How Do You Value Gold | What Price Could Gold Reach?

We received a question from a reader “What will the future resale value of gold be?” Or rather what they were really getting at, what price will gold likely reach in the future? How do you value gold?

They accepted we did not have a crystal ball – although that would be handy! They were merely after some kind of methodology to give them a possible indication.

We pointed them in the direction of a previous article we wrote: “When will you know it’s time to sell gold?

This gives a number of indicators to follow to determine when it might be time to sell gold.

However this article didn’t give an actual method for trying to place a value on gold.

 

Is Buffet Right That You Can’t Value Gold?

Just like Warren Buffett many people run into the problematic thinking that there is no way to value gold. The argument is that gold has no earnings and is of no productive use etc etc. And so therefore how can you place a value on it? The argument expounded by Buffett and others then goes that buying gold merely relies upon you finding a bigger fool to buy it off you.

To put it not so politely, this is all arse about face. You can’t measure gold using the elastic tape measure that is fiat currency. New currency is constantly being created distorting any measure. Rather it is gold that is actually the barometer of the fiat currency being produced. So to try and put a price on gold is nigh on impossible. Because it is dependent upon how many more fiat Dollars/Yen/Pounds/Euros/Renminbi the Central Banks of the world create.

That’s why we like to use measures like the housing to gold ratio to look at house prices. As using gold can give a more accurate picture of value rather than using inflated dollars.

 

But We Digress, Back to the Topic at Hand – How Do You Value Gold?

One methodology for valuing gold we’ve seen has now been wonderfully laid out over on Greshams-Law.com.

This methodology starts with simply looking at the percentage gold backing of the dollar at the current gold price.

 

How Do You Determine the Percentage Gold Backing of the Dollar?

Simply take the dollar amount of the Federal Reserve’s total balance sheet and divide into this the current value of the Federal Reserve’s gold (supposing they still have it all!).  See the chart below from Greshams Law.

Gold backing of the dollar 1915 to 2013
The degree to which Federal Reserve Notes are backed by gold. – Click image to enlarge. Source: St Louis Fed, World Gold Council

 

This calculation shows the dollar as of 6 February 2013 was only 15% backed by gold. Compare this to the 1980 high, where the dollar was in fact over 130% backed by gold!

Or said another way in 1980 gold was overvalued by 30%. And perhaps not so surprisingly this is when gold also started to fall.

(Interestingly at this point in time the US could have again returned to a gold standard had it chosen too. But the Reagan Gold Commission of 1981 didn’t quite conclude that. As an aside here’s an interesting article on the Gold Commission with some mind bending conclusions about it. http://www.roadtoroota.com/public/117.cfm)

However the Gresham’s Law website hasn’t been update since 2013. So we’ve gathered the data together to show the current percentage gold backing of the US dollar:

Table 1: Percentage Gold Backing of the US Dollar in Comparison to US Federal Reserve Balance Sheet

Date

Total US Gold Reserves (million oz. troy)

Gold Price (US$ per oz. troy)

Current Market Value of US Gold Reserves (billion US$)

Total Federal Reserve Balance Sheet (trillion US$)

Percentage Gold Backing of the US Dollar

6/02/2013 261.5 $1,664.00 $‎ 435.10 $‎ 3.015 14%
20/11/2018 261.5 $1,224.00 $‎ 350.10 $‎ 4.146 8%

???

261.5 $15,855.00 $‎ 4,146.00 $‎ 4.146 100%

Since 2013 the Fed balance sheet has increased while the gold price has fallen. As a result the percentage gold backing of the US dollar has fallen to only 8% in the last 5 years.

We can therefore use this level of gold backing of the dollar as an indicator for when to sell or swap our gold for something else. That is, when the dollar is close to 100% gold backed.

 

But What Price Could Gold Reach? How About a Likely Future Gold Price?

As we said above, determining a future price of gold is dependent upon how much more currency is created in the future. So it is a constantly moving value.  Nonetheless, it can give us a good indication of where the price could go based upon present numbers.

So using the methodology above we can plot over time, golds potential fair value. That is if the dollar was to be 100% backed by gold today what price would it need to be at?

With the size of the Fed balance sheet in 2013 – the answer was over $11,500!

Fair value of gold 1915 to 2013
Gold’s ‘Fair Value’ Vs. The Market Price – Click image to enlarge. Source: St Louis Fed, World Gold Council

 

However again the Greshams Law website has not been updated since 2013. So we have done the calculation again as of 2018.

Referring to Table 1 above we arrive at the figure of $15,855 for the US Dollar to once again be 100% backed by gold. That is of course assuming the US gold reserves don’t change and neither does the Federal Reserve balance sheet.

 

How Much Upside Does Gold Have Today?

At only 8% gold backing today and a current US dollar gold price of about $1200, it seems there is plenty of upside in gold yet. And a long way from the bubble territory of 1980.  Again you can see in the above chart how in 1980 gold reached its “fair value” – that is the dollar was 100% gold backed. (See the point in the chart where the 2 lines meet in 1980).

Gold would have to rise by almost 13 times the current price for the US dollar to be fully backed by gold as it was in 1980.

So if someone ever tells you Gold is in a bubble ask them – “Why?” Unless they say, “Because Gold is at fair value as the dollar is now 100% backed by gold”, you’ll know not to pay them too much heed.

Note:  This $15,855 value is a fair bit lower than that arrived by Mike Maloney of $20,000.  Also lower than this calculation: Gold Backing to Debt Ratio: A Reset Like in 1934 and 1980 Would Mean $21,000 Gold. But a bit more than the figure Jim Rickards arrives at, of around $10,000 per ounce.

These all use slightly different methodologies to compare gold to fiat currency. Some using base currency, some using the Federal Reserve balance sheet. Others using debt. But they arrive at the same conclusion as GreshamsLaw.com: That is – gold remains cheap today.  In fact due to the amount of currency created in the past decade, almost as cheap as gold was in 1999.

Check out the range of gold bullion to buy here.

 

Read more on valuing gold: How Does Gold Compare to Shares For the Past 100 Years? 

Editors Note: This post was originally published 24 April 2012. Updated 20 November 2018 to include latest charts and numbers.

 

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