How do you measure the value of gold?

Question

With stocks in a company, when you do valuations, you can look at things like how much profit the company has made, or how much dividends it gives back, in order to get values with Price Earning ratios, which you can base your valuation on.

With commodities, you can look at things like the supply and demand. Like say, with oil, you can use exactly how much oil is being produced, you can look at the nations that need oil, how rich they are, how much oil do they need, what they're doing with it etc.

I'm not sure how to measure the value of gold. Correct me if I'm wrong, but it doesn't seem like gold has all that much intrinsic value (I may be using the wrong term here). What I mean is that the material itself does not really produce much yield. It looks nice and you can make jewelery out of it and it's used in computer parts and other things, but I would argue that the price of gold has risen recently not so much because now people like looking at gold more or it's being consumed more but that it's principally used as a mechanism to park your money to hedge against currency devaluation.

So with that in mind, how do you measure whether the price of gold is overvalued or undervalued? It's seems that it is something that is very valuable whilst at the same time being not all that useful.

Answer 1

Gold may have some "intrinsic value" but it cannot be accurately determined by investors by any known valuation techniques. In fact, if you were to apply the dividend discount model of John Burr Williams - a variation of which is the basis of Discounted Cash Flow (DCF) analysis and the basis of most valuation techniques - gold would have zero intrinsic value because it produces no cash flow.

Legendary focus investor Warren Buffett argues that investing in gold is pure speculation because of the reason mentioned above. As others have mentioned, gold prices are affected by supply and demand, but the bigger influence on the price of gold is how the economy is. Gold is seen as a store of value because, according to some, it does not "lose value" unlike paper currency during inflation. In inflationary times, demand increases so gold prices do go up, which is why gold behaves similar to a commodity but has far less uses.

It is difficult to argue whether or not gold gains or loses value because we can't determine the intrinsic value of gold, and anyone who attempts to justify any given price is pulling blinders over your eyes. It is indisputable that, over history, gold represents wealth and that in the past century and the last decade, gold prices rise in inflationary conditions as people dump dollars for gold, and it has fallen when the purchasing power of currency increases.

Many investors have talked about a "gold bubble" by arguing that gold prices are inflated because of inflation and the Fed's money policy and that once interest rates rise, the money supply will contract and gold will fall, but again, nobody can say with any reasonable accuracy what the fair value of gold at any given point is.

This article on seeking alpha: http://seekingalpha.com/article/112794-the-intrinsic-value-of-gold

gives a quick overview, but it is also vague because gold can't be accurately priced.

I wouldn't say that gold has zero intrinsic value because gold is not a business so traditional models are inappropriate, but I would say that gold *certainly * doesn't have a value of $1,500 and it's propped so high only because of investor expectation.

In conclusion, I do not believe you can accurately state whether gold is undervalued or overvalued - you must make judgments based on what you think about the future of the market and of monetary policy, but there are too many variables to be accurate consistently.

Answer 2

There are three aspects of what to value gold over.

1. It doesn't easily chemically react with anything, so it stays pure over a long period of time (vs, say a bar of iron or a bar of butter). So it's valuable so far as it doesn't rot.

2. It is shiny, and there is the historical allure of having a bag of shiny, jingly gold coins.

3. Other people will give you other items of perceived value in exchange for it.

I believe it was Warren Buffett who stated his opinion on gold - paraphrased such:

"You pay people to dig it out of the ground, you pay people to purify it and pour into forms, you pay people to verify the number of nine's purity in it, you pay people to build a secure building to store it in, and you pay people to stand around and guard it. Where is the value in that?"

Answer 3

I can describe the method for determining a price floor, which may help. It starts with looking at the cost of mining. There's a ridiculously small amount of gold in the best ore, so it's measured in tonnes of ore to produce a given ounce of gold. Mines will only operate at a loss for so long, so for any mine which focuses on gold, when the price of gold is below that price for long enough, the mine will cease operation. Since not all mines have the same cost, the supply will not appear as a step function, it will reduce slowly as mines close.

"Gold Drops Below Cash Cost, Approaches Marginal Production Costs" offers a marginal cost of production just over $1100. This is not a floor price, as the market can act irrationally at times. It's just a number to consider.

On the demand side, the industrial use (I am thinking gold plating in electronics manufacturing) will serve to provide demand almost regardless of price. When a $100 microprocessor uses say 10 cents worth of gold (at $300/oz) $1500 gold increases the final chip price by 1/2%. The industry is still trying to move away from Gold where they can, but that's a long process.

As far as a ceiling goes, I highly recommend the book Extraordinary Popular Delusions & the Madness of Crowds which offers insight on a number of mania that have occurred not just in the past few decades, but over the centuries. At $1500/oz, the value of all the gold in the world is about US$7.5trillion (That's 12 zeros). Given that a portion of it is in jewelry and not available as an investment, it's safe to say that the entire world can only easily bid on about 1/3 of this (as the gold council cites 31% of gold going towards investments each year vs 57% jewelry and 11% industrial) or US$2.5T or so. With total world wealth at US$125T it would take a bit more hysteria to push gold from its current 2% of that value (funny how that number lined up perfectly) to much higher.

Note: I provided a number of links, as it's too easy to just throw numbers around. See the links and provide more current data if you're so inclined. Data isn't real time.

Answer 4

You acquire something because you expect to use it, or because you expect to exchange it for something that you want to use.

Gold is a good candidate for storing value because it's rare, it's not easily counterfeited, it's divisible, it's portable, etc. Contrast this with your favorite currency: more can be printed up almost at will, etc.

Overvaluedness/undervaluedness is only in reference to something else. How many dollars does it take to buy an ounce of gold? (About $1,500.) How many ounces does it take to equal the DJIA? (About 8.) How many ounces of silver does it take to buy an ounce of gold? How many barrels of oil can you buy with an ounce of gold? Etc., etc.

But whatever measure you're using, the value of the gold you have is directly related to the mass of gold you own. Two ounces are twice as valuable as one ounce.

As the old joke goes (no offense to taxi drivers intended!) when your cabbie starts talking about how to get rich with gold, it's probably overvalued. Sell it all! ;)

Answer 5

There is no such thing as intrinsic value.

Gold has value because it is rare and has a market. If any of those things decline, the value plunges. The question of whether gold is overvalued or not is complicated and depends on a lot of factors.

The key question in my mind is: Is gold more valuable in terms of US dollars because it is becoming more valuable, or because the value of US dollars, the prevailing medium of exchange, is declining?

Answer 6

Intrinsic value is a myth. There is no such thing. Subjective human demand is the only thing that gives anything value. This subjectivity is different person to person and can change very quickly.

Historically there are two main uses for gold: jewelry and money. How can you tell when a particular type of money is undervalued? It disappears from circulation since people prefer to use money that is overvalued. This phenomenon is paraphrased in Gresham's Law: Bad money drives out good money.

The Coinage Act of 1792 established the US dollar as 371.25 grains of silver or 24.75 grains of gold. This established a government ratio of 15 ounces of silver to 1 ounce of gold. In the late 18th century there was a large production of silver from Mexico and the market ratio of silver to gold increased to 15.75 to 1 by 1805. The government ratio, however, was still 15 to 1. This was enough incentive for people to exchange their silver coins for gold coins at the government ratio, melt the gold, and sell the gold bullion overseas at the market value. Thus, gold coins disappeared from circulation as people either hoarded the gold or sent it abroad. People used the overvalued silver coins (i.e. the "bad" money) domestically and gold coins disappeared from the market.

In an attempt to correct the problem of disappearing gold coins the Coinage Act of 1834 was enacted. It kept the US dollar at 371.25 grains of silver but changed the definition to 23.2 grains of gold which established a government ratio of 16 to 1. This was close to the market ratio of gold to silver at the time so both gold and silver coins appeared in circulation again. The gold rush of 1849 produced a lot of gold and the market ratio of silver to gold became 15.46 to 1. Now gold was overvalued so people began exchanging their gold coins for silver coins at the government ratio, melt the silver, and sell the silver bullion overseas at the market value. People used the overvalued gold coins (i.e. the "bad" money) domestically and silver coins disappeared from the market.

When you see gold circulating everywhere you will know it is overvalued compared to other types of money. Paper money always drives gold out of circulation since the market ratio of paper to gold severely under values gold.

Source here.

Answer 7

1) Get some gold.

2) Walk around, yelling, "Hey, I have some gold, who wants to buy it?"

3) Once you have enough interested parties, hold an auction and see who will give you the most dollars for it.

4) Trade the gold for that many dollars.

5) You have just measured the value of your gold.

Answer 8

We measure the value of gold by comparing it to other things. Sorry, but there is no better answer than that. There is no gold standard (pun intended) by which objects can be measured in value because "value" is a subjective term. It would be comparable to asking how funny is an object. Different objects are funny to different people. Even if we gathered all the really "funny" object together, there is no guaranty those objects would be funny next year - unless we all agreed they were as part of a social contract. Which is basically what we do with currency.

While gold does not need a social contract in order for it to retain its value, this is only because it is has been (1) very useful and (2) rare. If either of these two factors change, the value of gold will change - which it has on several occasions.

WARRING: Rant about "Intrinsic Value" of gold below.

Gold has no "intrinsic" value. None whatsoever.
"Intrinsic value" makes just as much sense as a "cat dog" animal. "Dog" and "cat" are referring to two mutually exclusive animals, therefore a "cat dog" is a nonsensical term.

Intrinsic Value:

"The actual value of a company or an asset based on an underlying perception of its true value ..."

Intrinsic value is perceived, which means it is worth whatever you, or a group of people, think it is. Intrinsic value has nothing, I repeat, absolutely nothing, to do with reality.
The most obvious example of this is the purchase of a copy-right. You are assigning an intrinsic value to a copy-right by purchasing it. However, when you purchase a copy-right you are not buying ink on a page, you are purchasing an idea. Someone's imaginings that, for all intensive purposes, doesn't even exist in reality! By definition, things that do not exist do not have "intrinsic" properties - because things that don't exist, don't have any natural properties at all.

"Intrinsic" according to Websters Dictionary:

"Belonging to the essential nature or constitution of a thing ... (the intrinsic brightness of a star)."

An intrinsic property of an object is something we know that exists because it is a natural property of that object. Suns emit light, we know this because we can measure the light coming from it. It is not subjective.

"Intrinsic Value" by definition is the OPPOSITE of "Intrinsic"

Answer 9

The problem with all definitions of the value of Gold is in trying to measure the value of gold in terms of something else.

Gold is the denominator to measure value of everything else. That is why you cannot establish a value of gold because gold is value. You may as well say "what is the value of value?" or the question posed, reworded, "how do measure the value of value?" Rather, the true subjective nature of the question is rather, how do you determine what you will spend your value (gold) on? The answer to this is a varied as the men who are asked the question.

Everyone measures value in dollars or other currency, but they fluctuate more than gold in the sense that they are printed and increased far more easily and quickly than the supply of gold, or silver for that matter, can be.

Metrology tries to establish the measurement of 7 metrics - length, time, mass, temperature, current, lumens, substance in terms of physical constants. Gold is the physical constant of value. Hence a gold "standard".

If an inch was not an inch, or a meter a meter, how could we agree on length in a contract? You may as well rephrase the question at hand as: "how do you measure the length of an inch?" or "how do you measure the time of a minute?" or "how heavy is an ounce?"

We need standard units of measurement that do not change.

Gold, in that sense, does not change. The increase of supply at less than 2% is on par with both the increase in world population as well as the consumption of gold in industry where it is no longer retrievable.

Credit can explode in derivatives, but Gold remains a physical constant, despite the machinations of alchemists.

If you measure price in ounces or grams of gold, you would see Sine waves in value of commodities over natural cycles versus the ever increasing price in dollars or other currencies, as these currencies are perpetually debased, with varying times from increase in currency supply to the eventual effect on price in said currencies. Ripples may move quickly or slowly through the pool of value.

The reason the value measure in commodities change over time is due to man's estimate of their value in the moment as to need and scarcity. So Gold has not changed, but the desired commodity vacillates in its perceived need and scarcity relative to gold. Commodities can be measured in this fashion to other commodities, but they lack the uniformity, consistency and familiarity and fungibility of gold which make it a useful yardstick.

With reliable measures of value, business and society can prosper as better estimates and projections can be made and transactions can be made more confidently.

In metrology, measuring sticks must be traceably calibrated against standard tools of measurement, which must further be traced to primary standards based on physical constants, such as units of wavelength of light that have low measures of uncertainty.

That which is constant is that which can be relied upon, can be trusted. Man's transactions are built on trust; where trust is compromised, business is undermined.

Gold is incorruptible among elements, and therefore the best measure of value over time. Wood (paper), hay (food commodities) and stubble all burn. Gold is refined by fire and sustains value through the harshest environments, saltwater, floods, humidity, and turbulence of time and mankind's influence.

So the real question is not "how do you measure the value of gold?" but rather "why do you measure value of anything in anything other than gold?" The answer may surprise you, because governments cannot manipulate gold in a free market. Follow the money. Trace it back to gold. Gold limits government in its unchanging value and rarity. They prefer you measure value in their diktat; and by law they make it easier and even necessary to measure value in their creation. But their diktat holds value until it doesn't; when confidence in their con is gone. While every fiat currency eventually reverts to its intrinsic value of zero, or the value of a used piece of paper with negligible heat value in BTUs, Gold remains.

Do not measure the value of gold, measure value in gold.