Evaluating the Long Term Value of Gold
An oft cited negative about Gold is the inability for investors to value it, unlike stocks and bonds.
A company’s revenues and earnings can be forecast to arrive at a valuation multiple.
A bond’s cash flows can be discounted to come up with a present value.
Gold does not produce either, so investors often struggle with assigning a fair value.
However, there is 1 long-term indicator an investor can monitor when reviewing portfolio allocations and initiating a position in physical Gold
It is the S&P 500 to Gold Ratio.
This is simply the amount of Gold, expressed in oz’s, equal to the level of the S&P 500.
Below is the Ratio and real Gold price since Y 1968, as follows:
As you can see, the ratio has varied widely with a low of .17 in 1980, when the precious Yellow reached an inflation adjusted high of 2100 oz., to over 5 at the height of the tech boom in late 1990’s, when it was trading around 400 oz.
Currently the ratio is 1.90, 21% above its historical average of 1.57.
The data shows that since Y 1970, each time the ratio has been around 2 Gold turns to being a good investment. There have been 2 such instances since Y 1970 and each time resulted in large gainers.
We could well be reading to a 3rd now.
- In June of Y 1970, with the reading at 2.03, an investor would have purchased Gold at 235 oz. By November 1974, Gold was trading at 970 oz., and by the Summer of Y 1980, Gold was over 2,000 oz, a cumulative gainer of almost 800%, or 24.5% annually.
- The 2nd instance occurred in November of Y 1996, with Gold trading at 570 oz. and a ratio of 2.04. The internet bubble of the late 1990’s drove stocks to extreme valuations, so the ratio soared to over 5. But if an investor had the patience to hold, the return far outpaced the stock market for the next 10 years. Gold went from an inflation-adjusted 570 oz. in Y 1996, to 800 in early Y 2006, and then onto 1,940 oz. in August of Y 2011, representing a gainer of 240% or 8.8% annually. During this same frame, the S&P 500 had a total return of 52%, or 2.9% annually.
Market timing is very difficult
That being the case it generally more advantageous to risk being early and leaving some profit on the table than trying to squeeze every point return from an investment.
Investors who believe that the current 8-year Bull Run has room to run may benefit by waiting for the ratio to rise above 2, but keep in mind PE of the S&P 500 in 1999–2000 was near 30X, about 2X its historical average of 16X.
Currently it is around 23X, and some say stocks are fully valued, but they can be overvalued for a long time,
While the S&P 500/Gold ratio is not excessive in here, it is at a 10-year high, and we are in a different market environment and economic climate.
Study the benefits of diversification benefits of Gold.
It is your money, it is your responsibility.
Have a terrific weekend.
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