Is Gold Overvalued?

Of all the commodities gold is the most glamorous. I admit I personally own some gold coins. I think it's the history and romance, and something to do with pirates that attracts me. But are they a good investment?

In a previous post on commodities you might recall that gold came bottom of 16 commodities that we surveyed with an expected annual return of -1.3% a year.

Why So Low?

Below is a price chart for gold for the last 10 years:

As you can see it's pretty much straight up. In fact the annualised 10 year returns on gold are about 20% a year.

Another chart shows gold compared to US GDP since 1970:

As you can see over the last 40 years gold has increased at a much faster rate than the GDP (although in the late 1990s and early 2000 gold looked historically cheap). Does this mean gold is expensive now? Maybe. Will the returns in the future be lower than historical returns? It's more probable. Over the last 42 years the annualised return on gold has been 9.3% compared with a 6.7% annual nominal increase in the GDP of the USA.

Clearly gold has been an excellent investment over the last 10 years but the chances of it being the best investment over the next 10 years looks unlikely to me. Prices seem to have moved beyond rational levels.

Inflation Hedge

Some people argue that gold is a good investment because it's a hedge against inflation. That's true but so are most commodities. The popularity of gold looks a bit overdone and investors looking to hedge against inflation might be better advised to invest in other commodities.

So What's Gold Worth?

 

If you recall this chart from last week's posting on commodities :

 

The purple line represents the price target based on a 2000 day moving average price with a 2000 day 1.282 standard deviations Bollinger band added to it. This is around the $1470/oz level. At this level the expected returns from investing would be 0%. Even to get a modest 4% annual expected return you would be looking at a price just below $1000/oz. So for now gold isn't investment grade.