[Paper Review] An impressionistic View of “Real” Price of Gold around World

[Written by YS]

 

From:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2148691

The authors try to answer questions as follows:

• Can gold be priced by valuation like most other assets, or price of gold is free of any valuation concerns?

• Is the real price of gold historically high in some countries and historically low in others?

• Across countries, does the inflation adjusted price of gold have a trend?

In conclusion, they say that if the real price of gold is a barometer of perceived troubles then there is trouble everywhere. Or, alternatively, gold is just expensive everywhere. However, authors did not derive any conclusion on methodology of deriving fair value of gold.  

*  *  *

 They have tried to price gold in local currency terms, adjusted gold price by each country’s own CPI with local currency terms. But no clear logic in pricing gold price itself. Gold price were historically high and was breaking records at that time. It does not represent CPI, there were no evidence that the price of gold can classify country as “safe” or “troubled”. (ie. If the real Gold price adjusted by each country’s CPI is high than country is in trouble than other country)

 I think price of gold is a function of investor sentiment, currency, and CPI expectation. It served as inflation hedging alternative, but soon it evolved as economic risk hedging alternatives when economic situation is pretty bad. It is natural to think that country’s bad economy can cause weak currency, and weak currency can somewhat preserve capital when investing in gold.

  Even 10 trillion tons of gold is around, only small amount of gold is tradable – and it is illiquid than currency. So Ray Dalio said in his speech people perceive gold as a currency or alternative, but ineffective alternative. But it could be a barometer, and it is an alternative for smaller amounts of money. (http://www.cfr.org/world/ceo-speaker-series-conversation-ray-dalio/p35307 )

 In conclusion, I did not find any good pricing tool in this paper, however I still have belief that gold is worth tradable, and it has useful function in multi asset allocation scheme since it works as a shelter when uncertainty dominates. As can be seen in below charts, when uncertainty dominates investing in gold in local currency can help.

 Dollar weakness would continue till rate up again (good news for gold), uncertainty in net oil exporting countries will push gold price in local terms, and Euro bank issue will clearly pressure price of gold upward. I will hold long gold position till these issue goes off.

 

*  *  *

 I updated authors approach using most current data till 2016. 2. 18.

 Considering the date when this paper was published (2012. 9. 18), the authors were right in that the price of gold has dropped more than 35% till end of 2015 as in Fig1.

 [Fig1. Price of the gold after paper published till 2016. 2. 19]

 

 And here is Gold price adjusted by CPI index.

 [Fig 2. Gold price adjusted by CPI index]

 

 From 2012. 10. 31 to 2016. 2. 26 Gold price in USD dropped -28.46% where as Gold price adjusted for CPI dropped -31.11%.

 However, countries like Brazil and Russia adjusted gold price (gold price in local currency divided by CPI) is quite different.

 [Fig 3. Gold price in Russian local currency adjusted by CPI index]

 

 [Fig 4. Gold price in Brazilian local currency adjusted by CPI index]

 

 Uncertainty in net commodity exporting countries is clearly pushing up gold price to new highs.