Sunday, October 17, 2010

Gold is Undervalued

I have come to the conclusion that gold as a financial hedge or currency is undervalued, probably by a very large factor. Actually, a better way of saying that is that today’s currencies, all of them, are very much over valued in terms of gold as a standard of value. A further way of saying this is that as the world population begins to realize the problems that fiat currencies, social programs, high debt, and reduced freedom have created, they will at least try to flee to gold to some extent, and the limited quantity of gold in existence will result in an amazing increase amount of fiat currencies required to purchase a troy ounce.

My conclusion may seem to be obvious, maybe even trivial. My point is that the current price level is not something to be seen as high or remarkable. The current price level is the result of a few people out of our total population, worldwide, who have decided to use gold as a store of value. The current portion of our wealth that is placed in gold is a very small portion.

Currently, the gold market goes up and down (trending upward in what is really a fairly slow assent) as a result of daily random news releases about things of little, long-term significance. None of these news events about government activities or economic events addresses the underlying problems or will stop the consequences of those problems.

What is up in the air, I think, is whether the consequences will be swift and catastrophic or wind us down painfully over a longer period of time. But, the reality of the situation is absolute. Some of those people who claim to be gold bugs who pay any attention to the daily or short-term prices changes, including trumpeting new “highs”, are missing the point. Sure, point out the new high level of fiat currency needed to buy gold, but also keep people’s eye on the necessity of the price going higher. The price is still low. By keeping your eye on the fundamentals, you will not get caught up in day-to-day irrelevancies. If the price of gold should fall for a while, keep in mind that nothing has changed in the fundamentals, you should not be concerned. It is actually a buying opportunity.

The relationship between gold and the present day currencies is just as any other market relationship. There is a limited supply of gold, more so than most items for sale, even more so than most commodities. A higher demand for gold will elicit a greater production, as the prospect for profit encourages a search for more sites to mine and makes it possible to mine ore that would be unprofitable at lower levels of demand. Yet the amount of new production has rarely been sufficient to have much impact on the supply and demand balance. New production will not change the fundamental problem of fiat currencies. New production of gold will not sufficiently affect the day-to-day prices to enter into any purchase decision.

The amount of currency that is needed to acquire a troy ounce of gold depends then on the amount being offered for all the gold for sale. If the amount of fiat currency being offered raises, then the amount per ounce will raise. Supply and demand is a root an exercise of arithmetic. The relationship between the current level of fiat currencies and gold would require a much higher exchange ratio than currently exists. Since nearly all countries are continuing to inflate their currency, the amount of those fiat currencies necessary to buy an oz. of gold will rise even higher.

Gold has reached its current quantitative relationship with the currencies of the world in an environment in which few regard it as a real alternative to today’s fiat currencies and few are willing to take the risk of placing their liquid assets in a mere commodity. Gold has reached a high dollar “price” with only a few people actually using it as a value repository.

When gold was last widely known to be a store of value, the earth’s population was less than a quarter it is today. A century ago, there were perhaps only 5% the number of dollars in existence as there are today (the dollar has lost 95% or its purchasing power since 1913, and there is more loss to come). There are more currencies today and much more of each currency. I doubt that there is more than twice the amount of gold in human hands today than 100 years ago, maybe even less.

How many people own significant amounts of gold, say even $1000? How many people own gold as part of their portfolios? How many Objectivists own gold? The quantity of each has got to be very low, even after the last monetary crises.

As long as people with assets continue thinking that moving into dollar assets, especially U.S. government debt is a “safe” move, the upward pressure on gold will be slight. Probably enough to keep it rising and hitting new “highs”, but not enough to push it toward a realistic value in today’s world. Keep an eye on these people who are using U.S assets for safety. When the U.S. dollar assets are also viewed as less than safe, gold will begin moving upward on a steeper angle. At this point I don’t know what is required for people to realize the dollar’s weakness. The added debt, the continued current account deficit, the lack of movement in the U.S. economy, and the threat of more “stimulus” should have everyone worried. It seems that people worldwide have not accepted that gold could have a real role to play. The attacks by the Keynesians have had some impact. Instead, people are bouncing between the Yen, the Euro, and the dollar. At some point you would think that they would get tired of the bouncing and look for some actual safety. Given the state of the gold market, it would not take many new buyers for the dollar price to balloon. It won’t be an asset inflation, but a dollar fall.

If and when people become worried and there is a more concerted movement toward actually safe, real assets, the number of dollars or other currency necessary to acquire an ounce of gold will skyrocket. We haven’t seen anything yet.

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