Ignore the Momentum-Driven Rationalization — There Is Value in Gold

People are especially willing to accept such arguments for the price action in gold because they fail to comprehend its economic function as they can with other commodities, and they fail to understand its role in their investment portfolios because they cannot value it according to the metrics that they use to value other assets (e.g. earnings yield, dividend yield, revenue or earnings growth, etc.).

Quite simply, gold is a store of value — over long periods of time, similar amounts of gold can be exchanged for similar quantities of goods. This function of gold has been lost to us, especially in the United States, as we tend to think of our dollar holdings as our savings, as our store of value. But over long periods of time, dollars lose their value because the Federal Reserve continues to create more of them. Naturally, as the supply of dollars increases, it follows that the number of dollars needed to purchase gold or any other marketable good increases.

Thus, we should ignore the aforementioned momentum-driven rationalization and look at gold supplies and dollar supplies. James Turk, one of the most sober and clear-headed minds on this subject, decided that in order to determine whether gold offers good value, he should compare the amount of gold held by the United States to the amount of dollars, asking a hypothetical question: If the dollar were still backed by gold (as it was until 1971), at what gold price would the quantity of dollars equal the value of all of America’s gold (about 287.5 million ounces)?

While Turk looks at the broadest measure of money supply — M3, which includes money and credit — we might get a better idea of how to value gold by looking at the monetary base. This is the case because both in the 1930s and in 1980, the value of America’s gold peaked at just more than 100 percent of the monetary base. In fact, the 1980 peak in the gold price coincided with the value of the U.S. gold supply reaching about 130 percent of the monetary base.