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Gold Price Forecast: Market-Long-Wave Analysis 2009-2012

Commodities / Gold & Silver 2009 Apr 22, 2009 - 06:29 AM GMT

By: Andrew_Butter


Best Financial Markets Analysis ArticleApparently gold is "hard to value" since it doesn't have a cash flow (the gold game) (well actually until you decide to sell it has a negative cash flow because you got to keep it in vaults or nasty people are disposed to steal it).

Valuation 101

Mmm...the way I was taught to do valuations you got basically three options, the Market Value (how much you can sell it for today - commonly and sometimes incorrectly referred to as the "price"), income capitalization (an Other-Than-Market Value under International Valuation Standards (IVS)), which is the net present value of future cash flows, complicated by the fact that you get into a debate about (a) what discount rate to use and (b) what the terminal value is (that's when you sell it in ten or twenty years time).

Then you got the depreciated replacement cost, which is broadly the cost of buying a gold mine, and digging it out of the ground, which is slightly complicated by the current market price (affects how much you can buy gold mines for), and the fact that "effective life" of gold is infinite.

The other thing about valuation is that if the Market Value (the price), the value from income capitalization, and the value from the depreciated replacement cost are not exactly the same, then by definition, either (a) you got your sums wrong or (b) the market is in what IVS calls "disequilibrium", and if that's the case you can expect change.

Gold is an Asset

This is the thing, gold is an asset, and like any asset there are two components to value, there is the cash flow you can expect it to generate plus the prospect of selling it for some guess of a price in the future.

Pretty much like an owner-occupied house, you can often not get a worthwhile rent, some people pay to keep their second or third homes going even if they don't live in them hardly ever, but there is an expectation they will be worth more, in the future. Not much different from gold, and the similarity doesn't end there, some people buy gold so they can hang it around their necks from time to time to impress lesser mortals how rich they are, some people buy big houses for exactly the same reason.

So presumably there might be a correlation between the "disequilibrium" of the US housing market and the price of gold?

What a surprise, it looks like there is!!

This chart compares the average price of gold over a year and a calculation of the disequilibrium of the market for housing in USA

Looks like once people started to fully appreciate the "value" of gold in about 1980, it has roughly tracked the extent of over or under valuation of housing, which logically makes some sort of sense, except there appears to be a two year lag or so.

In which case perhaps by about mid 2012 gold might be worth about $200 an ounce, that's a sort of deflation scenario rather than an inflation scenario (the line was "eyeballed" and the projection for the future for house prices is explained in

How reliable is that projection?

The plot of housing price over/under value lagged two years compared to the price of gold from 1980 to 2008 (28 years) gives a 78% R-Squared. OK that's not 95% and it's not exactly a long time-series but at least the projection is within the range of the correlation.

Mmm...interesting, might be worth having another look at that in ten years time.

By Andrew Butter

Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.

© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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