Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
Coronavirus is America's "Pearl Harbour" Moment, There Will be a Reckoning With China - 6th Apr 20
Coronavirus Crisis Exposes Consequences of Fed Policy: Americans Have No Savings - 6th Apr 20
The Stock Market Is Not a Magic Money Machine - 6th Apr 20
Gold Stocks Crash, V-Bounce! - 6th Apr 20
How Can Writing Business Essay Help You In Business Analytics Skills - 6th Apr 20
PAYPAL WARNING - Your Stimulus Funds Are at Risk of Being Frozen for 6 Months! - 5th Apr 20
Stocks Hanging By the Fingernails? - 5th Apr 20
US Federal Budget Deficits: To $30 Trillion and Beyond - 5th Apr 20
The Lucrative Profitability Of A Move To Negative Interest Rates - Pandemic Edition - 5th Apr 20
Visa Denials: How to avoid it and what to do if your Visa is denied? - 5th Apr 20 - Uday Tank
WARNING PAYPAL Making a Grab for US $1200 Stimulus Payments - 4th Apr 20
US COVID-19 Death Toll Higher Than China’s Now. Will Gold Rally? - 4th Apr 20
Concerned That Asia Could Blow A Hole In Future Economic Recovery - 4th Apr 20
Bracing for Europe’s Coronavirus Contractionand Debt Crisis - 4th Apr 20
Stocks: When Grass Looks Greener on the Other Side of the ... Pond - 3rd Apr 20
How the C-Factor Could Decimate 2020 Global Gold and Silver Production - 3rd Apr 20
US Between Scylla and Charybdis Covid-19 - 3rd Apr 20
Covid19 What's Your Risk of Death Analysis by Age, Gender, Comorbidities and BMI - 3rd Apr 20
US Coronavirus Infections & Deaths Trend Trajectory - How Bad Will it Get? - 2nd Apr 20
Silver Looks Bearish Short to Medium Term - 2nd Apr 20
Mickey Fulp: 'Never Let a Good Crisis Go to Waste' - 2nd Apr 20
Stock Market Selloff Structure Explained – Fibonacci On Deck - 2nd Apr 20
COVID-19 FINANCIAL LOCKDOWN: Can PAYPAL Be Trusted to Handle US $1200 Stimulus Payments? - 2nd Apr 20
Day in the Life of Coronavirus LOCKDOWN - Sheffield, UK - 2nd Apr 20
UK Coronavirus Infections and Deaths Trend Trajectory - Deviation Against Forecast - 1st Apr 20
Huge Unemployment Is Coming. Will It Push Gold Prices Up? - 1st Apr 20
Gold Powerful 2008 Lessons That Apply Today - 1st Apr 20
US Coronavirus Infections and Deaths Projections Trend Forecast - Video - 1st Apr 20
From Global Virus Acceleration to Global Debt Explosion - 1st Apr 20
UK Supermarkets Coronavirus Panic Buying Before Lock Down - Tesco Empty Shelves - 1st Apr 20
Gold From a Failed Breakout to a Failed Breakdown - 1st Apr 20
P FOR PANDEMIC - 1st Apr 20
The Past Stock Market Week Was More Important Than You May Understand - 31st Mar 20
Coronavirus - No, You Do Not Hear the Fat Lady Warming Up - 31st Mar 20
Life, Religions, Business, Globalization & Information Technology In The Post-Corona Pandemics Age - 31st Mar 20
Three Charts Every Stock Market Trader and Investor Must See - 31st Mar 20
Coronavirus Stocks Bear Market Trend Forecast - Video - 31st Mar 20
Coronavirus Dow Stocks Bear Market Into End April 2020 Trend Forecast - 31st Mar 20
Is it better to have a loan or credit card debt when applying for a mortgage? - 31st Mar 20
US and UK Coronavirus Trend Trajectories vs Bear Market and AI Stocks Sector - 30th Mar 20
Are Gold and Silver Mirroring 1999 to 2011 Again? - 30th Mar 20
Stock Market Next Cycle Low 7th April - 30th Mar 20
United States Coronavirus Infections and Deaths Trend Forecasts Into End April 2020 - 29th Mar 20
Some Positives in a Virus Wracked World - 29th Mar 20
Expert Tips to Save on Your Business’s Office Supply Purchases - 29th Mar 20
An Investment in Life - 29th Mar 20
Sheffield Coronavirus Pandemic Infections and Deaths Forecast - 29th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast - Video - 28th Mar 20
The Great Coronavirus Depression - Things Are Going to Change. Here’s What We Should Do - 28th Mar 20
One of the Biggest Stock Market Short Covering Rallies in History May Be Imminent - 28th Mar 20
The Fed, the Coronavirus and Investing - 28th Mar 20
Women’s Fashion Trends in the UK this 2020 - 28th Mar 20
The Last Minsky Financial Snowflake Has Fallen – What Now? - 28th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20

Market Oracle FREE Newsletter

Coronavirus-stocks-bear-market-2020-analysis

Is the Gold Price a Bubble?

Commodities / Gold & Silver 2009 Nov 24, 2009 - 03:36 AM GMT

By: Michael_S_Rozeff

Commodities

Best Financial Markets Analysis ArticleGold remains undervalued, even at its current price of $1,150 an ounce. One signal of this is that at current market prices of gold, the notes of the FED – its dollar bills – are not fully-backed by gold. That is to say, gold’s price is lower than the Zero Discount Value (ZDV) of gold by a wide margin.


Medley Global Advisors does not accept this idea or does not understand it. They may be operating on a different theory of money than mine, which is that gold never stopped being the medium of account for prices, even though the FED has suspended convertibility of its notes into gold since 1971.

Since people can exchange the dollar for gold in the open market, they can bypass the lack of FED redemption. The market can substantially remove the undervaluation of gold and the overvaluation of the dollar. It has done this before and it can do it again. The reasons why the market drives gold’s price further away from its ZDV, as in the 1990s, or closer to its ZDV, as in the 1980s, may be cloudy; but the fact of undervaluation is clear from the following. Dollars can be converted into gold at a rate of $1,150 an ounce in the open market, but the implicit rate of conversion derived from the FED’s gold holdings compared with the dollars it has issued is at least $7,725 an ounce in order to equate its asset and liability values.

Medley Global Advisors sells advice to the financial elite:

"Medley Global Advisors LLC (MGA) is the leading macro policy intelligence service for the world's top hedge funds, investment banks, and asset managers."

"We combine intensive dialogue with senior policymakers, years of experience with the most sophisticated investors, and in-depth knowledge of global markets to provide concise, timely, and accurate analysis that helps clients understand and anticipate the major policy events driving interest rate, currency, equity and energy markets."

But Medley doesn’t understand why gold is rising in price, or pretends not to. In a recent note that was published by the New York Stock Exchange called "The Vogue of Gold," it jocularly pooh-poohs

"...the usual lectures on Austrian Economics, ‘fiat money’ and fractional reserve banking conspiracies that make most gold bugs such incredibly boring dinner partners."

Instead the reason for gold’s rising price, it says, is that people in China are saving more than they spend, and saving in the form of gold. If so, why is this so? Because "they don’t trust local banks, and they don’t trust green paper money." So Medley is right back to Austrian Economics, fiat money and fractional reserve banking.

The Medley note ends with something that puzzles them:

"Still, the most thought provoking statistic of the week had to be from a Societe Generale report. Their analyst calculated that with the U.S. monetary base of $1.7 trillion, and 263 million troy ounces of gold in the U.S. government’s vaults, that the dollar could be fully ‘gold-backed’ if the price per ounce rose to $6,300. We’re not sure what that really means in practical terms. Maybe Ron Paul can tell us."

Let’s bring the numbers up to date. The monetary base is now 2.02 trillion dollars. I use 261.5 million ounces in calculating the Zero Discount Value (ZDV) of gold, which is the same concept as the fully gold-backed price of Société Générale, and that price is now $7,725 per ounce. This doesn’t take into account the bad loans in the banking system. In the next two years, many more bad mortgage loans are going to surface in areas other than subprime. In addition, a large volume of commercial real estate loans is going to default. The system-wide ZDV of gold as a result of these bad loans can easily become $10,000 per ounce or more.

There is no need to split hairs, worry about trivial differences in calculations, or forecast the future, for the ZDV at present is already far above gold’s market price of $1,150 an ounce.

What does this mean in practical terms? It means that gold’s price is not a bubble price. It means that gold is undervalued. It means that the downside risk of gold is less than that of the dollar and that the upside potential is large. It means that one might be better off holding assets in gold than in dollars, unless one’s dollar investments provide enough return to compensate for various dollar risks that are mentioned below. It does not mean that buying gold is a sure-fire winner or that gold is going to jump to $10,000 an ounce. Markets do not usually work that way; crashes and parabolic rises are not as common as prolonged price movements that form into major trends with many intermediate ups and downs.

The FED is like an open-end mutual fund whose shares have a fixed nominal price of $1 a share. The shares it issues are the notes (dollar bills) in the monetary base. It has issued 2.02 trillion shares (dollar bills.) The asset it holds is gold certificates. The physical gold, which is held by the Treasury, is supposed to be 261.5 million ounces. If the FED were an open-end mutual fund, we’d calculate its net asset value by dividing the worth (in dollars) of its assets by the number of shares. Instead let us calculate a real net asset ratio by dividing the FED’s gold holdings in ounces by the number of notes outstanding. We get 0.000129455 ounce of gold per Federal Reserve note (dollar). This measures the amount of real assets per share of the FED, viewed as a fund.

As the FED issues more and more shares (notes) without changing the ounces of gold it holds, the real assets per share decline. It’s convenient to calculate the inverse of real net assets per note. This is 1 divided by 0.000129455. It comes out to $7,725 notes per ounce of gold. This is the ZDV. The more notes that the FED issues, the lower the ounces of gold per FED note, and the higher the ZDV. The ZDV measures the FED’s note inflation directly. If the FED reduces the monetary base, the ZDV will decline.

If we view the FED as a mutual fund that issues notes, then the ZDV tells us how many notes it takes to get an ounce of gold through participating in the fund by buying or holding the fund shares. At present, it takes $7,725 FED notes to have an interest in one ounce of gold via the FED mutual fund.

There is a cheaper way to gain an interest in gold, and that is in the open market. Gold’s market value of $1,150 an ounce is just under 15 percent of $7,725. For $7,725 we can buy 6.72 oz of gold in the open market.

We can also think of the FED’s open-end fund in terms of market net asset value. The market value of the 0.000129455 ounces of gold (per FED note), at the current gold market value of $1,150 an ounce, is $0.14887, which is just under 15 cents. Thus, the market net asset value of the fund is $0.15 per note (or share). But the fund shares are selling at $1 a note. This suggests that the fund’s shares (FED dollar bills) are overvalued.

Gold selling at $1,150 an ounce in the market is selling at an 85 percent discount to what it sells at if we hold on to the dollars and get a gold participation indirectly in that manner. In other words, by holding dollars, we are always acting as if we are buying gold at the ZDV of the FED’s mutual fund. At present, it is as if we are paying $7,725 an ounce when gold is actually available for 85 percent less in the market. This is a remarkable discrepancy.

One practical meaning of this is that the FED’s notes have an insecure foundation. The notes have a valuation risk that has several sources. For one thing, they are trading at a price ($1 per note) that is far above the current market worth of the gold that the FED holds ($0.15 per note.) There is therefore at all times a strong incentive to dispose of these notes in exchange for gold at its current market price.

Another source of valuation risk arises from dilution. The FED has a long history of adding to the number of these notes, which dilutes the equity. This drives the ZDV higher, which strengthens the incentive to exchange the notes for gold. Since the notes have a constant nominal value of $1, the movement out of notes and into gold shows up as a rise in the price of gold. This is not to say that gold must rise in price or rise when we may think it should. The vagaries of the market do not make life that simple.

The dilution is variable in extent over time. All of a sudden, the FED can increase its note issue because of fiscal pressures and because it costs the FED virtually nothing to produce more notes. These two factors add further to the valuation risk of holding dollars over long periods.

Due to the dilution brought about by the FED’s note issues without adding to its gold holdings, the dollar has not maintained its purchasing power. Hence, there is a risk of capital loss to anyone who uses dollars as a store of value.

The discrepancy between gold’s market value and its ZDV is an indicator of all these risks. If every dollar were fully-backed by gold and the market value equaled the ZDV, these risks would be negligible for as long as that full backing lasted or until people began to expect legal or other changes to decrease the backing. The risks of holding a fully-backed dollar become the risks of holding gold itself and the risks of holding it in the form of a claim to physical gold issued by whoever issues the dollars. There are no riskless assets in this world.

Another risk to holding the FED’s notes over time is a "peso" risk. This is that they may suddenly lose widespread acceptance, or that people en masse turn to using alternative currencies and stores of wealth. If that happens, the price of gold rises quite sharply. The FED’s notes carry this risk because the gold backing is low and because people understand that fiscal and political pressures on the FED can induce it to print more notes. If gold fully-backed the dollar by law, this risk would be diminished. The main risk would be of future changes in law to debase the dollar.

The risk of non-acceptance is not well-understood. It is a judgment or decision to move one’s business out of one currency and into another (gold included). It is a decision that involves a major change in habit and customary way of engaging in transactions. It is a decision that may be influenced by others who may also be revising their judgments or seriously reconsidering what currencies they use. What all this means is that once this decision is made, it is unlikely to be reversed. When people make up their minds, there is something of a point of no return about it. Once confidence is lost in a currency, rebuilding it is no longer a routine matter. There have to be basic changes made for a depreciating currency or a new currency to regain acceptance.

In the present situation, a tipping point seems to have been reached in which major players like India and China are moving away from dollars. Japan has not done this. Japan is still buying dollars. The momentum is shifting away from the dollar. Central banks have started to buy gold. There has been a turn in the tide. There is no tidal wave, although one could develop. Reversing the tide seems increasingly unlikely.

The practical meaning of a ZDV of $7,725 (or higher due to bad loans in the banking system) is that gold can rise in price substantially without ever being overvalued. The high ZDV is an indicator of the dollar’s substantial overvaluation. It is an indicator that dollars are a poor way to store value over the long run. It is an indicator of substantial valuation risks and risks of capital loss in holding dollars. The ZDV by itself does not tell us in which direction the tide is running, but it suggests the probable direction.

Michael S. Rozeff [send him mail] is a retired Professor of Finance living in East Amherst, New York. He is the author of the free e-book Essays on American Empire.

    http://www.lewrockwell.com

    © 2009 Copyright LewRockwell.com - 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.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules