Gold Price Under Differing Scenarios
Silver Stock Report
by Jason Hommel, June 24, 2000
Many people argue that gold is undervalued, but by how much? What are some rational higher prices, and how can we determine these other prices?
To answer this question I have envisioned different scenarios to determine relative values of gold at varying parameters.
I started with the high price of $850/oz. in 1980, because this reflected the U.S. government's 1971 decision to let the price float up from $35/oz. in the free world markets. Things changed after 1980, when short selling was allowed to add a new paper supply of gold, which held back this free market price.
Indubitably, gold protects against inflation. Since Money Supply (M3) has grown over time, it seems logical that the price of gold should also increase. Assuming an increasing gold price - in an environment devoid of short selling in the past - allows one an insight into what the price of gold might have been. The power of compound interest is difficult to picture in one's mind, so I used an Excel spreadsheet to determine the hypothetical values that gold could have increased to over the last 20 years, given different rates.
What if in 1980, the U.S. Government decided to stop the runaway gold price by returning to a gold standard? What if it artificially fixed the price at $850, but allowed the 'fixed exchange rate' to slowly increase at a known standard, a fixed 3% per year increase, to provide both monetary stability and monetary growth? A 3% fixed annual growth rate is still lower than the rate of inflation and average interest rates levels during the period. Amazingly, gold would have grown to over $1500 an ounce by 2000.
What if in 1980, the U.S. Government used a different rate? What rate? How about letting gold rise as fast as M3? This works out to a 6.7% annual increase from 1980 to 2000. This would be a different sort of fixed gold standard, because each dollar of M3 money creation would result in an increase in the official price of gold. Amazingly, we see that the price of gold could have been fixed at a certain rate, and it would have grown to over $3000 an ounce by 2000.
To be sure, the actual price of gold has decreased from $850 to about $274 over the last 20 years. This averages out to 5.5% annual decrease. In light of the inflation of M3 money growth, today's pathetically low gold price is unrealistic.
As long as gold can be legally purchased with dollars, each dollar in existence is a potential claim on gold. The U.S. holds 8,139 tonnes of gold in reserves. In 20 years M3 has risen from 1.8 Trillion in 1980 to 6.6 Trillion in 2000. If you divide the M3 U.S. Dollar totals by the U.S. Gold reserves, you have a dollar price for gold. In 1980, this means that there were $6,966 dollars that had already been created for every ounce of gold held in the U.S. reserve. In 2000 there are $25,221 in M3 that have already been created for every ounce of our nation's 261,676,989 oz. gold reserve.
What kind of growth rate takes $850 in 1980 to $25,000 by 2000? An 18.5% annual rate. Thinking in these terms then, a rise in price to $25,000/oz. does not seem so unrealistic. Those 20 years of gains seem typical of a wise investment. Even Warren Buffet has done better than 18% for his investors for over 20 years. Who says gold does not pay interest?
At $850/oz. gold, the U.S. 8,139 tonne gold reserve is worth $222 Billion. At $274/oz. gold, the U.S. gold reserve is worth $71 Billion. Needless to say, if our dollars can never be worth more than the gold of our reserve, our nation's gold reserves are worth exactly the same as M3. At about $25,000 oz. gold, the gold reserves are worth the $6.6 Trillion of M3 today.
Nixon's 1971 gold default and gold revaluation was the result of $70 Billion dollars held overseas, and the U.S. gold reserves of 8,139 tonnes being valued at $10 Billion, (at $35/oz.). In other words, the gold default/revaluation took place because gold was valued 7 times less than it should have been. Today, using M3 divided by the gold reserves to arrive at about $25,000/oz. gold, gold at $274/oz. is valued 94 times less than it should be. We are ready for another gold revaluation.
In my analysis I used official statistics for M3 and the U.S. gold reserves. These numbers are real facts that cannot be refuted. The sad part is that the dollar figure may be higher, and the gold figure may be lower - given the fact that no official audit of the U.S. reserves has occurred since 1971. If there are more dollars, and less gold, then the gold price could eventually far exceed $25,000/oz.
Since the Washington Agreement of September 1999, other gold analysts have shown that U.S. gold export figures have averaged 100 tons a month. With this much gold leaving the U.S. on an average month, the allegations are that our government is secretly dumping our nation's gold reserves to prevent the dollar from devaluing... This condition cannot last very long, and the price to be paid will be horrible when we realize we have sold our gold for less than 1% of its true worth, and for what? At the most, 8,139 tons of gold being dumped on the world market at a rate of 100 tons a month will last a maximum total of 81 months, or 6.7 years, starting in September, 1999.
Perhaps you might assume that gold will never go back to full dollar parity of $25,000/oz., because of the thought that the people manipulating gold and the free market are just too smart, powerful, and wise, and that our nation's gold reserves are NOT being liquidated. You might then naturally assume that once the short selling stops, gold will rise to reach the percentage of parity that it did in the climb to $850 back in 1980, or, in other words, 12% of the $6,966 dollars in M3 for each of the 8,139 tonnes. Today then, we might expect the price of gold to reach 12% of $ 25,221. Which brings us back to over $3000/oz. for gold in 2000.
Perhaps all this figuring will allow the prudent investor to know at what price gold might be considered overvalued in the gold bull to come.
Can gold really be valued so highly?
It is imperative to recall that once in the past the total stock market valuation of the NYSE was 1 Trillion dollars. And the total stock market valuation of all the world's gold mines was 1 Trillion dollars. Today, the NYSE market cap is about $15-20 Trillion, while the total stock market valuation of all the world's gold companies is 1/20th of what it once was; that is, less than $50 Billion.
Yes, the gold price is going to go back up again, this next time more violently than ever.
My complete study plus Excel tables for the various growth rates since 1980 may be found at the author's website at:
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By Jason Hommel