# WHY GOLD IS CHEAP NOW

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WHY GOLD IS CHEAP NOW

WHY GOLD IS CHEAP NOW

Today I listened to the David McAlvany (2011: A look at Risk and Uncertainty) interview Saxplayer posted in the Daily Digest.  It helped me develop my understanding of how PM’s help preserve the future purchasing power of our life’s labors, i.e. our savings.  We live in a world of “prices in currency.”  It is very difficult to see “sustained value for labor.”  So hear me out and please critique the analysis.

Assume Gold to be the currency of reference.

Assume the CCI to represent the consumables we will need to purchase in our futures.

Assume you cannot store those consumables and will have to buy them in the future with either dollars held or Gold exchanged for dollars.

Assume if you hold dollars you will loose to depreciation. Assume if you buy and hold Gold to the future purchasing event you will have a 5% commission to get into the Gold and a 2% commission to get out.  Assume you will be taxed on the gains at 37%. Your net cost on your gains in Gold will be 44% and your net cost when you liquidate the principal invested in the Gold will be your commissions of 7%.

Do you save \$450 in dollars or do you save in Gold? The number 450 makes the math easier later.

In 1988 the CCI was trading at \$250, in 2008 it was at \$500.

In 1988 Gold was \$450, and in 2008 it was at \$900 ( these are means taken for each year).

The first obvious thing is that your purchasing power in dollars was reduced by 50% over 20 years.  So if you held dollars your purchasing power has been cut in half.  The same \$450 you saved instead of “investing” in Gold is now only \$225 in current purchasing power.  The second interesting thing is over those 20 years Gold and the Commodities pretty much kept parity.  This makes sense. So far the math is easy but we all know the tax man needs his share.

Fifty percent of your holdings in Gold are only commission cost so the original \$450 gets chopped to about \$419. The remaining \$450 of gains gets whacked by taxes and commissions and looses 44% to equal \$252.  419 + 252 = \$671 in purchasing power.  The price of the CCI and Gold went up 100% in 20 years and the purchasing value of your Gold after expenses has now lost 25% against the CCI   ( 500/500 vs. 671/900.)  See how the powers that be and the government make it impossible to hold you purchasing power into the future?  But if you held cash you faired even worse because your \$450 in the bank now buys only 50% of the commodities you need to consume.  So if you time the Gold thing right and the government doesn’t pull any fast ones’ you keep 75% of your purchasing power and if you just hold on to the cash you only keep 50% of your purchasing power.

With all this in mind I charted the CCI divided by front month gold futures.  The ratio varies from 1988 to the present from a high of about .85 to a low of .37.  This range in values can be considered the variance in the value relation between the two “assets.”  We need to leave the world of dollars and ask ourselves a value question.  Is now a good time to buy Gold as a proxy for our future resource needs?  Well we have already shown that over a 20 year period buying gold is a heck of a lot better than holding cash.   But the best time to buy Gold would be when the CCI/Gold ratio has past historic lows and is rising.  Why?  You want to put dollars into Gold when the volume of commodities that ounce of Gold buys is low and going up!  You want to see the purchasing power of that ounce of Gold appreciate over time.  I’m not talking about appreciation in the inflationary context of fiat currencies, I’m talking one hard asset for another. The higher the CCI/Gold ratio the more your ounce of Gold purchases.  It just so happens that the lows in this ratio formed a double bottom early 2009 and early 2010.  That’s right, lower than any time since 1987 which is as far as my charts go back.   Today the ratio is .45 and is at a “higher high” coming off the double bottom.  For you non technical people out there that is a signal for a continued increase in the ratio.

What happened to the DOW in dollar terms over those twenty years?  It went up FIVE FOLD and that is not counting dividends.  Makes inquiring minds go “hmmmmm.”  The cost basis and tax issues involved in holding the Dow I will leave for another day. However it is likely that holding the index funds over those years would have probably carried the value of your savings forward fully and then some.   Where is the bubble now?  Gold?  Commodities? Housing?  Equities?  Does this make you rethink the issues of a “balanced” portfolio?  What will cause you to rebalance or change your weighting besides your retirement date?

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