Fair Value of Gold

And Why Investors Buy

We have commented on what the future has in store for stocks, whether you are buying for dividends sake, or for earnings valuations. Now we care to top it all off with an explanation as to why any conservative investor would and should buy gold.

Why So Unconventional?
In the early chapters of The Intelligent Investor, after explaining the balance between bonds and common stocks, Ben Graham goes into a lengthy analysis regarding earnings-price ratio relative to dividend yields. It does not pay, he explains, for the investor to remain invested in bonds during times when inflation of general goods are rising, and is better off holding stocks, albeit the lesser of two evils.

Mind you, the above is written by a man who experienced markets between the 1920s and early 1970s. Unfortunately, when Graham wrote the above in 1971, gold was still unavailable to the average investor and was still linked to the U.S. Dollar. This means that inflation, although an issue had no weight whatsoever with gold, as nominal loss and Dollar devaluation were synonymous.

If his book were written just a few years later I believe he’d be all the more wiser (and wealthier!) and would have urged investors to buy gold as an adequate hedge against inflation relative to interest rates. Real Interest Rates (IRs minus CPI).

Real Interest Rates and Gold
When real rates turn negative due to rising inflation greater than the return on cash, it makes little or no sense to hold anything currency denominated. This is where gold plays a crucial role that it has not played in over 120 years – the ultimate sound currency.

When investors squabble over gold being a hedge against inflation (flight to assets) or deflation (flight to currencies), what they really refer to are real rates of interest. Gold now has the ability to act as both a currency that retains its value amidst a flight from fiscal assets and debt, and a commodity that rises with the tide of the rush to hard goods.

Dow/Gold Ratio
This trend can be seen on a wide scale from the Dow-Gold ratio. Seemingly, the business cycle runs through years of investment and expansion, with money flowing out of cash into businesses, to times of savings and contraction, with liquidity flowing out of enterprise and into the highest yielding accounts.

Not much explanation should be necessary to understand what this ratio represents. Why would I buy shares trading at 20-40 gold ounces when I can just hold my gold and expect to buy a business at a later date at practically parity?

Hold and Buy!
The ratio reminds us that just as the “buy-and-hold” strategy worked so well for so many throughout the 40s, 50s, 80, and 90s… a “hold-and-buy” strategy would have done just as well during the 30s, 70s and 10s.

What would Buffett Say?
Quite frankly, I believe that the wealthiest investor of our time may have missed out on one of the greatest profit opportunity of the decade (excluding Uranium). Buffett himself expressed his thoughts when he said regarding his silver investment “We bought too early and sold too early”. He knows better than to buy into a rally. He missed out and that’s something he’s gotten used to over the years. If you asked me, I think that the $40 billion pile of cash in his portfolio is filling gold’s role as his savings. And don’t be surprised to see him splurge it all at once in the coming months!

Real Valuations
Many investors look for opportunities that stand square in their favor. With the Dow crossing over the 15 ounce line stocks will soon be trading in the lower buying range. The last chance to buy gold is now!

Unless you know of a stock that has fundamentals set to rally over 300% in the coming years, you may want to look into gold!


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