The buying power of Gold

With a decade of surging gold prices behind us and a<br /> more recent period of weakness that has sent bullion back to mid-2011<br /> levels, investors are left wondering what to do. This question actually<br /> consists of two real dilemmas. Firstly, for those owning copious<br /> amounts of bullion, gold-stocks, or other precious metals – do I sell?<br /> For everyone else the question reduces down to, should I buy because<br /> gold is “cheap”?.

Navigating a Sea of Opportunity

a decade of surging gold prices behind us and a more recent period
of weakness that has sent bullion back to mid-2011 levels, investors
are left wondering what to do.  This question actually
consists of two real dilemmas. Firstly, for those owning copious
amounts of bullion, gold-stocks, or other precious metals – do I
sell?  For everyone else the question reduces down to, should
I buy because gold is “cheap”?

Investment GuidanceBurdening the
decision making of investors is the overabundance of polarized articles
by “gold-bugs” and those less in favor of the yellow metal. 
Even billionaire investor Warren Buffet is frequently cited in the
debate through his 1998 observations on gold in which he stated, “Gold
gets dug out of the ground… we melt it down, dig another hole, bury it
again and pay people to stand around guarding it. It has no utility.
Anyone watching from Mars would be scratching their head.”

It is true that Gold is a relatively useless metal.  It is not
used widely in electronics unlike silver, it isn’t widely used in the
automotive industry unlike platinum, nor does it conduct electricity as
well as copper, and we needn’t even begin to make a comparison on the
uses of gold versus steel.  However, it is important to
remember that gold has spanned thousands of years as a cornerstone of
monetary systems.  Ancient Egyptians used gold bars
to standardize exchange of goods and gold even backed the US dollar
until as recently as the 1970s.

is because of this that gold investors should ultimately view gold as a
currency similar to the Yen, Euro, or US Greenback.  The value
of gold comes from the fact that it is an element and can’t be created
thereby holding its value through scarcity and not through any
industrial uses. This point becomes even more important as
governments around the world look to devalue their currencies through
stimulus programs such as the US Fed’s Quantitative Easing, or as in
Japan with their recent attempts to reflate their deflationary economy
through massive Yen devaluation.  As these fiat currencies
become more abundant, their purchasing power should ultimately suffer.
 Or so the common argument goes.

Gold versus stocks

Click Here to view a larger version of
this diagram

natural question that now arises is if gold is a currency, then what is
its buying power?  The chart above examines this by comparing
stocks, S&P 500, to gold bullion for the last 142
years.   Specifically, how many ounces of gold can be
purchased by one “unit” of the S&P 500 (US stocks). 
The higher the number, the less buying power gold has versus stocks,
thus gold is “cheap” relative to stocks historically.  The
lower the number, the greater buying power gold has, or gold is
“expensive” relative to stocks historically.

bullion-stock ratio peaked during the dot com bubble as equity markets
soared and bullion pricing remained stagnant.  The ratio
reached a record of five ounces of gold for each “unit” of the
S&P 500.  The gold bull market that ensued for the
following decade reduced the ratio to just under a value of
one.   Comparing this ratio to the period after 1971
when gold was enabled to be freely priced following the abolishment of
the gold standard is revealing.  The purchasing power of gold
relative to US stocks is actually very close to what it has been over
the last four decades.  Although gold does not look extremely
cheap relative to stocks as it did in 2000, it also does not look
extremely expensive as it did in the early 1980s.  Thus
fleeing bullion as a result of a belief  that its buying power
is  over extended may be less than prudent.

The triggering event in the panicked sale of bullion this week was the
announcement by Cyprus that it would be selling €400m
worth of gold from its gold reserves.  This amounts to a
sizeable fraction of Cypriot gold holdings.  However,
according to the World Gold Council, Cypriot gold holdings are only the
59th largest gold holdings in the world.  Thus even a sale of
their entire gold reserves, or 13.9 tonnes, would amount to only 0.17%
of US reserves or 0.059% of the gold reserves of the 10 largest
countries and organizations (including the IMF).  Putting the
Cypriot gold sale into perspective should make investors questions
whether the magnitude on the bullion sell-off is warranted.
 The above comparisons do not even take into consideration the
1,100 tonnes of bullion held by the SPDR GLD gold shares exchange
traded fund.

Canadian investors whose portfolios are heavy on bullion should be
aware that despite the apparent reasonableness in gold prices versus
stocks, gold price volatility will likely continue. Canada being the
seventh largest gold producer in the world and home of five of the ten
largest gold companies is already intimately tied to the strength or
weakness of bullion.  Approximately 10% of all Canadian
publicly traded companies are gold or precious metal producers and
exploration companies. With demand for the precious metal comes demand
for the Canadian dollar and therefore a very palpable impact on the
Canadian consumer.


Management Inc.

Navigating a Sea of Opportunity

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