huge vs the production per annum. A sound paper monetary system is superior to Gold - the problem is however "sound" politics. Hence the bull is still there, but it consolidates here. So I hold some Gold as a worst case protection. Link to comment Share on other sites More sharing options...
muscleman Posted June 10, 2013 Share Posted June 10, 2013 According to Seth Klarman's book, Margin of safety means your stock is either backed by significant assets, or cash flow of the business. There is no real margin of safety for gold here. Just because you think gold should trade at $3500 and it trades at $1300 doesn't mean there is margin of safety. This is your ex-ante upside, not your ex-ante downside protection. :) Link to comment Share on other sites More sharing options...
BargainValueHunter Posted June 10, 2013 Share Posted June 10, 2013 What is the value of a commodity that comes into existence via a computer keyboard? If any object can be assigned the term "money" then why the dollar? Why gold for that matter? Shouldn't scarcity safeguard the value of "money"? Link to comment Share on other sites More sharing options...
bmichaud Posted June 10, 2013 Author Share Posted June 10, 2013 According to Seth Klarman's book, Margin of safety means your stock is either backed by significant assets, or cash flow of the business. There is no real margin of safety for gold here. Just because you think gold should trade at $3500 and it trades at $1300 doesn't mean there is margin of safety. This is your ex-ante upside, not your ex-ante downside protection. :) You are correct - I peg gold's fair value somewhere around $1,280 (see attached for a short-hand valuation analysis), thus the current price does not provide a traditional "margin of safety" (for comparison, gold's 2001 average price of $271 was 36% of its $747 FV....). However, I am operating under the premise that gold's secular bull run has not yet concluded, and will likely conclude at valuations akin to the 1980 bubble. Using the 1981 average price of $460 as a more conservative end-of-secular-bull run target, the $460 in today's dollars is approximately $2,880. Thus at a current $1,380, I believe gold provides a margin of safety, within the context of a continuation of its secular bull run. So assuming A) gold currently trades at approximately fair value and B) the secular bull market has room to run, buying gold here is akin to being bullish on stocks in the middle of a secular bull run while trading at 15X earnings (approximate FV PE) knowing that secular bull runs end somewhere well above 20X.... Plus, bottom line it is tough to find any financial asset as despised as precious metals right now. That in and of itself is a margin of safety with the reward being a significant short-covering rally.....Gold_Fair_Value.xls Link to comment Share on other sites More sharing options...
muscleman Posted June 10, 2013 Share Posted June 10, 2013 According to Seth Klarman's book, Margin of safety means your stock is either backed by significant assets, or cash flow of the business. There is no real margin of safety for gold here. Just because you think gold should trade at $3500 and it trades at $1300 doesn't mean there is margin of safety. This is your ex-ante upside, not your ex-ante downside protection. :) You are correct - I peg gold's fair value somewhere around $1,280 (see attached for a short-hand valuation analysis), thus the current price does not provide a traditional "margin of safety" (for comparison, gold's 2001 average price of $271 was 36% of its $747 FV....). However, I am operating under the premise that gold's secular bull run has not yet concluded, and will likely conclude at valuations akin to the 1980 bubble. Using the 1981 average price of $460 as a more conservative end-of-secular-bull run target, the $460 in today's dollars is approximately $2,880. Thus at a current $1,380, I believe gold provides a margin of safety, within the context of a continuation of its secular bull run. So assuming A) gold currently trades at approximately fair value and B) the secular bull market has room to run, buying gold here is akin to being bullish on stocks in the middle of a secular bull run while trading at 15X earnings (approximate FV PE) knowing that secular bull runs end somewhere well above 20X.... Plus, bottom line it is tough to find any financial asset as despised as precious metals right now. That in and of itself is a margin of safety with the reward being a significant short-covering rally..... It is all about capital allocation. Do you think we can conclude that GLD's risk profile is not as attractive as traditional blue chip stocks like BP or AIG? Why should we buy GLD for a 100% upside IF everything works out, and potentially a lot more downside, when we can buy a cheap blue chip stock? Link to comment Share on other sites More sharing options...
bmichaud Posted June 10, 2013 Author Share Posted June 10, 2013 According to Seth Klarman's book, Margin of safety means your stock is either backed by significant assets, or cash flow of the business. There is no real margin of safety for gold here. Just because you think gold should trade at $3500 and it trades at $1300 doesn't mean there is margin of safety. This is your ex-ante upside, not your ex-ante downside protection. :) You are correct - I peg gold's fair value somewhere around $1,280 (see attached for a short-hand valuation analysis), thus the current price does not provide a traditional "margin of safety" (for comparison, gold's 2001 average price of $271 was 36% of its $747 FV....). However, I am operating under the premise that gold's secular bull run has not yet concluded, and will likely conclude at valuations akin to the 1980 bubble. Using the 1981 average price of $460 as a more conservative end-of-secular-bull run target, the $460 in today's dollars is approximately $2,880. Thus at a current $1,380, I believe gold provides a margin of safety, within the context of a continuation of its secular bull run. So assuming A) gold currently trades at approximately fair value and B) the secular bull market has room to run, buying gold here is akin to being bullish on stocks in the middle of a secular bull run while trading at 15X earnings (approximate FV PE) knowing that secular bull runs end somewhere well above 20X.... Plus, bottom line it is tough to find any financial asset as despised as precious metals right now. That in and of itself is a margin of safety with the reward being a significant short-covering rally..... It is all about capital allocation. Do you think we can conclude that GLD's risk profile is not as attractive as traditional blue chip stocks like BP or AIG? Why should we buy GLD for a 100% upside IF everything works out, and potentially a lot more downside, when we can buy a cheap blue chip stock? Doesn't need to replace those names. Just may be an attractive hedge that provides uncorrelated returns. Particularly if we have some type of inflation whoopsy later this decade that drives blue chip stock PEs downward. Link to comment Share on other sites More sharing options...
bmichaud Posted June 11, 2013 Author Share Posted June 11, 2013 Good comments by Friedberg here on gold: http://friedberg.ca/webpieces/reports/quarterly/First%20Quarter%202013%20-%20Quarterly%20Report.pdf Link to comment Share on other sites More sharing options...
bmichaud Posted June 26, 2013 Author Share Posted June 26, 2013 http://theshortsideoflong.blogspot.com/2013/06/chart-of-day-gold-correction-in-197576.html Good analog of gold's current bear market v. its mid-1970s pre-bubble bear market. Link to comment Share on other sites More sharing options...
ERICOPOLY Posted June 28, 2013 Share Posted June 28, 2013 This commodity is now priced near it's cost of production. I guess when somebody wants to buy gold it either comes from a miner (who won't produce below cost of production) or it comes from an investor/hoarder who wants to unload it. So it goes lower for a time perhaps, but should eventually return to it's cost of production at least when investors are through being afraid to hold it. So perhaps it's safe to own now, even though it might keep going lower for a short whie. Link to comment Share on other sites More sharing options...
ItsAValueTrap Posted June 28, 2013 Share Posted June 28, 2013 If I remember correctly, the production of gold is very, very small compared to the overall gold market. The supply of new gold from mines is only a small factor in the gold market. 2- Gold production exists on a continuum. There are miners on various places on the cost curve. But certainly the historical trend for gold production has been absolutely dismal. Gold miners have been putting most of their earnings back into new production, yet the industry as a whole has largely failed to mine more ounces/year than before. This is despite record profitability and soaring gold prices over the last decade. 3- I'm no good at predicting commodity prices. Link to comment Share on other sites More sharing options...
ERICOPOLY Posted June 28, 2013 Share Posted June 28, 2013 Gold isn't really my thing, but if I had to guess I'd put a credit contraction in China as a negative event for gold prices. Haven't they been the biggest buyer of this stuff? EDIT: To spell this out, when the Chinese have a yard sale to repay debt, who is going to step in to replace their demand in the gold market? To the extent that gold has been popular in Chinese portfolios, it would be at risk in proportion. Link to comment Share on other sites More sharing options...
watsa_is_a_randian_hero Posted June 28, 2013 Share Posted June 28, 2013 For what its work, my current FV of gold is $836. This is based on regressing world population, nominal world GDP (nominal in USD terms), and CPI (with estimates for all of these for the 1800's based on various sources). A "historical" low here would be $353 (would be equivalent to 1970 gold); and "historical" high here would be $2422 (would be equivalent to 1979 gold). That is based on over 200 years of data and the minimum/maximum residuals of my regression. SUMMARY OUTPUT Regression Statistics Multiple R 0.957777631 R Square 0.917337991 Adjusted R Square 0.915020364 Standard Error 0.398647022 Observations 111 ANOVA df SS MS F Significance F Regression 3 188.7053647 62.90178823 395.8092547 9.48745E-58 Residual 107 17.00438093 0.158919448 Total 110 205.7097456 Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0% Intercept -8.191898356 2.223394069 -3.684411355 0.000361509 -12.59951778 -3.784278928 -12.59951778 -3.784278928 LN World Real Per Capita GDP (2011 USD) -0.935732742 0.225090491 -4.157140249 6.51549E-05 -1.381948389 -0.489517095 -1.381948389 -0.489517095 LN Population 2.249849044 0.565610374 3.977736528 0.000126823 1.128592445 3.371105643 1.128592445 3.371105643 LN CPI 0.664507902 0.164000416 4.051867182 9.65309E-05 0.339396206 0.989619599 0.339396206 0.989619599 Link to comment Share on other sites More sharing options...
ERICOPOLY Posted June 28, 2013 Share Posted June 28, 2013 Remember March 2008? Never yet even heard of QE. Gold has now appreciated 3% annualized since the highs in mid-March 2008. Link to comment Share on other sites More sharing options...
bmichaud Posted June 28, 2013 Author Share Posted June 28, 2013 Eric it is a good question on a Chinese credit crunch. GMO has a good paper out discussing the high correlation between emerging markets demand for gold and the price of gold - so perhaps a credit crunch is negative. But if China is looking to diversify away from US Treasury bonds, could they not simultaneously be buying gold while printing Yuan to paper over a local credit crunch? I don't see why not. Marginal cost of production for a commodity that is not consumed in a traditional sense appears to be a rather moot analysis. Where would the price of oil be if all oil ever produced just sat in oil drums (akin to gold in a vault) or in a pretty clear vase in someone's home (akin to gold in jewelry - stupid analogy I know)? So there must be something more to the price - hence why I like Dalio's formula of all currency units divided by ounces of gold outstanding. Link to comment Share on other sites More sharing options...
FCharlie Posted June 28, 2013 Share Posted June 28, 2013 If I remember correctly, the production of gold is very, very small compared to the overall gold market. The supply of new gold from mines is only a small factor in the gold market. 2- Gold production exists on a continuum. There are miners on various places on the cost curve. But certainly the historical trend for gold production has been absolutely dismal. Gold miners have been putting most of their earnings back into new production, yet the industry as a whole has largely failed to mine more ounces/year than before. This is despite record profitability and soaring gold prices over the last decade. 3- I'm no good at predicting commodity prices. I think what you said in point #2 is very telling. If miners are constantly putting earnings back in to new production, yet not producing more ounces, then it seems that the high grade gold has been mined already. As miners go after lower grade ore the cost of production will continue to rise, and the price of gold should rise accordingly. I remember reading that many large gold mines are blowing up enormous amounts of rock, entire mountains, to mine for tiny flecks of gold. The prices we see now are approaching the point where less efficient miners shut production off. I would like to know how quickly a miner can shutter production. The move down has been very violent and it may take some time for everyone to react. Very interesting though. Silver as well. Link to comment Share on other sites More sharing options...
valueorama Posted June 28, 2013 Share Posted June 28, 2013 Just an FYI, 1. I thought china was not a big consumer of gold. I think India consumes 50% of world production! 2. As Gold price went up, labor cost also went up. Can't labor go down as prices start falling? it is sticky but still eventually it will fall. Valueorama Link to comment Share on other sites More sharing options...
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