Paraphrasing Winston Churchill, gold is a "riddle, wrapped up in a mystery inside an enigma", at least as far as I am concerned. I don't understand what moves the gold price and I have never held gold in my portfolio. That does not mean, however, that I am not fascinated by the price of gold and immune from its movements. That was brought home last week, when the price of gold dropped by 9% on April 15, 2013, the biggest one day drop in thirty years. Not only did the prices of other precious metals (silver dropped 12%) and industrial metals drop, but stock prices took a tumble as well. While the attention has focused on the price drop in recent days, gold has had a good run over the last decade.
The nominal and inflation-adjusted prices of gold have soared in the last decade, and at the end of 2012, the nominal price was at an all time high of 1664 and the inflation-adjusted price was close to its previous high set at the end of the 1970s. The big question that has been debated in recent days is whether gold will continue to drop in the coming days. More generally, is gold is under or over priced? With my limited understanding of gold, I decided to give it a shot.
Does gold have an intrinsic or fundamental value?
The intrinsic value of an asset is a function of its expected cash flows, growth and risk. Since gold is a non cash-flow generating asset, I argued in this earlier blog post that you cannot estimate an intrinsic value for gold. It is the same argument I would make about all collectibles: Picassos, baseball cards or Tiffany lamps included. If one of the central tenets of value investing is that you should never invest in an asset without estimating its value, that would seem to rule out gold as an investment for a classic value investor. In fact, Warren Buffett has repeatedly argued against investing in gold because it's value cannot be estimated.
There is an alternate route that can be used to estimate the "fundamental" value of a commodity by gauging the demand for the commodity (based on its uses) and the supply. While that may work, at least in principle, for industrial commodities, it is tough to put into practice with precious metals in general, and gold, in particular, because the demand is not driven primarily by practical uses.
What drives gold prices?
If gold does not have an intrinsic value, what is it that drives its value? There are at least three factors historically that have influenced the price of gold.
1. Inflation: If as is commonly argued, gold is an alternative to paper currency, you can argue that the price of gold will be determined by how much trust individuals have in paper currency. Thus, it is widely believed that if the value of paper currency is debased by inflation, gold will gain in value. To see if the widely held view of gold as a hedge against inflation has a basis, I looked at changes in gold prices and the inflation rate each year from 1963-2012.
The co-movement of gold and inflation is particularly strong in the 1970s, a decade where the US economy was plagued by high inflation and the correlation between gold prices and the inflation rate is brought home, when you regress returns on gold against the inflation rate for the entire period:
2. Fear of crisis: Through the centuries, gold has been the “asset” of last resort for investors fleeing a crisis. Thus, as investor fears ebb and flow, gold prices should go up and down. To test this effect, we used two forward-looking measures of investor fears – the default spread on a Baa rated bond and the implied equity risk premium (which is a forward looking premium, computed based upon stock prices and expected cash flows). As investor fears increase, you should expect to see these premiums in both the equity and the bond market increase.
While the relationship is harder to decipher than the one with inflation, higher equity risk premiums correlate with higher gold prices. Again, regressing annual returns on gold against these two measures separately, we get:
3. Real interest rates: One of the costs of holding gold is that while you hold it, you lose the return you could have made investing it in a financial asset. The magnitude of this opportunity cost is captured by the real interest rate, with higher real interest rates translating into much higher opportunity costs and thus lower prices for gold. The real interest rate can be measured directly used the inflation indexed treasury bond (TIPs) rate or indirectly by netting out the expected inflation from a nominal risk free (or close to risk free) rate.
A Relative Valuation of Gold
Knowing that gold prices move with inflation, equity risk premiums and real interest rates is useful but it still does not help us answer the fundamental question of whether gold prices today are too high or low. Can you do a relative valuation of gold? I don’t know but I am going to try.
A. Against the inflation index
The most comprehensive paper that I have seen on the relationship between gold prices and inflation is available here, with a follow up here. In these papers, the price of gold is related to the CPI index and a ratio of gold prices to the CPI index is computed. I try to replicate their findings and I use the US Department of Labor CPI index for all items (and all urban consumers) set to a base of 100 in 1982-84, but with data going back to 1947. The level of the index at the end of 2012 was 231.137. Dividing the gold price of $1664/oz on December 31, 2012, by the CPI index level yields a value of 7.20. To get a measure of whether that number is high or low, we computed it every year going back to 1963:
At the year-end price in December 2012, gold prices were at an all time high, relative to the CPI. Updating the gold price to 1382.2/oz, the price on April 17, yields a Gold/CPI ratio of 5.98.
The median value is 2.55 for the 1963-2012 time period and 2.91 for the 1971-2012 period. Thus, based purely on the comparison of the current measure of the Gold/CPI ratio to the historical medians does miss the fact that equity risk premiums are high and real interest rate are negative today, both of which should make gold more attractive as an investment. Consequently, I regressed the Gold/CPI index against equity risk premiums and real interest rates and while real interest rates seem to have little effect on the Gold/CPI ratio, there is strong evidence that it moves with the ERP, increasing (decreasing) as the ERP increases (decreases):
B. Against other precious metals
There is another way that you can frame the relative value of gold and that is against other precious metals. For instance, you can price gold, relative to silver, and make a judgment on whether it is cheap or expensive (on a relative basis). At the end of December 2012, the gold price was $1664/oz and the silver price was $30.35/oz,, yielding a ratio of 54.84 for gold to silver prices (1664/30.35). To get a measure of where this number stands in a historical context, we looked at the ratio of gold prices to silver prices from 1963 to 2012:
The median value of 51.22 over the 1963-2012 period would suggest that gold is not over priced, relative to silver. In fact, silver has dropped in price more than gold has this year and using the April 17, 2012 prices for gold (1382.2) and silver (23.31), we get a ratio of 59.30. Given that gold and silver move together more often than they move in opposite directions, I am not sure that this relationship can be mined to address the question of whether gold is fairly priced today, but it can still be the basis for trading across precious metals.
Gold as insurance
It can be argued that pricing gold relative to silver or against the inflation index misses the primary rationale for investors holding gold, i.e., as insurance against uncommon but potentially catastrophic risks to their assets, from hyper inflation to war and terrorism. Viewed from that perspective, gold operates as insurance for an investor whose assets are primarily financial and thus exposed to these catastrophic risks. Put in less abstract terms, if you add gold to your portfolio, it is not to make money, per se, but to buy protection against “black swan” events that could swamp your other investments. If you view gold as a hedge/insurance against event risk, there are two implications:
The bottom line
I have always been uncomfortable talking about the value of gold as an asset and its place in my portfolio. Writing this post has been cathartic, since it has allowed me to recognize the two sources of my discomfort. First, I am most comfortable with cash flow generating investments, where I can estimate an intrinsic value, and my valuation tool kit is limited when it comes to valuing gold. Second, I don't share the fervor that some investors have for gold, who seem to view it as much in emotional terms as in financial ones.
The nominal and inflation-adjusted prices of gold have soared in the last decade, and at the end of 2012, the nominal price was at an all time high of 1664 and the inflation-adjusted price was close to its previous high set at the end of the 1970s. The big question that has been debated in recent days is whether gold will continue to drop in the coming days. More generally, is gold is under or over priced? With my limited understanding of gold, I decided to give it a shot.
Does gold have an intrinsic or fundamental value?
The intrinsic value of an asset is a function of its expected cash flows, growth and risk. Since gold is a non cash-flow generating asset, I argued in this earlier blog post that you cannot estimate an intrinsic value for gold. It is the same argument I would make about all collectibles: Picassos, baseball cards or Tiffany lamps included. If one of the central tenets of value investing is that you should never invest in an asset without estimating its value, that would seem to rule out gold as an investment for a classic value investor. In fact, Warren Buffett has repeatedly argued against investing in gold because it's value cannot be estimated.
There is an alternate route that can be used to estimate the "fundamental" value of a commodity by gauging the demand for the commodity (based on its uses) and the supply. While that may work, at least in principle, for industrial commodities, it is tough to put into practice with precious metals in general, and gold, in particular, because the demand is not driven primarily by practical uses.
What drives gold prices?
If gold does not have an intrinsic value, what is it that drives its value? There are at least three factors historically that have influenced the price of gold.
1. Inflation: If as is commonly argued, gold is an alternative to paper currency, you can argue that the price of gold will be determined by how much trust individuals have in paper currency. Thus, it is widely believed that if the value of paper currency is debased by inflation, gold will gain in value. To see if the widely held view of gold as a hedge against inflation has a basis, I looked at changes in gold prices and the inflation rate each year from 1963-2012.
The co-movement of gold and inflation is particularly strong in the 1970s, a decade where the US economy was plagued by high inflation and the correlation between gold prices and the inflation rate is brought home, when you regress returns on gold against the inflation rate for the entire period:
Annual % Change in Gold price = -0.08 + 4.37 (Inflation rate)
R squared = 19.9%
While this regression does back the conventional view of gold as an inflation hedge, there are two potential weak spots. The first is that the R-squared is only 20%, suggesting that factors other than inflation have a significant effect on gold prices. The second is that removing the 1970s essentially removes much of the significance from this regression. In fact, while the large move in gold prices in the 1970s can be explained by unexpectedly high inflation during the decade, the rise of oil prices between 2001 and 2012 cannot be attributed to inflation. In fact, taking a closer look at the data, it is clear that gold is more a hedge against extreme (and unexpected) movements in inflation and does not really provide much protection against smaller inflation changes.2. Fear of crisis: Through the centuries, gold has been the “asset” of last resort for investors fleeing a crisis. Thus, as investor fears ebb and flow, gold prices should go up and down. To test this effect, we used two forward-looking measures of investor fears – the default spread on a Baa rated bond and the implied equity risk premium (which is a forward looking premium, computed based upon stock prices and expected cash flows). As investor fears increase, you should expect to see these premiums in both the equity and the bond market increase.
While the relationship is harder to decipher than the one with inflation, higher equity risk premiums correlate with higher gold prices. Again, regressing annual returns on gold against these two measures separately, we get:
Annual % Change in Gold Price = -0.25 + 8.91 (ERP)
R squared = 10.3%
Annual % Change in Gold Price = 0.10 + 0.25 (Baa Rate - T.Bond Rate)
R squared = 0%
These regressions suggest little or no relationship between bond default spreads and gold prices, but a positive relationship, albeit one with substantial noise, between gold prices and equity risk premiums. Thus, gold prices seem to move more with fear in the equity markets than with concerns in the bond market. Every 1% increase in the equity risk premium translates into an increase of 8.91% in gold prices.3. Real interest rates: One of the costs of holding gold is that while you hold it, you lose the return you could have made investing it in a financial asset. The magnitude of this opportunity cost is captured by the real interest rate, with higher real interest rates translating into much higher opportunity costs and thus lower prices for gold. The real interest rate can be measured directly used the inflation indexed treasury bond (TIPs) rate or indirectly by netting out the expected inflation from a nominal risk free (or close to risk free) rate.
Note that the TIPs rate is available only for the last decade and that the real interest rate is computed as the difference between the ten-year US treasury bond rate in that year and the realized inflation rate (rather than the expected inflation rate). Regressing changes in gold prices against the real interest rate yields the following:
Annual % Change in Gold price = 0.27 - 6.94 (T.Bond Rate - Inflation Rate)
R Squared = 36.6%
High real interest rates are negative for gold prices and low real interest rates, or negative real interest rates as is the case today, push gold prices higher.
A Relative Valuation of Gold
Knowing that gold prices move with inflation, equity risk premiums and real interest rates is useful but it still does not help us answer the fundamental question of whether gold prices today are too high or low. Can you do a relative valuation of gold? I don’t know but I am going to try.
A. Against the inflation index
The most comprehensive paper that I have seen on the relationship between gold prices and inflation is available here, with a follow up here. In these papers, the price of gold is related to the CPI index and a ratio of gold prices to the CPI index is computed. I try to replicate their findings and I use the US Department of Labor CPI index for all items (and all urban consumers) set to a base of 100 in 1982-84, but with data going back to 1947. The level of the index at the end of 2012 was 231.137. Dividing the gold price of $1664/oz on December 31, 2012, by the CPI index level yields a value of 7.20. To get a measure of whether that number is high or low, we computed it every year going back to 1963:
At the year-end price in December 2012, gold prices were at an all time high, relative to the CPI. Updating the gold price to 1382.2/oz, the price on April 17, yields a Gold/CPI ratio of 5.98.
The median value is 2.55 for the 1963-2012 time period and 2.91 for the 1971-2012 period. Thus, based purely on the comparison of the current measure of the Gold/CPI ratio to the historical medians does miss the fact that equity risk premiums are high and real interest rate are negative today, both of which should make gold more attractive as an investment. Consequently, I regressed the Gold/CPI index against equity risk premiums and real interest rates and while real interest rates seem to have little effect on the Gold/CPI ratio, there is strong evidence that it moves with the ERP, increasing (decreasing) as the ERP increases (decreases):
1963-2012 Time Period:
Gold Price/ CPI = -1.75 + 115.4 (ERP)
R Squared = 52.9%
1971-2012 Time Period
Gold Price/ CPI = -0.88 + 100.2 (ERP)
R Squared = 49.1%
The implied equity risk premium for the S&P 500 at the start of April 2013 was 5.79%, and plugging that value into the gold/CPI regression yields the following:
Gold/CPI (given ERP = 5.79% on 4/1/13) = -0.88 + 100.2 (.0579) = 4.92
While gold remains over priced, relative to historic norms, it looks far less over priced once we account for today's risk premiums.B. Against other precious metals
There is another way that you can frame the relative value of gold and that is against other precious metals. For instance, you can price gold, relative to silver, and make a judgment on whether it is cheap or expensive (on a relative basis). At the end of December 2012, the gold price was $1664/oz and the silver price was $30.35/oz,, yielding a ratio of 54.84 for gold to silver prices (1664/30.35). To get a measure of where this number stands in a historical context, we looked at the ratio of gold prices to silver prices from 1963 to 2012:
The median value of 51.22 over the 1963-2012 period would suggest that gold is not over priced, relative to silver. In fact, silver has dropped in price more than gold has this year and using the April 17, 2012 prices for gold (1382.2) and silver (23.31), we get a ratio of 59.30. Given that gold and silver move together more often than they move in opposite directions, I am not sure that this relationship can be mined to address the question of whether gold is fairly priced today, but it can still be the basis for trading across precious metals.
Gold as insurance
It can be argued that pricing gold relative to silver or against the inflation index misses the primary rationale for investors holding gold, i.e., as insurance against uncommon but potentially catastrophic risks to their assets, from hyper inflation to war and terrorism. Viewed from that perspective, gold operates as insurance for an investor whose assets are primarily financial and thus exposed to these catastrophic risks. Put in less abstract terms, if you add gold to your portfolio, it is not to make money, per se, but to buy protection against “black swan” events that could swamp your other investments. If you view gold as a hedge/insurance against event risk, there are two implications:
- You should not expect to gold to generate high annual returns over long periods. In fact, notwithstanding boom periods (the 1970s and the last decade) gold has, for the most part, generated low returns over long periods, relative to other risky investments.
- It also follows that the price of gold should reflect the cost of buying the insurance, which in turn will be driven by the uncertainty you feel about the future and the likelihood of catastrophic events. Thus, the multiple crises over the last decade (banking, war, terrorism) explain both the surge in gold prices over the last decade and the correlation with equity risk premiums.
The bottom line
I have always been uncomfortable talking about the value of gold as an asset and its place in my portfolio. Writing this post has been cathartic, since it has allowed me to recognize the two sources of my discomfort. First, I am most comfortable with cash flow generating investments, where I can estimate an intrinsic value, and my valuation tool kit is limited when it comes to valuing gold. Second, I don't share the fervor that some investors have for gold, who seem to view it as much in emotional terms as in financial ones.
As a complete novice in assessing the value of gold, here is how I see its value. As a stand-alone investment, I would not buy gold, given its history (of delivering low returns in the long term) and given how it is priced today. As insurance, though, I think it makes sense to add to your portfolio, even at today's prices. You don't have to be a conspiracy theorist or paranoid about central banks to have legitimate fears that prices in financial markets, built upon uncommonly low interest rates, may collapse. I know that the price of gold as insurance is higher than it has been in the past, but the risks that you are insuring against are also much higher than they have been historically.
Update: If you are interested in exploring the data on your own, you can download the raw data on gold prices, silver prices, CPI, interest rates, ERP and other variables.
Update: If you are interested in exploring the data on your own, you can download the raw data on gold prices, silver prices, CPI, interest rates, ERP and other variables.
131 comments:
Gold isn’t a stable store of value, an inflation hedge, or a guard against volatility or political turmoil. it’s just a commodity.
And as a long-term investment, it’s underperformed equities.
Since you've admitted that you've never actually participated in owned gold as an investment, your entry would have been far more useful if you presented your readers with an opinion by someone who's actually made money investing, or possibly trading in gold.
Thank you.
Anonymous,
I have never held bitcoin either, but I have an opinion on it. I have never owned a sports team, but I will post on how it is valued.
If gold is insurance, it should underperform equities over the long term. That tells you nothing about whether you should hold it.
Oil is just a commodity but gold definitely is not just a commodity.
I laid out a model for the price of gold here:
http://www.crossingwallstreet.com/archives/2010/10/a-model-to-explain-the-price-of-gold.html
How do you value a currency?
Could you value gold as a currency?
@Anonymous: Why would someone need to be invested to reason about gold? What difference would it make to eg. gold's relation to inflation?
Also, by listening to only gold owners, you are basically filtering out all the opinions against gold as an investment.
Professor --
Great post!
I too am fascinated by gold, and the past week forced me to re-visit it. Though your correlation only yielded a 20% R-squared, I wonder if inflation *expectations* would explain more. Though expectations stayed pretty well anchored this time around, I wouldn't expect that pre-Volcker.
Paul Krugman had argued in late 2011 that the real driver of the price of gold is low real interest rates, and I was glad to see your . This week, Deutsche Bank reported that a 3% short-term real interest rate tips gold into negative yields [http://jasondacruz.com/?attachment_id=521].
If you want to dive into the market psychology explanations, FT Alphaville pointed me towards an article by Alham Partners speculating that the EZ crisis spilled into gold through a collateral squeeze (and, in my opinion, a worry that Cyprus, Italian, and other weak EZ central banks may start to sell).
WIth all of the above confusion, I'm to side with Blanchard's comment on the price of gold: "Only a fool would try to predict it .. it is of no macroeconomic import"
Wonderful post. Thank you for your generosity in sharing so much of your knowledge.
Gold is to some extent a reflection of the lack of trust in government ( by its people) , and /or the lack of trust between govts ( trading partners).
It rose strongly in the 1970s when distrust in govt rose sharply ( Vietnam War, Nixon etc). It recently started a sharp rise in 2002 or so ( Bush, Iraq etc).
I dont mean to be harsh - but a theory of investments that fails to come remotely close to explaining ( let alone predicting) a 500%+ return over a 12 year period ( gold) , far outperforming common equities - needs to re-evaluated.
Academics in economics and finance should be less dismissive of actual, real world data that does not fit their theories.
"Every 1% increase in the equity risk premium translates into an increase of 8.91% in bond prices".
I think little confuse here. Revised "...an increase of 8.91% in gold prices" ???
What we often forget is the "time" factor for Gold is INFINITE - unlike most other things. Even if it has very little use - NPV could suggest a very high number?
I have a rather general question regarding the difference between intrinsic valuation and relative pricing. In intrinsic valuation we derive the value of an asset or business from the cash flows it generates and a risk-weighted cost of capital. Now the confusing part for me is, when we project those cash flows don't they largely consist of the level of future input/output prices? So the intrinsic valuation is in a way just more sophisticated relative pricing method with an added layer?
How can gold ever be a form of investment? There is no cash flow there. You have also argued that cost of gold as an insurance is high. But the insurance argument itself is also a bit debatable.
Gold in my opinion is for the punters. Nothing wrong with that but they should know that they are buying gold and then are constantly in the look out for someone who can buy (at a higher price) from them.
No sensible person can value gold. Here's something related - http://valueanalyst.blogspot.com/2012/11/gold-buggers.html
Linking price of gold to inflation, equity risk premium, default spread, silver price or some crisis - is actually pricing rather than valuing gold. It's cool as long as we know that.
So we can't really say gold is over or under priced at any point in time. The right question is for a speculator to ask himself can I at this stage speculate a bit (or a bit more).
Don't you think?
"If gold does not have an intrinsic value, what is it that drives its value? There are at least three factors historically that have influenced the price of gold."
this seems to suggest price=value. Yes?
Great article. Very clear and well thought-out.
And besides insurance against the small probability of loss of confidence in currencies (say dollar), gold is also excellent in diversification. A simple way to push a portfolio towards the efficient frontier.
First anonymous: Can you get any more stupid? "your entry would have been far more useful if you presented your readers with an opinion by someone who's actually made money investing, or possibly trading in gold."
Go to university first, get a bachelor degree at least, and then you can comment on serious stuff.
Prof Damodaran: Excelent post as always. Do you maybe know if there is anything on using gold prices to forecast the equity premium?
All the best
I believe that trying to find the intrinsic value of gold is not the best way to figure out whether or not to invest in gold. I believe that gold needs to be treated as currency and not a commodity.
I'm no expert, but I have rarely heard about central banks holding reserves of any commodity other than gold. Modern monetary policy may have technically broken free from the Gold Standard but it still influences the psyche of investors/bankers/policy makers like no other commodity.
This is easier to accept if one thinks of appreciation in the price of gold as merely a debasement in the value of the US Dollar and other major currencies.
Professor: I find the American investor propensity to regress gold prices against U.S CPI or interest rates to be a flawed analysis for many reasons. U.S. economic statistics and the USD have been uncommonly stable compared with most countries. Thus, it should not be surprising to see little statistical relationship between them and the price of gold. It would be far more interesting and relevant to regress gold prices against the statistics and currency of a country that has been around for a very long time and where its citizens have been large investors in gold as a percentage of their wealth (not the U.S). India, for example, would be interesting to see although I don’t know how reliable its data is or how far back in time it goes.
Dear professor,
the pricing of gold principal is driven by the demand/supply and follows a commodity pricing- the factors like inflation, fear of crisis and real interest rates changes in most cases increase demand as investors / speculators primarily had used gold as hedge. I am not sure if the valuation could ever be reached and the gold price would always be determined on the demand supply principal.
a simplistic view though...
Regards
Hi
Being from India, where Gold is considered an investment by the majority (because popular feeling is that it is the "only" liquid investment you can physically carry around with you which cannot be influenced by someone else (viz., a government can do something that makes a land holding worthless, a bank can go bankrupt with your money) but a Gold - at least you can palm it off during a marriage in the family and we're talking about serious stuff here - it is not unreasonable for a %$ 5000-6000 worth of gold to be passed down during a marriage/across family generations in a country where average annual income is less than $ 2000 !. Since in India 99.9% of the population does not care about equities/mutual funds, the only real benchmark they have is comparing it to real estate (which obviously is a very local phenomenon but gold is a lot more liquid (can be sold any day without a wait), can be stored safely and can be lugged around should a migration happen - a fact that has been proven mightily by the fact that India now has 3-4 monoline gold mortgage houses (where one can pawn gold and collect cash which is often a lifeline given that India has no public safety net - social security, insurance, medical support) that are rapidly growing and are about $ 1bn or so in terms of Mcap.Given that India consumes 33% of the world's incremental demand and most of it is actually physical gold, it seems to me that :
1. Gold is considered an pseudo investment by well, the largest consumer of gold, India - who only looks at a long term nominal return of 9-10% (in comparison with a fixed deposit at a bank). Professor, from your curve, it looks to me that the nominal return on Gold has been huge over the last decade. This coupled with the "gravy train" mentality (easy way to make money) has only got more money into this asset class over the last few years.
2. The interesting point would be to observe the contribution of "physical delivery" trades to the overall price discovery of gold. Should that be substantial, I suspect what I said above might hold a fair amount of water. Given that I do not expect substantial domestic money in India to flow into equities over the next decade either, I suspect this might also give pointers about the direction and strength of the recovery in price.
Professor Damodaran,
I appreciate the objective look at gold. Something about the shiny yellow metal attracts sloppy analysis from both bulls and bears! It is a market place that becomes a tool for political expression, partially because I think it hedges against government related actions.
When you hold gold, you have money outside of your country's banking system. This gives you flexibility if rates are below the inflation rate (which you noted had a high r^2), but also it allows you to get around capital controls if you need to leave the country.
Finally, I think it is very important to emphasize that stocks, bonds, bills, and even commodity futures contracts, are all claims on real wealth. Gold is a form of real wealth itself, which makes "intrinsic value" somewhat meaningless. There are extreme times in history where claims are not honored, and having a portable form of real wealth becomes very highly valued.
Thanks for the post!
@Anonymous, agreed. We can not determine the fundamental value of gold. The price is driven only by those three factors. And in the long run only the inflation that has the effect of the gold price.
Very good article.
I advised my parents against buying Gold in 2008 ... they went ahead anyway and bought it. And today they feel vindicated. My argument was essentially the same as yours. Theoretically speaking, Gold is not a productive/active economic asset, so it MUST be less rewarding as an investment than some productive asset like stocks (technically speaking, stocks are the epitome of an active asset).
However i have been thoroughly trounced over the last four years. And this has taught me one lesson. Active assets are for active times. Passive assets are for passive times. Since you do not know when a passive time strikes, it makes sense to keep some passive asset. Gold being the densest and safest asset to keep, naturally qualifies. Besides it has some other qualities -
1. it is infinitely fungible.
2. it is secure.
3. nobody wud ever refuse to take Gold.
4. it's existence is beyond humanity. and hence no one can forge it.
5. it's purity is unquestionable.
6. it is easy to hide and store safely.
7. Govts cannot dig for it or find it in papers/books/accounts and hence cannot go after it.
8. it is not prone to something manmade like bank runs
9. no natural/human/godly force can destroy Gold.
there is no asset which possesses all the above qualities except Gold. True, I still do not understand that Gold shd be considered an investment. But I totally understand it's value as a hedge against something catastrophic. Any family must keep some Gold with them and never sell it. It is not investment but the final safety net before the family is reduced to begging.
I now propose something else - Buy Gold but not for trading. Keep only as much as you think is essential in times of catastrophic distress, but no more ... and never sell it in normal times.
Prof, Shells beads and feathers were once more than just commodities...
In India and elsewhere, isn't gold not so much an investment, but rather a hedge against depreciating currencies. And falling purchasing power?
Who here has been so fortunate as to make serious long term profits from investing in gold?
When it comes to gold, readers may also prefer to hear and learn the whys from someone who's done so.
Thank you.
Professor, take a look at this paper. What do you think about it?
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2078535
It's not really a great inflation hedge or safe haven.
Gold has a lot of value, it moves an entire nation. It is a symbol of power and wealth. Without gold, a nation will succumb to wars and hunger. Without gold, a nation wouldn't grow.
Probably the best post I read about gold valuation ever!
Maybe it is because it takes someone with less experience who are less biased to make a neutral analysis.
I will keep an eye on this blog!
DEar Damo,
Indeed gold is a hot topic since the late break in its technicals mainly caused by a factor which was not mentioned. This was the Cyprus Central Bank intention for selling its Gold reserves. Moreover take into account that this will form a trend after the ECB relevant announcements for other countries which hold important reserves in their portfolio (Spain, Italy ...). To be honest instead a focus on Cash Flows we mainly base valuations on commodities on General Equilibrium Models (based no Macro-Micro Dynamics, once I used dynamic simulation). I can also refer the cost plus methods taking into account E&P etc... eventhough gold is a very well marketable asset whose value currently is far higher than its intrinsic value.
Although Gold is the best asset, but the prices of gold are too much high that only few people can afford it. This is the reason that the demand of gold has decreased. Cyprus has decided to sell the gold so the prices of gold decreased & demand of gold increase with these falling prices. So Everything is going w.r.t. each other.
Thanks
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Gold can never be an investment, because it as no inflows. It's a pure speculative asset, doesn't matter for how long you hold it and why. :) I think your title is inappropriate and miss leading.
Professor:
The gold isn't insurance. Only in nuclear cataclysm have sense consider to gold how an insurance. What sense make it? The gold is in a dangerous bubble.
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Thanks for article.
If gold is an insurance then did it prove its value to individuals in situations where countries have eg been invaded, suffered massive economic destruction, loss of normal markets, etc. World wars, major regional conflicts?
Thanks
Great post, really interesting. It would be interesting to compare the spot price of gold, with the price of gold adjusted for inflation (and assuming no independent price fluctuations). It would allow an estimate of whether gold is over- or undervalued relative to its inflation-dictated price
"does gold have an intrinsic value"?
gold is a CURRENCY NOT an asset!!!!!!!
You're saying federal reserve notes have no value because they don't generate cash flows.
gosh b-school really is a waste of money
At the guy screaming "gold is a currency", I beg to differ.
Gold has many, many real uses - there are all kinds of tech stuff that uses gold, such as HDMI cables, medical machine and, of course, jewelry.
If you want to buy a currency, you may buy eur or francs, and you can exchange them for bread or bullets - you can't do that with gold.
Of course, most of gold's price comes from speculation, hedging, etc, like the professor pointed out.
The funny thing is that all those "end of the world" conspiracy theorists love gold, but if something really bad happens gold may very well become illiquid (or worthless). Do you think anybody was buying gold during the big famines of the last century? It would be nice to see anybody succeeding to exchange this "currency" for a sack of beans in 1917 Russia...
Gold does has some little value, but most of it depends on greater fools or protection hopes. But that's no currency. Nor is BitCoin BTW...
Going further on BitCoin, it's basically for suckers now because the market is extremely easy to manipulate.
If some bigshot decides to manipulate BitCoin he or she just needs to buy a billion dollars, see the price through the roof, sell the position and watch the suckers collect the pieces. It is illegal manipulation, but bitcoin's secrecy becomes its own demise, because nobody will be able to find out who did this
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Since you said gold is insurance, treat the cost of producing gold as a base value and treat the rest of the price as a premium. One can try and infer if gold is over valued or under by backing out inflation from the premium. Any thoughts?
How would I get a good gold price in montgomeryville? I want to sell my gold!
The X factor here is gold's extremely long history.
Consider it the oldest currency where length of use = predictive factor of value into the future. Thousands of years of culturally agreed value stand behind every ounce of gold. It is like priceless goodwill, like a word that has never been broken and so likely never will.
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I think to some extent the character of gold has changed. With growth in Asia, it has taken on several characteristics of a consumer discretionary item. Many ladies will buy bangles ahead of an iphone! The change in its character from "old" money versus "fiat", means a need for radical different ways to value it!
I dont know if its wise to invest in gold. For example - at last 6 months the price is going pretty down ( according to graphs - http://www.wealthprotecting.com/gold-price/).
Its questionable, if it wasnt just "gold bubble" last months an years and many people will not just lose their money. (like in any other investing without enough knowledge).
Very helpful article, thank you for this one.
This is a very clear explanation of investment! Thank you for sharing this idea. i hope that people would start thinking to invest on something as early as now! Employment should not be the last stop for anyone! Be your own boss with wise investments you can get.
From this post I get the understanding that one should be buying the insurance I.e. gold during boom periods when the price of gold goes down and people are more sure of the future....and hold it till a big crisis really hits you big time which could be around somewhat like 20 years later...I am not really sure if buying gold would be advisable today ...the world seems to be getting more stale unless Europe explodes or US stinks with inflation....could happen tomorrow but difficult to imagine....as normally a crisis happens when no one is expecting one....everyone is too cautious about these two things happening.... Which will prevent it from happening. I think there is more chance for the world to get stable from here on. It's not suddenly I woke up and thought of Gold being a bubble...infant I have the view that Gold has been in the bubble since 2010 and I did comment on this in some of the previous posts on this forum...the latest being when Sir wrote about 700 Apple price and folded his investments.... Which is start of this new year...It would be difficult to imagine gold going up beyond 1900its previous high in the foreseeable future...I would rather bet on other commodities like steel and equities in general in developing economies over the next 3 to 5 years and think of gold when everyone forgets that gold had risen so much ...
Small corrections....stale meant stable in above post....also I wrote about Gold and Apple being in bubble category around April 12 last year and not end of last year....it's been a year and both seem to have moved down considerably..
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Gold is indeed a good investment but they said that investing in gold will give you a break even because it is used as measurement of currency. Try investing in other countries stocks. Philippines underwent correction these past few weeks and the stocks are being oversold. A very good time to buy some profitable investments at bargain prices.
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Its very well detailed and appealing to keep to eye to read more.
We also try to keep our blog filled with information and helpful methods.
Once again great blog. Very well informative.
Great Post Professor! If any of you are interested in investing in gold, please check out this gold investment website: GoldCurrent: http://goldcurrent.org and register for the free gold investment kit.
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I like gold as an investment. It's the ultimate financial security. But right now I look at shares of junior gold and silvermines. They are very low priced.
I like silver better. It's more volatile and good for trading. I trade it with leverage.
I like gold for investment and business, even after the decline in the price of gold. You have shared some important information regarding gold investment.
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Cash for gold is a great way to try to give someone a chance to get more use out of the gold and although it is super easy to recycle gold jewelry.
Great looking blog and a very well written article. Gold will have an impact and it is the only asset that will have a true future value.
Great looking blog and a very well written article. Gold will have an impact and it is the only asset that will have a true future value.
Great looking blog and a very well written article. Gold will have an impact and it is the only asset that will have a true future value.
Great looking blog and a very well written article. Gold will have an impact and it is the only asset that will have a true future value.
Thanks for sacrific specific crucial material. Carry on posting accurate very great word for us thank you.
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I was looking to invest in gold last year and have looked at the various
alternatives available to small investors.
Here are my thoughts, hope it helps
1) Futures - Risky, limited life, highly leveraged. Good if you want to
bet your house that the price will move within a short time frame.
Unlimited down side risk
2) Mutual fund - Diversifies risk relating to individual company and
geographic concentration of reserves. Lots of investing style to choose
from. Expenses is low compare to commission on stocks.
3) Gold Stocks - Company involved in gold mining or have a huge reserves
of gold. Simple to invest, just like all your other stocks. Comes in all
shapes and size. I've picked Alta Gold (ALTA) which has a very high
correlation with gold price. You can easily find a list of gold stocks in
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Happy investing
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I have always been hesitant when it comes to the online sales. I usually just buy gold in Montgomeryville but I think you bring up some good points about the viability of buying online.
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Professor, there is a yield on gold for those who own it in its physical form; it is called the Gold Forward Offered Rate (a bit like a repo rate). Please see my recent note on the topic: http://sprottgroup.com/thoughts/articles/central-banks-bullion-banks-and-the-physical-gold-market-conundrum/
It would be interesting to price it using those cash flows.
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Nice information about best gold prices
My friends from the insurance business once told me that buying gold is a wise investment depending on the current economic situation. Nice arguments by the way.
Great article. I have been wanting to sell gold in Long Island NY for a while now and this really helped me understand it a little better.
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Gold will have an impact and it is the only asset that will have a true future value.
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Investment in gold can be a better option but I prefer to invest in money because this is one thing that everybody can comfortably afford to lose.
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? How can anyone comment that Gold has underperformed other investments? That is not true. And yes it is a strong long term investment. Look at any graph that compares Gold with Inflation over the last 50 years. Documentation Beats Conversation. I've rolled over some of my retirement in a Gold IRA and am happy with it.
An interesting discussion is worth comment. I think that you must write much more on this topic, it may well not be a taboo subject but typically folks are not sufficient to speak on such topics. To the next. Cheers
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The problem I have with all these arguments is that if you say it's undervalued because of "this" or its over valued because of "this". You are implying that it should go up or down depending on your reasoning, logic or computation. What use is that? The current price is always the right price no matter what you "think" it should be. It's just reality; wishing and hoping doesn't change what will you pay today.
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Thank you! I feel the same way about my ring. It’s my gift for me, and no matter what happens, it will be on my hand. I also think it’s therapeutic to take something that used to symbolize hope (until it didn’t) and trade it in for something that will always symbolize hope.
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Great post! Been reading a lot about this recently. Thanks for the info!
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OK I have a question for you. The people in the website above called me because I filled out a form on Precious Metals IRA. They are pretty firm in their stance that I should switch over to Gold because it is up 8% and the GDP is only up 1.3%. They are saying that I need to protect myself in this flat economy and avert disaster when the dollar crashes. Obviously I want to protect my IRA. I know that gold fluctuates, but it seems to steadily grow at a much faster and larger rate. What is your opinion on this? At this point, all information is helpful. I will try to get a call into the Clark Howard show to see if I can get his opinion to:) Thanks Jere
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If gold does not have an intrinsic value, what is it that drives its value? There are at least three factors historically that have influenced the price of gold.cash for gold
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Do you think that High ERP value could be reason of high cost of Gold?
I'm inclined to agree with Warren Buffet, and it's not just because I'm from Omaha (where he lives). While we can't nail down an intrinsic value for gold, there seems to be a symbolic value that, like it or not, refuses to fade. Despite its actual value, I think people look at gold as a shining beacon of light that represents treasure and riches...both of which are reminiscent of the frontier. Great article!
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