Is Gold Overpriced & Overvalued?

The price of a troy ounce of gold has moved between $1,000 and $2,000 over the 2010 decade. Is that a fair price for this precious metal, or an unjustifiable premium?

‘Is gold is overpriced / overvalued?’ is a natural question for new investors to ask once they’ve settled on which method to use to invest in gold.

Before investing in commodities, it makes sense to understand whether the market is trading at a fair value.

Is gold overvalued? Well, it’s a simple question, and I have a simple answer: Yes.

Is Gold Overvalued?

Is gold overvalued?

In my humble opinion, gold is overvalued. This undermines the case for investing in the shiny metal. Below, I’ll give three reasons which I believe support this view.

Reason #1 – Gold has no inherent value

As I’ve written before, I consider myself to be an adventurous investor with a healthy investment risk appetite.

Yet this risk-seeking behavior doesn’t tempt me into the land of gold.

One issue is that investment-grade gold bullion is a lump of refined ore that sits idly. It doesn’t do anything.

Gold doesn’t sell goods at a profit. Gold doesn’t hire bright employees who innovate and create revenue from new ideas. Gold does not pay a growing dividend.

Investors in gold are speculators. They hope to profit from a dramatic rise in its price. But what could drive this increase?

Changes in the industrial supply & demand of the metal can and do move the markets. But investors need returns of 8%+ annually. Such swings can only be caused by the arrival of further investors with more cash to throw at the metal. It’s a self-perpetuating cycle of confidence… which can lead to bust.

Speculator logic quickly becomes circular. Because gold doesn’t produce an income, no ordinary valuation models cannot even be applied to gold. Analysis of the gold price descends into soothsaying.

Gold’s investment case requires a leap of faith that few other investments demand. A shiny bar of gold bullion produces no additional value, produces no income, and does not naturally grow in size.

Given that other asset classes such as investments in land, investments in property and investments in shares all do this – why take the risk on gold?

Reason #2 – Gold has objectively been over-valued before

Is Gold overpriced?

When the markets display warning signs, I listen. The current market picture is reminiscent of 30 years ago.

Back in 1980 investors were getting very excited. Extraordinary profits were being made in the commodities markets and they wanted a piece of the action. Inflation concerns were contributing to unrest, and speculators were seeking sanctuary in gold.

Gold experts cited the conditions at the time as ample justification for future price gains, and traders were seeing record prices. Two years later, the price of gold had halved and retail investors were nursing considerable losses.

We could draw parallels between today’s markets and that of 1980. Why take the gamble that this time gold will be a safe investment?

Reason #3 – Prudent portfolio re-balancing rules are giving a sell signal

Is gold overvalued and overpriced?

Asset allocation is the tool behind the science of diversification and is the way in which investors divide their money across different asset classes such as bonds, stocks, cash and property.

Portfolio ‘rebalancing’ is the act of taking a hacksaw to your portfolio each year to re-adjust the balance in the asset classes back to your original plan.

Any investor which has held gold for the two years will have seen its value multiply within their portfolio, meaning that gold would now represent a much larger share of their assets than they originally planned.

To rebalance their portfolio, theory dictates that these investors should sell some of this holding and buy other asset classes to ‘re-balance’ and bring their portfolio risk back down.

Re-balancing has worked so effectively over the past century because it naturally instructs investors to sell assets when they are valued highly, and buy other assets that are priced relatively low.

So, if prudent long term investor are currently being advised to sell a big chunk of their gold holdings, does it sound like an ideal time for you to be buying?

Keep reading

Leave a Reply

Your email address will not be published. Required fields are marked *