A gold price correction?

The gold price has increased every year for 11 straight years. A correction is due.

Most valuation is objective; an income stream is discounted or asset values totted up. Even for difficult to value commodities, economics lends a hand in the form of marginal cost analysis. Gold, however, is an exception. It is amongst the most difficult asset to value. It produces no income, has no industrial value and, because all the gold ever dug up throughout history is still around today, new mine output is only marginally useful in price discovery.

Instead, the price of gold depends on how you view gold. If it is, as many claim, just another commodity, it looks mighty pricey. But I’d argue that gold is a currency, not a commodity (see The case for gold - Intelligent Investor membership required). If valuing gold depends, in part, about beliefs about the role of gold, how do you tell if it’s cheap or expensive? Not easily. Gold is a hedge not for inflation, nor against uncertainty, but it’s a measure of faith in fiat currency. As long as paper money is suspect, gold prices remain high.

Hardly a scientific approach, but qualitative analysis can be useful. There are definitely tell-tale signs of booms.  As a lot more articles are written about the subject, a narrative is constructed, and people scramble to jump onboard. At its peak, of course, a unanimous consensus is drawn; the cycle is tamed and it’s different this time. That’s why it’s best to worry about gold prices when everyone else thinks they can only go up.

Consider the situation today. Gold is the best performing asset over the decade. It has increased in price every year for 11 years (see Chart 1). Central banks are tempted to, if they haven’t already, weaken their currencies. And everyone knows this. The stars have seemingly aligned for gold, and that should make a contrarian nervous. A correction, perhaps a harsh one, wouldn’t surprise. In the last big gold bull market during the 70’s and early 80’s, the gold price halved before reaching a bubbly peak. There is a growing risk that gold prices could, once again, fall savagely for a time.

Disclosure: The author, Gaurav Sodhi, owns shares in Kingsrose Mining and  Cortona Resources. 

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