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Monday, October 19, 2009

Gold's inflation adjusted high: $2,000+

Here's an article on gold from Bloomberg that we highlighted on Twitter this morning. It notes that gold's recent nominal high of $1,072 an ounce still puts it well under the 1980 inflation-adjusted peak.

For gold to surpass that peak in real (inflation-adjusted) terms, it would have to climb north of the $2,000 an ounce mark. More on that from Bloomberg:

"Gold’s rally to a record means prices are still 53 percent below the 1980
inflation-adjusted peak.

While gold rose 19 percent this year to $1,072 an ounce on Oct. 14, consumer prices almost tripled in the past three decades, eroding the metal’s value. Bullion hasn’t kept pace with the cost of bread, fuel or medical care. In 1980, gold hit a then-record $873 an ounce. In today’s dollars, that would be $2,287, according to the U.S. Labor Department’s inflation calculator..."

However, I take exception to the statement that "consumer prices tripled...eroding the metal's value". If anything has been eroded over time, it is the purchasing power of the dollar (and other fiat currencies like it). Those who study gold know that over long periods of time, the precious metal does remarkably well as a store of value and preserver of purchasing power.

The basket of goods or services that you can buy with an ounce of gold today, versus what you could buy with an ounce of gold in 1980, or in 1880, for that matter, remains relatively constant. There are changing tides in valuation, of course, when an ounce of gold will buy so many more (or less) barrels of oil, or so many shares in the Dow (figuratively speaking).

Unlike an inflated fiat currency, whose value is continually eroding over time, gold will retain its role as a store of value and maintain its purchasing power when the prices of a given asset or quality good come back in line with their historical mean. You can look to the Dow/Gold ratio chart for an example of this property illustrated over time.

One other quick point to mention. During the run of this current gold bull market, I've often heard comparisons made regarding gold's current price in relation to its inflation-adjusted 1980 high. What often seems to be missing from the discussion is the fact that the 1980 high was just that: a peak price high that came at the end of a parabolic spike in gold (as measured in US dollars).

Right now we are in the middle of a bull move in gold prices. We don't know when this current move will end, but for now it may be more instructive to use middle to latter portions of past gold bull markets (for example, 1975-1978 vs. 2006-2009), rather than past peaks, when comparing current nominal gold prices and inflation-adjusted prices.

At some point, gold may run up quickly to "catch up" with monetary inflation, but it's difficult to foretell such a move. In fact, noted gold watcher, Paul van Eeden points out that there may actually be too much of an "inflation fear" premium built into the current $1,000+ gold price.

I'm a little rusty and need to brush up on some of these points, so further study is needed here. If our readers have any insights to share on gold's purchasing power in relation to past highs or previous decades, I'd definitely appreciate their sharing them with us.