Gold has intrinsic value, and it may be near

September 3, 2014 11:57 AM

From 2008 through 2011, gold was a hotly debated subject within financial circles as we acclimated to the idea that the Fed could double and triple its balance sheet and somehow not debase the dollar. On the one hand there were gold bugs, who argued that gold was the only true form of money based on the precedent of thousands of years of economic history.  On the other side there was the intelligentsia, which argued that gold was a “barabarous relic” purchased by uncivilized people, and that the value of gold was purely psychological.

At first, gold bugs had the advantage in the debate–between 2008 and 2011 the price of gold rose by 150%, but since then the price has fallen by 35% from its peak.  As gold prices collapsed and the price of stocks rose, the gold debate has mostly faded from the discourse.

I’ve often thought that both sides of the gold argument had the gold market mis-analyzed.  The intelligentsia’s argument was flawed because at the most basic level, the value of all goods and services (e.g. a Coca Cola, BMW or a massage) are just as psychological as the value of gold.  The value of companies, which generate profits by producing goods and services, are just a derivative of that psychological (“hedonic”) value.

On the other hand, the gold bugs were wrong because gold doesn’t have significantly greater monetary characteristics than anything else that has tradable value.  You can get people to do things for you if you promise to give them an iPhone too.

Gold is a product like any other and its underlying value is tied to its hedonic value just like everything else.  The hedonic value of gold, which sets the intrinsic value of the metal is set by its value as jewelry.  Certain consumers will pay money to adorn themselves gold it because they think it looks pretty.  The price at which they are willing to do this sets the price for the rest of the gold market.

With this view of the gold market, Tiffany said something about gold on its earnings call last week that made me take notice.  The company noted that sales of gold jewelry were strong:

we’re pleased that fashion jewelry unit sales are benefiting from strength in gold jewelry.”

If jewelry demand is picking back up, it could be a sign that the price of gold has gotten closer to its intrinsic value.

In 2011, prices reached high enough that gold jewelry sales slowed meaningfully.  Now though, gold may be starting to look more affordable again, especially when the buyer looks at a savings account that has been increasing with the stock market.

Because stocks have risen and gold prices have fallen, the price of gold relative to stocks has fallen back to 2008 levels.  This can be taken as a rough proxy of what the cost of gold looks like relative to a person’s discretionary savings.  Gold is a luxury purchase, typically made when someone feels flush with cash.  As the stock market has risen, more people are feeling more financially secure, and since the price of gold hasn’t risen at the same pace, gold may look cheap on a relative basis.

Gold S&P 500 Ratio

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