The Relative Value Of Gold In A World Of Freely Floating Exchange Rates
10 January 2008"All that is gold does not glitter; not all those that wander are lost."
- J. R. R. Tolkien
Here's another unfinished project of mine that I'd like to share with the FM audience.
Although stock markets have opened this year on a somber note, not all investors are completely negative and anxious about recent market developments. Although we have had quite a bull run in local and US equities since 2002, more recently commodities markets have taken center-stage, notably: Oil and Gold, whose prices have continued to advance in the face of declining equity markets especially after the sub-prime crash last August 2007. Gold, in particular, continues to be viewed as a store of value, despite the abandonment of the gold standard in the 1930s and is used as a hedge against the inflationary effect of fiat currency systems.
The various factors and positions concerning gold are too many to be discussed here, however last year I read an online article written in 2003 by Adam Hamilton on a gold-bug website: Zeal (see links below) and dealt about analyzing the rising gold price not just in the usual dollar-centric sense, but in a more internationally wholistic sense, considering the fluctuating fiat currencies of the world. In reflection, while it may be true that Gold could be the last permanent store of value remaining nowadays, that value is at best relative depending on what you measure it against.
In a way, Gold is really a currency in itself, and its value also fluctuates against other currencies. But since Gold's value is traditionally measured in dollars, the strength in gold price is also due to the relative weakness in the US Dollar. Measured against other currencies, the picture may be different, as well as the inferences we can derive.
Inspired by Hamilton's article, I sought to gather updated data on gold prices and FX rates to see the relationships.
Using data from Feb 24, 2000 to Jan 7, 2008 (this is the largest range that all the prices were consistent). By applying the exchange rate to the spot price, it's easy enough to derive the price of gold (per troy oz.) in other currencies:
I'm sure not everyone is used to seeing gold prices quoted in other currencies, especially our peso. You will notice that, across the board, gold prices have indeed appreciated, but the relative degree of appreciation is not obvious until we normalize the prices against each other by using a base price–in this case: the earliest price in our data (2/24/2000 = 1):
Viewed against the dollar, gold has nearly tripled in value. Against other currencies, the variances differ slightly. If we look at Gold against the Aussie dollar, the Euro, and the Canadian dollar, the rise is slightly lower, due to the prevailing weakness of the US dollar against these currencies, mainly reflective of the relative weakness of the US economy against the economies of these countries.
We can measure the impact of the dollar weakness by deducting the other base rates against the USD base rate. The difference is the appreciation of gold adjusted for the weakness of the dollar against a particular currency:
When viewed against the Aussie Dollar, Euro, and Canadian Dollar, the USD weakness has accounted for almost 100 percentage points appreciation in Gold. Over the last 7 years, the declining value of the dollar has magnified the appreciation of Gold against US assets:
We can also chart the gold differential brought about by the USD weakness over the last 7 years:
The trends in the differentials mirror the value of the USD against other currencies. For the stronger AUD, EUR, and CAD, the strength in gold has been losing steam as the USD depreciates. Against the Yen, the dollar has been fluctuating in a band, so the relative strength of gold has been consistent against the Yen.
In the case of the Peso, given the weakness of the currency 7 years ago, gold has been appreciating at a much faster pace, but that relative gap with the dollar is being closed with the peso strength in the recent months.
The data we have seen should be reassuring to gold-bugs, as it reinforces the sentiment that gold is strengthening against all fiat currencies. However, the widening gap in gold valuations that is due to the weakness in USD should be noted, as this can affect relative returns of gold-related investments. On a forex-adjusted basis The attractiveness of gold is highest now amongst holders of US assets, but could be losing ground everywhere else.
Apart from gold as investment, relative valuations also affect operations of companies that rely on gold prices to drive their PNL, whether as a cost base (such as semiconductor manufacturers for instance), or revenue base (mining companies, jewelers, etc.). The impact on such companies based in Australia, EU, or Canada will be slightly different to similar companies in the US, Japan, and the Philippines. Over time, these trends and differences can become significant.
Further comments and insights on the above are appreciated. Meanwhile, for as long as it remains on its current trend, gold remains the closest thing to absolute value we can have nowadays, in a world of relativity and fluctuations.
References and Readings:
A wiki-primer on the Gold Standard and Fiat Currency Systems
http://en.wikipedia.org/wiki/Gold_Standard
Adam Hamilton's 2003 article on multi-currency valuations of Gold
http://www.zealllc.com/2003/goldfx2.htm
Downloadable historical Gold Spot prices (London Fix):
http://www.onlygold.com/TutorialPages/SearchPricesFS.asp
I got gold spot prices from Only-Gold.com. I would have preferred a more popular site, like Kitco, but unfortunately Kitco doesn't provide prices that can be easily downloaded onto Excel.
Downloadable historical FX rates (daily weighted averages):
http://www.chartflow.com/fx/historybasic.asp
Take the Gold poll and Swap insights in the FM gold forum:
http://financemanila.net/forum/viewtopic.php?t=627
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