What Price Suits Gold?

Gold bullion just crossed $1,000 an ounce. But what's it really worth?

Bud Conrad, chief economist at Casey Research and a leading gold bug, says it's worth far more. Based on long-term analyzes of macroeconomic trends such as the money supply, he says, "a lot of ratios… get you into the $4,000 to $5,000 level without any problem.

Congressman and former presidential candidate Ron Paul also a major gold bug likewise sees the price of bullion rising from today's levels. "It's trebled in the last ten years," he says. "There's no reason it can't triple in another ten years, that wouldn't surprise me." Congressman Paul says the government will erode the dollar's purchasing power, so gold will gain value however, he says this is a political opinion, and not investing advice.

Is it realistic to think gold could really go to $3,000?

A long-standing rule of thumb among gold enthusiasts is that an ounce of gold should equal the cost of one high-quality man's suit. (A fund manager I know in London argues that this goes back to ancient Rome, when an ounce of gold allegedly was enough to purchase a top-of-the-line toga.)

That wisdom isn't particularly helpful today. At Saks Fifth Avenue you could pay $795 for a Hugo Boss suit, or $2,050 for Dior. When I last bought a suit on Savile Row in London some years back, it cost me about $1,200, but one could have spent a lot more.

Michael Narwani, a tailor and the owner of Custom Clothiers in Wellesley, Mass., says his bespoke suits vary from around $700 up to many thousands, but "$1,000 would buy you an excellent suit." By that measure, gold would be about the right price now.

A silly debate? Maybe. But this is the central issue any investor faces when dealing with gold.

With stocks, you can look at the price-to-earnings ratio and the dividend yield and reach some conclusions about likely returns. With bonds, you can look at the yield to maturity, which includes both the coupons and any capital gains.

But gold generates no income. It is, in a sense, a perpetual zero coupon bond. So valuing it isn't easy.

You can, at least, establish a threshold price. A rational person wouldn't buy an ounce of gold for $1,008 today unless he or she was very confident it would be worth at least $1,500 or so in ten years' time, and at least $2,400 in twenty years. (Otherwise, that person could earn the same amount simply by investing in Treasury bonds.)

Some months ago I suggested here that gold could easily become the next bubble. Some people thought I was suggesting gold already was a bubble. Hardly: I would have to know what something was worth before I could conclude it was overvalued.

But there is potential albeit uncertain for gold to go much higher. Led by the Fed, central banks world-wide have flooded financial systems with vast amounts of money in the year since Lehman Brothers failed. Those moves risk devaluations in the dollar, along with other paper currencies. Gold and other items in limited supply may well benefit.

source : http://online.wsj.com/article/SB10001424052970203917304574415193376917198.html