The Real Value of Gold

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I bought some Mexican gold on Monday.

Old gold. Pre-World War II stuff. Two-peso coins slightly smaller than a U.S. dime that Mexicans used to carry around in their pockets — only these are not all banged up and gnarly like normal pocket change. They’re all in uncirculated or “about uncirculated” condition, meaning they’re really nice coins.

They each contain about a 1/20th of an ounce of gold, rounding out my coin collection that starts about 1.2 ounces per coin and decreases in size down to these tiny pesos.

I’ve built this collection not because they’re particularly rare. They’re generally not. Though they’re certainly collectible, their real purpose is something altogether different — my Boy Scout-like preparation for prices that will exceed $10,000 an ounce in a currency crisis.

And I don’t say that as a goldbug with blinders on. I say it as a sober-minded investor who sees a growing risk to Western currency stability and the potential that governments are forced to take some of our wealth to pare the unmanageable debts they’ve built up.

Gold, as I’ve said many times, has played a primary role in every substantial financial crisis in history — from Roman emperors devaluing the currency to wage wars and pay for governmental excesses, up through FDR’s confiscation act in 1933 and Nixon taking the buck off the gold standard in the early ‘70s.

Today is no different. Fiat currencies are a disaster, particularly in the West. Because they’re backed by nothing but government, governments feel they have free rein to spend without much resistance. So, they’ve accumulated tremendous debts by spending in tremendously stupid ways.

But that horse is out of the barn. Now, we just wait for what will likely be the collapse of one or more currencies, or for a central bank to announce that it will shore up its currency by backing it with gold in some fashion.

Which raises the biggest question: What is the metal really worth in a world where fiat currencies are failing and central banks have to reassess the construction of those currencies?

Well, there are some mathematically rigorous ways to answer that question — to effectively come up with a “shadow” price. And in every case, the answer puts the precious metal well into the five-figure range.

Metal Mispricing

Back when America was fully on the gold standard, every Federal Reserve note (our dollars) was redeemable for a quantity of gold. So that gives us a very simple, though intellectually honest, way to value gold today: Divide the dollar amount of Federal Reserve liabilities ($4.4 trillion, roughly) by America’s official holdings (about 287 million ounces).

That simple equation says that the shadow price is close to $15,500 an ounce.

But that’s just one way to honestly value gold relative to currency.

I showed attendees of our recent conference in Uruguay three other intellectually honest calculations that all put prices well north of the current level in the $1,250 range.

For instance:

  • Based on the M1 money supply in America, gold carries a price tag approaching $10,800 an ounce.
  • Use the Global Money Supply, and we’re up to prices that exceed $38,000 an ounce.
  • And base it on America’s national debt — the idea that government would revalue gold so that it could use the metal to eradicate the debt and effectively reset the economy — the value is more than $66,000 an ounce.

I am not saying gold will ever reach any of these levels.

What I am saying, however, is that gold is a fundamentally mispriced asset. It’s treated by Wall Street and many economists as an anachronistic asset unworthy of investment merit in the modern world. They continue to call it a commodity though that’s a misinterpretation of reality; its commodity uses are negligible, while its wealth-preservation characteristics — from jewelry to coins and bars — is unmatched for historical longevity.

Which is precisely why I added those Mexican two-peso coins to my collection.

Gold Wins in a Currency Crisis

Gold will be more valuable than it is today. As desperately as the West needs to address its fiscal woes, I see very little desire to do so at a political level. Politicians risk pushing us into a crisis of confidence in currencies. That’s great for gold.

And if they decide to repair what they have befouled, then that’s good for gold, too, since it will likely have a role in the prescription.

In a currency crisis, gold in various denominations will come in handy. Those little two-peso Mexican coins, at about $70 each today, might be handy for buying groceries or gasoline one day.

Next week, I’ll tell you why I want to own these kinds of old, gold coins instead of bullion coins like the popular American Eagles.

Until next time, good trading…

Jeff D. Opdyke
Editor, Frontline Investor

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