Gold Price Relationships

When talking about value, for many investors it all comes back to gold. How many ounces of gold does it take to purchase an asset, whether it be real estate, equities or anything else. Please note that the following charts use monthly prices with the last data being that of September 2008.

Current Value: Today it appears that median home prices could be as low as $200,000 if not below. This is based on my own research since the last reports released. At $200k and $740 gold, the ratio is sitting at $270 roughly in-line with the chart above.

Current Value: The chart above has changed significantly over the past few months due to the sharp drop in the price of oil. With crude sitting at $55 and gold at $740, the ratio is at 0.074324 very close to it’s average ratio of 0.074076.

Current Value: Keep an eye on this one when the data is released tomorrow (Wednesday Nov 19)

My Thoughts

The purchasing power of gold has increased dramatically over other real assets since 2001. Calls for this trend to continue significantly further are unjustified in my opinion. I have had some people comment that they expect housing prices to half from current levels and gold price to double. That would put the price of the median homes at around 67 ounces of gold.

It’s interesting to note the divergence between crude (global demand issues) and real estate (U.S supply issues). The global trend has moved towards historical levels while the regional trend is significantly below. This makes sense given that the rest of the world is offsetting demand, to a certain extent, with regards to crude. Real estate on the other hand is experiencing regional over-supply that will take a very long time to work it’s way through the system.

The cost of purchasing the CPI basket of goods has decreased significantly in terms of gold. I have a thesis that we are moving towards the next phase of economic progress (on a much larger time scale). Pending limited protectionism arising from this crisis, we have never experienced so much global competition. I believe that we are moving more in the direction of zero economic profits - the theory that companies don’t earn excessive profits beyond an adequate return for the risk they are taking. In this environment, profit margins are very tight and consumers pay the cheapest possible price. The Internet will enable this process as it allows companies to sell directly to the public, thus cutting out the middle man and reducing large real estate overheads. Take a look at Amazon to see the efficiencies of this model. Compare the price of the same book on amazon.com to the price in your local book store - it’s shocking to see the difference.

As this plays out, I expect consumer prices to come down globally, unless currencies lose catastrophic value. Take a book that used to cost $70 and is now selling for $32 on Amazon. Even if the currency lost 20% of it’s value over that time, it would still be a significant discount to the consumer. As companies race to cut costs and to keep their market share, consumers will be handed considerable discounts that will likely be large enough to withstand a large currency devaluation. I could take this a step further and discuss the range of free services that used to cost businesses and consumers a lot of money (ie Google Docs vs Office), but I think I have made my point.

Conclusion

In the case that my theory plays out and consumer prices fall significantly, imagine coupling that with cheap alternative energy. The cost of living could plummet. Imagine further breakthroughs in agriculture, some of which is already happening as yield-per-acre for many crops is on the rise due to technological advance.

In the long term, both the cost and the maintenance (efficiency) of goods get cheaper - even if the dollar value rises. This may not necessarily be good for the economy from the perspective of fast growth (middle men being cut out, smaller profit margins, etc), but it is a far healthier, efficient economy. Those who would be the hardest hit would be large debtors, and the current crisis that we are in may be the precursor to this economy I am describing, where the large debtors have to get knocked out at some point, pushed into bankruptcy, and forced to restructure with less leverage.

It’s also not just the dollar losing value, but all currencies. In fact, the Pound is doing what the bugs expected the dollar to do. The dollar’s relative value could increase in terms of a reference to the basket, but it’s absolute value (purchasing power relative to real assets) should decline. The allure of gold to hedge the global liquidity injections has driven many investors to buy the precious metal, while other real assets have adjusted to reflect real value and have been more subject to economic conditions. This has led to these other real assets trading at a discount to gold. If you are looking to buy real assets to hedge currency debasement, consider the entire sphere of real assets as the gold market is already very crowded as can be seen by the shortage of gold coins and ridiculous premiums some retail investors are willing to pay. In the short term these other real assets may be more exposed to economic factors, but in the long term represent better value as real asset ratios return to normal levels.

Posted in Categories: Commodities, Contributor, External Research.

Subscribe by RSS Subscribe by Email