Ratio Analyses Suggest Much Higher Prices for Gold and Silver

So says Ronald-Peter Stöferle in a 71 page report* which Lorimer Wilson, editor of www.munKNEE.com, presents below, in part with reformatted and edited [..] excerpts for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.) Stöferle goes on to say:

1) Dow/Gold Ratio Suggests Possible Future $10,400 Gold!
At 8.5x, the ratio is currently slightly above the long-term median of 8x. This means that gold is still relatively inexpensive in comparison with the Dow Jones. Bull markets tend to end in euphoria and excess, however, which is why we expect substantially lower values. In 1932 the ratio was 2x, and at the end of the last bull market the ratio was 1x. We think that values of 1-2x might be reached again as a result of the secular bull market. Under the assumption of a constant Dow Jones index, gold would therefore have to rise to USD 10,400/ounce.

2) Gold/S&P 500 Ratio Suggests Possible Future $6,000 Gold
Currently the ratio is almost exactly on its long-term median of 1x. Looking at the development in the 1970s, we expect a dynamic increase. Bull markets do not end around the long-term median – they end in extremis. In order to reach 6x, gold would have to increase to more than USD 6,000/ounce given a constant S&P index.

3) Gold/Silver Ratio Suggests Future Price for Silver Somewhere Between $75 and $650
Currently the ratio is about 65x and thus above the median of 55x. This means that silver is attractively valued relative to gold. A low was hit in 1920, when 15 ounces of silver would buy 1 ounce of gold. 1940 saw a row of historical highs, when one ounce of gold bought 100 ounces of silver. We experienced similar values in 1990.

Looking back over the centuries, we find that gold has been substantially more expensive since the beginning of the 20th century than in the previous three centuries. The long-term median (since 1687) is 15.7x. This also reflected the actual ratio of physical supplies: gold is about 17 times more scarce than silver. According to USGS, the measured and assumed silver resources are about 6 times as high as the ones of gold. Therefore silver is at the moment clearly undervalued at a ratio of 65x relative to gold.

[Using a gold:silver ratio of 16:1 equates to a price of $75 per ounce for silver based on the current ballpark price of $1200 per ounce for gold and suggests a price of $650 if gold were to reach a parabolic top of $10,400!]

Silver is, like gold, a monetary metal, but the relevance for the industrial sector is much higher than that of gold. This is why silver tends to outperform gold in economic upswings, whereas gold usually outperforms silver in periods of stress. The long-term average correlation since 1970 has been 0.68x.

4) World Gold Mining Index/Gold Ratio Suggests Much Higher Prices for Gold and Silver Mining Shares
Currently the ratio of the World Gold Mining index and gold is 1.7x and thus above the longterm median of 1.4x. A rise indicates that gold shares are outperforming gold. Since the beginning of the bull market shares gold mining shares have performed more or less in line with the gold price.

5) Gold/Oil Ratio Suggests Possible Future Prices for Gold and Oil in Excess of $3,150 and $250 Respectively
Oil and gold have a strong positive correlation with each other. Both commodities are traded in US dollars and tend to increase when the dollar depreciates against the most important currencies. Also, oil is one of the most important indicators for inflation and thus also for the gold market. On top of that, the argument that oil production is about to see its peak (“peak oil”) can also be applied to gold along similar lines. The constant purchasing power of gold can also be measured in terms of this ratio. For example, one ounce of oil today buys the same amount of oil as in 1945, 1982, and 2000.

The current ratio of 15-16x is slightly above the long-term median. The all-time high was set in 1973, when one ounce of gold would have bought 42 barrels of oil. On the other hand, in 2008 the ratio hit its historical low at less than 6 barrels per ounce.

[Looking at the extremes if gold were to reach the $10,400 mentioned above a 42:1 gold:oil ratio would put oil at $250; the long term median ratio of 15-16:1 would put oil at an unbelievable $650-$700 per barrel; the extreme ratio of 6:1 would put oil at an astronomical $1,733.33 per barrel. Conversely, applying the 42:1 ratio to the current price range of oil between $75 and $80 would put gold at between $3,150 and $3,360 while, for what it is worth, a 6:1 ratio would put gold at between $450 and $480.]

6) House Price/Gold Ratio Suggests Future Price of Gold at No More Than $3,000
At the moment it takes close to 250 ounces of gold to buy an average home in the USA. This means that in comparison with 2001, where the ratio was at 800 ounces per home, gold is relatively expensive and property is relatively cheap; the long-term median is 403x. However, we are still far away from the 1980 all-time low of 100x.

[Based on the current average price for a U.S. home of $300,000 a 100:1 ratio would suggest a price of $3,000 for gold; a long-term median ratio of 403:1 would suggest $750 gold and the extreme ratio of 800:1 would suggest an unrealistically low of only $375 for an ounce of gold. Furthermore, with continuing declines in the average price of a house to be expected in the U.S. this can only decrease the projected price for gold in the future using the house price:gold price relationship.]

Conclusion
The long-term comparison of gold and other asset classes paints a clearly positive picture. While many ratios are close to the median, this goes to show that the current valuation is certainly not excessive. It is therefore also very easy to rebut the heavily cited argument of the “gold bubble”.

Bull markets end in euphoria, and this substantiates our argument in favour of an imminent transition to an accelerated trend phase [- to somewhere between $3,000 and $10,400 per ounce for gold, between $75 and $650 per ounce for silver and in excess of $250 per barrel for crude oil.]

*http://www.gata.org/files/ErsteGroupGoldReport-06-2010.pdf

Editor’s Note:
– The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
– Permission to reprint in whole or in part is gladly granted, provided full credit is given.
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