Recently I came across an article (which no doubt is doing the rounds) which presented a "groundbreaking" chart showing how gold had gone up 50 times since 1913 whereas prices had only increased by 25 times. The author then proceeded to draw the conclusion that gold is 50% overvalued. The corollary of that conclusion is also that individuals, governments and central banks are crazy not to be selling their gold at today's "inflated" prices.

I guess it was this great insight that led John Brown to sell England's pile of bullion some years ago and we all know the result of his decision. But is it true that gold is 50% overvalued?

In the 1920's you could buy a loaf of bread for around 10c for which you would now pay around $2. With gold at $20.67 in the 1920's you could buy 207 loaves with an ounce of gold whereas today you could buy around 520 loaves. So far so good for the author of that article, but is he really right?

• Unfortunately, I beg to differ for a number of reasons, the main one being that the approach is highly limited and oblivious to other more relevant factors. These include:



• The approach only looks at the relative value of the dollar and gold. To be more meaningful the question could perhaps have been, "how much gold could two comparable workers buy in 1913 and 2009 with a week's worth of wages?"



• The second error lies in forgetting that gold is also an asset and that a comparison must be made between gold and other asset classes. For example, one could look at how many ounces of gold it would take to buy comparable houses between 1913 and 2009.
  
  In an interesting article by Charles Hugh Smith (When Housing is Priced in Gold) one of the charts presented shows that the cost of housing in 2009 in gold terms was almost identical to what it was in 1988. That is, you needed 160.5 ounces in gold to buy a house in each of those two years. This is hardly evidence of gold being over-valued. In the interests of scholarly integrity I should also point out that between 1988 and 2009 a tremendous surge in housing prices resulted in 490.5 ounces of gold being needed to buy a house in 2005.
  
  Comparisons should therefore not only include other asset classes but also graphs showing movements over a period of time. Being selective about which asset or time period to use for comparison purposes can be misleading and most un-useful.



• The third error arises from forgetting about the financial "fatalities" of history. I would like to remind my readers that Exxon-Mobil continues to be the only company that has a place in the Dow Jones Index since its inception. The other twenty nine have been relegated to the dust bin of history. Gold has been "wounded" as in the period between 1980 and 2000 but it has never been a fatality. Even then it was wounded because the world was deluded into believing that an ever increasing number of paper dollars could create long term prosperity when in fact that 20 year period was the incubation chamber for the greatest economic cataclysm since 1929.
  
  So before we condemn gold as being overvalued I would like you to ponder the long list of fatalities including, countless stocks, businesses, junk bonds, CDO's, MBS's, etc that have left many investors looking like sun bleached bones in the desert. Whilst the little man on the street has been stripped bare, he should take comfort that university foundations and charitable foundations full of directors with degrees have fared just as badly.



• Finally, I would like to appeal to your commonsense. There was a time when gold was literally scooped from rivers whereas today gold is mined from ever deepening holes and increasingly challenging circumstances due to costs, location and ore grades. On the contrary, the technology of the printing press with its digital heir, the computer, can now literally spew out dollars at the flick of a switch. So which Einstein among you will prefer the cotton fibre of the dollar to the endurance of gold?

Despite all this, I would be the first to admit that the price of gold may be less or more than it is at the moment. But gold is not bought for the moment. It is bought as insurance against future moments of madness, calamity, destruction and upheaval. History does not have a living paper winner, only gold and silver carry that title. Any premium they currently carry, or which they may carry in the future, is simply a reflection of fear and caution and exhibits at least a partial appreciation of history.

Today the Chinese are making every possible attempt to trade in their US dollars for ownership of foreign oil wells, gas fields and gold. If the dollar was a better deal they would be selling gold, but they aren't. If the Russians really wanted to sell gold, they would sell it quietly to the Chinese. There's more to what meets the eye.

Tomorrow, the day after and for as long as history has a human hand to record it, gold and silver will be one of the few anchors which will withstand the test of time over the longer run. In the short run, there will always be flashes of brilliance shown by the latest Wall Street product or darling until they hit the wall. Gold has outperformed these "darlings" infinitely but does that mean that gold is over-valued or does it mean that those that ignored gold and embraced the darlings were destroyed?

As with all investments and decisions in life, balance is not a fixed position or formula. One must duck and weave, thrust and parry as well as well as have a little bit of luck in recognition of the fact that the relative values of all assets fluctuate over time for many, many reasons. If therefore, you feel that that gold is over-valued, I suggest you buy your 520 loaves of bread today, otherwise sit tight.

PETER SOULELES B. Com LLB
Sydney Australia
30 October 2009