Is gold cheap or expensive? Its own history suggests the latter, but a return to some form of gold standard could imply a price above $7,000.
Our own gold model suggests a current fair value of $1,640, although a premium to this does seem reasonable given current uncertainties.
Looking at the price of gold in the traditional way reveals that it has been higher, with a peak of $1898 in September 2011 versus the current price of $1,732.
However, when putting the price in real US CPI terms, there were only two periods when gold has been higher than today. In 1979 and 1980, the level was $1,856 and $1,831 respectively, while in 2011 and 2012 it was $1791 and $1,853.
The annual average since 1833 is $605 (including 2020), but this may be overly harsh as the price was effectively controlled until 1971, since when the average has been $939.
Of course, we live in extraordinary times, with government deficits once again exploding. Rising debt is one reason to fear for the stability of the financial system, with the risk that government actions could eventually debase the value of their currencies.
This is even more so if we consider that the aggregate balance sheet of the Fed, ECB, BOE, SNB and BOJ will likely have increased seven-fold in the 15 years to the end of 2021.
If these are the sorts of concerns that encourage investors to buy gold, how high could gold go in a catastrophic scenario? One way to think about this is to imagine an outcome so bad that policy makers opt for a return to a form of gold standard. What would this mean?
According to the US Department of the Treasury, on 30 April 2020 the US government held 261.5 million ounces of gold. At a price of $1,732 per ounce, that gives a market value of $453bn.
What if that stock of gold had to back the US currency? If it were to replace the monetary base ($4.85trn in April 2020), that would imply a gold price of about $18,500.
That is dramatic, but is perhaps an overstatement because a large part of the monetary base is the reserves held by banks at the Federal Reserve system (which has increased rapidly since the launch of QE).
If gold is only required to back notes and coins in circulation ($1.8trn in April 2020), then the implicit price of gold becomes around $7,225.