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Gold Prices Falling, Gold Value Rising

Tuesday May 29, 2012 10:47

After a brutal May of declining gold prices, gold investors should take some solace from the Phoenician trader of yore.  Since May 3 the yellow metal has lost 5% to a strengthening U.S. dollar, but it has been steadily gaining value relative to key commodities oil, copper and silver. Our Phoenician friend, who has little use for modern fiat currencies, would point out that an ounce of glitter fetches one-and-a-half more barrels of oil than earlier this month; nineteen pounds more copper and nearly two ounces more silver – no panic selling in Phoenicia.

My Aug. 8, 2011 Kitco commentary   introduced The Eureka Miner’s Gold Value Index© (GVI) which computes the relative value of gold against a basket of commodities in much the same manner as the US Dollar Index® (DXY) determines the value of the dollar relative to a basket of foreign currencies. The commodity basket includes gold-referenced ratios for oil, copper and silver: oil and copper are reliable proxies for global growth and silver is both a precious and industrial metal which also competes with gold as a hedge against fiat currencies. The use of gold ratios removes currency from value comparisons which is indeed helpful as exemplified by the violent duel between the dollar and euro this month.

Figure 1 is a chart of the GVI from Sept. 1, 2010 through Friday’s close:

Figure 1 – The Eureka Miner’s Gold Value Index©

In this plot, a GVI of 100 represents a “High Value” benchmark for gold (dashed green line) set June 7, 2010 when the DOW closed below the intraday low of the 2010 “Flash Crash.”  A “Fair Value” of 83.56 (dashed yellow line) denotes gold trading at fair value with respect to its reference commodities. This analysis uses Nov. 26, 2010 to define this condition because it marked a period when not only gold-to-oil but gold-to-copper and –silver ratios returned to stable near historical averages after the extreme volatility of the 2008-2009 financial crisis.

During The Federal Reserve’s second round of quantitative easing (famously, QE2), gold lost significant relative value to oil, copper and silver causing the GVI (yellow triangles and line) to drop to a low of 67.68 on April 11, 2011 (red arrow).

With the end of QE2 in June followed by a credit downgrade in the U.S. and a worsening sovereign debt debacle in Europe, conditions quickly flip-flopped by early August of last year. Rising gold and falling commodity prices pushed the GVI above its benchmark to 109.97 on Oct. 4, 2011 (green arrow). After this peak, “safe-haven” allure faded and gold lost both dollar-price and value as it passed into 2012 as shown by the declining 1-month moving average (solid black line). Fortunes reversed again in April and accelerated May 4 with a “gap-up” in the GVI on rapidly declining oil prices and the pale cast of new euro-concerns on the markets (red dotted ellipse).

Presently gold is falling in price but gaining in relative value – a generally bearish condition for the key commodity comparisons given in Table 1:

Table 1 – Gold Price and Value Comparisons

Since the May 3, COMEX gold price is down 4.7% but the GVI has risen 5.9%. The largest boost to gold value has been falling oil prices which gave up 9.7% to the yellow metal. Copper and silver have lost relative value too; 4.4% and 3.0% respectively. On the year, gold price is almost where it left 2011 ($1,568.9 versus December’s close at $1,566.8) but gold value is up 2.5%; again driven by oil’s decline and just below value parity with copper and silver (down 0.3% and 1.2%).

The chart of Figure 2 illustrates the dramatic interplay between gold value and dollar-denominated price:

* Value Adjusted Gold Price© (VAGP) = (83.556/ GVI) * (US$ denominated gold price)
COMEX most active gold futures: morning prices (approx. 9:20 AM ET) or Friday closing price

Figure 2 – Value Adjusted Gold Price©

In this chart, the GVI is used to value-adjust COMEX gold futures (green diamonds and lines) over the same time period as Figure 1. The resulting Value Adjusted Gold Price© or VAGP (yellow triangles and lines) is the price of gold that supports current oil, copper & silver prices based on historical commodity norms. Three observations:

  1. From this Friday’s COMEX closing prices, the VAGP is $1,387.9 per ounce. In other words, gold trading at $1,568.9 per ounce is priced at a $181 per ounce premium to these three commodities.

  2. On the morning of Nov. 30, 2010 gold traded at $1,384.9 per ounce or a $1 premium to this same aggregate of oil, copper and silver prices (i.e. adjusted price was then $1,383.9 per ounce, just few dollars below Friday’s VAGP) - gold was "fairly valued" with respect to these key commodities

  3. During the S&P 500 low on Oct. 4, 2011, the morning gold price was $1,652.5 per ounce and a startling $397 premium to an adjusted price of  $1,255.6 per ounce.


Most gold investors would enjoy gold price and value rising together - the worst situation is a decline of both; not uncommon this spring prior to the April value reversal. Our Phoenician trader is unconcerned about the fickle nature of modern currencies and takes heart in the May ascendancy of gold value relative to key commodities. Although this may prove bearish for the latter it is certainly not an alarm to abandon long gold positions – we are nowhere near the gold premiums of the S&P 500 October lows. However, when on ounce of yellow metal buys less oil, less copper, less silver and falls below the May COMEX intraday low of $1526.7 per ounce, it may be time to set sail for Phoenicia.

By Richard Baker, CP Value Analytics

Related commentaries:
Is Gold Overvalued? (Richard Baker, Kitco commentary, Aug 8, 2011)
Buy or Sell Gold Now? Check the VAGP First (Richard Baker, Kitco commentary, Aug 22, 2011)

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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