Just how high could gold go?

Fears over the euro have sent gold spiking to new highs. But just how high could it go eventually? I’ve read a lot of interesting calculations recently. On Breakingviews, Martin Hutchinson suggests it could hit $5,000 an ounce or more. Based on consumer price inflation, he says, the $875 an ounce high seen in 1980 is equivalent to $2,400 an ounce today. But if you also consider the huge growth in the world’s economic output since then (it’s increased about six-fold), and “the gold price could top out at $5,300,” says Hutchinson.

Meanwhile, our own Tim Price told readers of his Price Report newsletter last week that you could argue that gold was worth $9,500 an ounce. How? Take it away Tim…

“The partners at hedge fund group QB Asset Management conducted an analysis at the end of 2008 to try and assess the intrinsic value of gold in dollar terms, what they called ‘The Shadow Gold Price’. They assumed that US Federal Reserve Bank liabilities were again exchangeable into gold and then divided the dollar amount of current Fed liabilities by official gold holdings. The results will probably surprise you.

“By dividing $2.5 trillion in FRB reserves by US official gold holdings of 8,100 metric tons, they came up with an “equilibrium” gold price of approximately $9,500 per ounce today. That is not their target price for gold necessarily, but it shows just how much potential there is for further gains in the spot gold price as expressed in US dollars.”

Those prices might sound outlandish. But I think Tim’s last point is the one to bear in mind – it’s not so much a target price, as an indication of the potential for further gains. As Société Générale’s Dylan Grice wrote in a similar report on gold, the point is that gold is a pretty tough object to value. It doesn’t provide an income, now or in the future, which is the way you measure the value of most investments.

So as more and more people become interested in gold, the more likely we are to see increasingly bizarre valuation methods cropping up – equivalent to the “eyeballs per page” measure and the like that used to come up when tech bubble analysts tried to value profitless dotcom stocks.

The point is that gold’s bull run won’t end when it hits a specific value. It will end when the central banks of the world finally decide that they need to hike interest rates and start protecting their currencies. As the actions of the European Central Bank so amply demonstrate, that doesn’t look like happening in the foreseeable future. So you can expect to see gold hitting new highs again and again.

Dominic Frisby, our commodities correspondent, has more on the near-term outlook for gold in Money Morning tomorrow morning (sign up for it here – for free – if you haven’t already).

* The Price Report is a regulated product issued by MoneyWeek Limited.

5 Responses

  1. 18/05/2010, Screwloose wrote

    Although I’d agree that gold will recover its former highs – which in unmolested inflation figures [Shadowstat's] would be around $7,300/oz – I’m cautious of the huge [naked] short position that has been built up by the manipulators on the COMEX futures exchange.

    This is now at record highs and the cynical $30 “instant takedown” on Friday was a declaration of intent from Da Boyz. Coupled with the determined grind-down today in both gold and silver; it could well be that the short term could see significant falls up to and including options expiry on the 26th.

    It’s too risky to lighten-up on core positions and move to cash for the summer [particularly in pounds...] but be prepared for some short term volatility and take the opportunities presented by any dips if you have less than you need.

  2. 18/05/2010, Alex wrote

    Interesting article. I’d have thought that silver would be the place to be if gold starts to head higher from here. MW used to print repeated stories about silver, but you stopped doing so about a year ago. I find that a bit odd as silver at almost $20 ( up from $6.50 when MW was tipping it intially ) is up three fold, the same as gold. But is still undervalued relative to gold.

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