Gold is the Courtesan of the investment World, making different, and contradictory promises all the time; often it acts like other speculative investments. At other times, Gold offers protection against financial meltdown.

Folks believe that Gold will protect against both deflation and inflation.

Today, Gold is favored by hedge fund managers, and lots of retail investors, by Bulls and Bears too. There is a catch: Gold lovers do not know how to value it.

If a “Bubble” could be identified by popularity, then Gold is in a “Bubble”.

In the UK, Harrods, the Knightsbridge emporium, sells Gold Bullion over the counter. There are even Gold vending machines in the street in some cities.
Commercial breaks on CNBC and other TV channels are filled with ads for Gold promoters.

Retail investors pile into the Exchange Traded Funds, while some of the most respected institutional investors take physical delivery of Gold Bullion.

The price of Gold is raises by demand from emerging markets. The Industrial and Commercial Bank of China’s recently launched “Gold Accumulation Plan” has attracted more than a million accounts. “After opening an account,” reports the World Gold Council, Asia’s modern Gold Bugs “can start to accumulate Gold on a daily basis?.?.?.?”

A decade ago, when Gold held below US$300 oz, it was ignored by brokers. After a 400% + rise, Wall Street is projecting the price appreciation into the distant future.

Goldman Sachs (NYSE:GS) aka Goldie on The Street, has a target 1,690 oz for Y 2011, some 20% above the current price.

HSBC forecasts Gold will rise by 8% annually for the rest of the decade and recommends a 15% portfolio investment allocation to the precious Yellow metal.

With the Euro shaky and the “Greenback” threatened by US Fed Chairman Ben Bernanke’s Money Press, Gold has become the hottest “Currency” behind Crude Oil.

“Bubbles” are defined by valuation and not by investors’ behavior. Over long periods, the valuation of Gold in inflation-adjusted USDs has been stable.

Since Y 1900 Gold has averaged 440 oz in Y 2010 Dollars. Using this measure, Gold at about 1,400 oz is 2.5 standard deviations above its long-run average.

Gold is also expensive relative to its cost of extraction, which Credit Suisse estimates at roughly 600 oz. Hence, Gold looks overvalued by traditional measures.

In Babylonian times, it was said that 1 ounce of Gold bought 350 loaves of bread. The loaf in my bread box cost US$2.99, which suggests a fair price for Gold of about 1,047 oz (by ancient Babylonia’s measure).

Another rule-of-thumb said, an ounce of Gold should purchase a gentleman’s suit. It is not clear what quality of tailoring is suggested.

However, Italy’s Brioni and Keton lines currently offers singles breasted Super 150 wool suits for US$5,000 and above.

Gold looks less pricey compared with other commodities from my POV.

Since Y1900, an ounce of Gold has on average purchased 50 times its weight in Silver.

After last year’s run North in Silver, this ratio has come down to 47 times.

The price of Gold in terms of Crude Oil has also been constant. Since Y 1900, an ounce of Gold has purchased on average 13.4 bbls of Crude Oil. Today, the same ounce of Gold buys 15.1 bbls.

So, now you see that there is clear method for valuing Gold.

Jim Grant observes in a recent Newsletter, “You cannot value a non-earning asset, even if you can pretend to.” Grant suggests valuing Gold by “1/n, where ‘n’ is the World’s confidence in fiat currencies, and the Mandarins who manipulate them. But, ‘n’ is an unknown.”

Wall Street’s Gold Gugs make little effort to identify value, as they point to the fact that Gold has tended to rise when interest rates have been Negative.

What they do not say is that Gold’s rise in Y 1980 declined rapidly after US Fed Chairman Paul Volcker started raising Key interest rates. Over the following 2 yrs, the Gold price fell by 67%.

The question of valuation should not be ignored. Gold needs to fall by about 70% to reach its long-term average price in inflation-adjusted Dollars. To come back in line with its cost of production, the Gold price would have to decline by about 55%.

Relative to the price of Babylonian Bread, Gold is about 40% overvalued and relative to Crude Oil it is 9% to high. In terms of a fine off the rack Italian suite it is undervalued by 400% if you include sales tax.

So, in terms of suits and Silver Gold appear cheap. The Bulls hope that in real terms Gold will regain its Y 1980 high, which would provide an upside of more than 70%.

But the average of our Crude Oil valuation metrics suggests a fair value for Gold of about 1,000 oz, about a 35% below its current price.

I am not suggesting that Gold will not rise over the coming year or years, or that there is no need to hedge inflation risks. What I am saying is that along with Gold there are other risk assets that can be used effectively to protect the purchasing power of consumer’s savings.—-Paul A. Ebeling, Jnr. www.livetradingnews.com

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Posted by Shayne Heffernan on Jan 18th, 2011and filed underEquities, Europe, Heffernan Capital Management, Latest News, Limelight, Markets.You can follow any responses to this entry through theRSS 2.0You can leave a response by filling following comment form or trackback to this entry from your site