Since the low in gold of $1045 in late 2015, gold has almost doubled in price.
Year to date gold bullion is up about 25% while the stock market as measured by the broad S&P is up only about 8%. Bonds as measured by AGG, core US aggregate, is up a little less than 8%.
With such good advances by gold, it is worthwhile asking: is gold getting expensive?
Since “expensive” is a relative term, you have to ask “relative to what.”? Relative to the past history of previous bull markets and relative to competing investments, seems a reasonable place to begin analysis.
The history we have for gold in a free market goes back only 50 years. But within that history we have three large bull markets.
The first began in 1971 with the Nixonian decision to sever the final tie of the dollar to gold. The result was an almost immediate move from $35 per ounce to $200. Thus, a move of about 7-fold. Gold was legalized for Americans to own shortly thereafter, and dropped down to $100 in the summer of 1976. It then advanced over the next four years to $850 or so, a move of about 8-fold off its bear market bottom.
Gold then wandered about in a 20-year desert that eventually saw prices move down to $250 per ounce during a bottoming period lasting about two years. It then started to advance, peaking in 2011 at about $1930 per ounce. Again, we see a move of about 8-fold off the bear market bottom.
So, at least based on past history, a doubling off the recent low near $1,000 is neither unusual nor particularly large. Going up 2-fold does not seem to place gold in an expensive range, at least in relation to past history.
But gold swims in the sea with other investments, so we can ask if gold is getting too high relative to the other fish.
This chart with gold bullion as the numerator and the S&P as the denominator, shows that gold remains relatively inexpensive to stocks, and at .55, it is actually only about on third of the cost of the last peak in 2012, and one tenth the relative value of 1980 when gold hit $850. So, at least relative to US equities, gold does not appear expensive. Since US equities have outperformed most other global indices, that also means gold is not expensive to stocks around the world.
The other major competitor, is the bond market. The bond market is an asset class with many different components, i.e. federal debt, foreign debt, private debt, junk debt, and municipal debt. Then, there is the added complication that bonds can vary extensively in terms of the length of maturity, and that length to maturity is a huge driver in their price action when interest rates fluctuate. Further, bonds can vary extensively in their quality.
Therefore, it is not easy to find either a bond fund, an ETF, or index, that measures all these variables well, and that has a long history. In this case, we settled on Bond Fund of America for comparison. However, we readily admit this is just a proxy and we chose it primarily because it has been around a long time. Even so, it did not take us back as long as we wanted.
What it shows is that gold is now fairly expensive relative to bonds. When bonds are doing much better than gold, the relationship drops. When gold is doing better, it goes up. However, the gold relationship still remains well off the peak of 2012. This is especially the case since rates remain near zero in nominal terms, and negative in real terms (meaning they yield less than the inflation rate), which in turn means bonds prices themselves are at historic extremes.
Therefore, this relationship can be misleading. With interest rates near zero, most experts do not believe bonds have much upside left and will have a lot of downside risk if rates begin to return to “normal” sometime ahead.
We would add one other nasty thought. The kind of economic circumstances that would produce profoundly negative rates, would be worldwide depression. In that case, bonds look quite hazardous because defaults would be rising.
Gold bullion coins, by definition, can’t default because there is no counter party risk. A mineral can’t default. Thus, if you had your choice of non interest paying bonds versus non interest paying gold, which has the best upside and which is safest from default? And importantly, which will hold its real purchasing power over time?
In a deflationary crisis, governments have amply demonstrated their propensity to flood the system with liquidity; money created out of nothing. Bonds are a contract for the future delivery of money, so if money is being purposely depreciated, that is another strike against bonds. So ironically, monetary creation to save the bond market, will serve to destroy the bond market.
We think with that formulation, gold beats bonds on all fronts.
If this is true, then the best relationship to watch will be the price of gold relative to stocks and gold’s behavior relative to prior periods.
Taking this logic one step forward, we conclude with our earlier observation, to wit: gold remains inexpensive compared to its most likely competitor for investment flows; the stock market.
Charts courtesy of stockcharts.com. All information is derived from sources believed reliable, but investment results cannot be guaranteed.
Neland D. Nobel, is a retired portfolio manager and Certified Financial Planner with 45 years of market experience in the securities and gold industry.
