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Is Gold Cheap or Expensive?

Feb 09, 2018 | Peter Christensen |

Is Gold Cheap or Expensive?

If you’re wondering whether gold is cheap or expensive, here are some tips on analyzing the price of gold today.

As we’ve discussed in recent articles, while we are seeing corrections in the stock market and cryptocurrencies, they are still booming while gold is less desired. What Warren Buffet has said about the stock market also applies to gold: “Most people get interested in stocks when everyone else is; the time to get interested is when no one else is.”

A reason for our optimistic outlook on gold is the mismatched valuation of gold and stocks. We can look at the S&P / GSCI index which compares the S&P to the commodities index. As the graph shows, commodities, when compared to stocks are currently at an all-time low, over a 65 year span.

Buy low, sell high

We must remember, though, that the commodities index really measures a mixed basket of unrelated commodities—in addition to gold, it contains copper, grain, corn, etc. To get a proper measure of the performance of gold, we must therefore isolate gold from the other commodities.

Below, we compare just the price of gold to the price of the S&P 500 index. Notice that the ratio of gold to the S&P 500 is low, which reflects the multi-year low that gold achieved in Dec. 2015. In fact, it’s the lowest in 10 years. For the prices to move back to their average or mean—this is called mean reversion—the gold price needs to increase substantially, or stock market share prices must collapse.

So, while gold may seem expensive at its current price of over $1,320, compared to $1,100 in 2015. compared to stocks, gold is a bargain.

Diminishing gold production

Let’s now take a look at gold supply. Gold production from existing mines was lower than expected for 2017 and is expected to drop further, which will increase gold price. There is, of course, always the “risk” of locating new gold reserves, but while there are many cases over the past 50 years where deposits of 30 million ounces or more have been found, no such large deposits have seen the light of day in the last decade.

Mining companies are cutting budgets for gold exploration due to lower gold prices—in 2016, the budgets were the lowest in 11 years—and they will keep doing so until gold prices increase. This is important because it takes a long time to locate a deposit, and once one has been found, it takes an average of 7 years to begin production. On top of that, the labor-intensive production is costly due to high wages, and there is no way to mine gold from hard-to-reach areas, unlike crude with fracking technology.

It should be clear by now that gold is a bargain these days, and that there is no reason to think the gold price will drop even lower. In fact, all evidence points toward higher prices.