Why gold is worth only $800 an ounce

A leading expert on the precious metal's prices says they won't soon return to the highs seen in 2011.

By MSN Money Partner Jul 7, 2014 12:34PM
Gold Bars © Photodisc/SuperStockBy Mark Hulbert, MarketWatch

The gold bugs are stirring.

A 10 percent gain by the yellow metal this year is rekindling hope among long-suffering bulls that the major bear market that began nearly three years ago finally might be over.

They argue that gold will continue to rise because investors will be seeking a hedge against rising inflation, currency fluctuations and geopolitical uncertainty.

Yet according to Duke University finance professor Campbell Harvey, one of academia's leading experts on gold prices, the odds are poor that the metal will return any time soon to its all-time high in August 2011. That month, the spot Comex gold contract reached an intraday high of $1,929.20, more than $600 above Thursday’s settle price of $1,320.40.

He puts gold’s fair value today at a little higher than $800.

A valuation model Harvey proposed in a National Bureau of Economic Research study 18 months ago, when gold was nearly $1,700 an ounce, correctly foresaw that the metal was overvalued.

That model is based on the tendency for gold to decline whenever the ratio of its price to the consumer-price index rises well above its average level of about 3.4, and to rise when it is significantly below that average. With the CPI now at 237.1, this ratio stands at 5.6.

To be sure, Harvey acknowledges, gold is perfectly capable of taking a long time to return to its fair value -- and by no means will the path it takes be a straight line. So a near-term rally isn’t out of the question.

There is a shorter-term factor that nevertheless leads him to doubt gold can mount even a short-term rally that is very significant: rising Treasury yields, which go up as bond prices fall.

Over the past decade, Harvey points out, gold's price has been quick to respond to changes in Treasury yields -- rising as yields fall, and vice versa. If you believe that yields will on average be higher in coming months than where they are today, as he does, then "gold will most likely decline" over the shorter term.

Shouldn't inflation be taken into account in predicting gold's performance? After all, gold is widely considered to be one of the best inflation hedges.

But gold's track record as an inflation hedge depends greatly on your time horizon, according to Claude Erb, Harvey’s co-author on the National Bureau of Economic Research study and a former commodities and fixed-income manager at mutual-fund firm TCW Group.

Over the short term, he says, gold is a very unreliable inflation hedge. It is only over the long term that it can be a decent hedge -- and he emphasizes that this long term must be measured over many decades at a minimum.

Based on the markets' recent behavior, Erb is confident that if inflation and Treasury yields were both to rise over the next couple of years, the most likely outcome still would be a lower gold price.

What steps should you take in your portfolio if you think inflation is about to heat up? Erb acknowledges that there isn't a great short-term inflation hedge. But he says that intermediate-term government bond funds should largely hold their own when inflation and interest rates rise, since they can reinvest in higher-yielding issues as their older bonds mature, thereby absorbing the losses of principal caused by those higher yields.

Erb points to the surprising resilience from 1966 through 1981 of intermediate-term U.S. government bonds -- those with five-year maturities. This 16-year period is often considered the worst environment in recent history for bond investors, since intermediate Treasury yields nearly tripled. Nevertheless, according to Ibbotson Associates data, these bonds produced a 5.8 percent annualized return over the period.

The most popular intermediate-term bond fund, among those advisers monitored by the Hulbert Financial Digest who have beaten the Standard & Poor's 500 Index ($INX) over the past 15 years, is the Vanguard Intermediate-Term Investment-Grade Fund (VFICX), which charges annual fees of 0.20 percent, or $20 per $10,000 invested.

The fund's current yield is 2.6 percent, and its average effective duration of the bonds it owns is 5.2 years. ("Duration" is a measure of sensitivity to interest-rate fluctuations; a lower duration implies less sensitivity.)

If you nevertheless want to bet on gold, or simply want to follow the advice of many financial  percent -- to gold for diversification purposes, shares of gold-mining companies are probably the cheapest way in, as the shares of such companies have significantly lagged behind bullion over the past 18 months.

Since the beginning of 2013, for example, the NYSE Arca Gold Miners Index has fallen 42 percent, nearly double bullion's 22 percent loss. Shares of smaller gold-mining companies have lagged behind even more.

Two exchange-traded funds that track such stocks are Market Vectors Gold Miners (GDX), with a 0.53 percent expense ratio, or $53 per $10,000 invested, and Market Vectors Junior Gold Miners (GDXJ), with expenses of 0.57 percent. In the first half of 2014, these funds gained 25 percent and 36 percent, respectively.

If you prefer the shares of individual gold-mining companies, Freeport-McMoRan Copper & Gold (FCX) is currently the one most recommended by the Hulbert Financial Digest-monitored advisers who have beaten the S&P 500 over the past 15 years. Also popular are Agnico Eagle Mines (AEM), Barrick Gold (ABX), AngloGold Ashanti (AU) and Newmont Mining (NEM).

More from MarketWatch

Jul 7, 2014 1:37PM
If Mr. Harvey has any gold for sale I'll buy it all for $800.00 an oz.
Jul 7, 2014 2:20PM
Gold  is worth whatever anyone is willing to pay per ounce.  How much are stocks "worth"?  How much is the US Dollar "worth"? 
Jul 7, 2014 1:22PM

So after printing and adding hundreds of billions of paper dollars into the banking system over the last two years and true inflation growing steadily, gold shouldn't adjust accordingly? Not to mention that Russia, China and India aren't accumulating gold as fast as they can get it for nothing.  When they decide to make their move and tie their currencies to a gold standard, let's see what the value of fiat currencies will be.


Just more anti-gold propaganda to keep the true value suppressed, but it just a matter of time until the house of cards will fall.


Jul 7, 2014 1:23PM
Jul 7, 2014 1:40PM

Because it makes perfect sense that the price for gold, a globally traded commodity, should always trend back to a certain multiple of the US CPI?  When the US is a tiny fraction of the world's population? And the physical demands of the Chinese and Indian markets are soaring as the average consumer becomes more affluent?


I guess it just goes to show that obtaining a doctorate and even landing a job with a prestigious university doesn't mean you're really all that smart...

Jul 7, 2014 12:48PM

Hmmm Gold "only worth" $800 an ounce....??

Cost about that much to just get it out of the ground and smelted...With "all in costs".

Don't think I really need to read anymore of this article...?

Jul 7, 2014 2:20PM

If gold is marked up that much! Makes one wonder how much oil is really worth?

Jul 7, 2014 1:17PM
Yah, and the fednaked shorting gold overseas through various shadow groups has nothing to do with it of course. Financial reporting at it's worst.
Jul 7, 2014 6:22PM
Jul 7, 2014 1:48PM
I bet there are a lot of unhappy buyers that got in at $1800
Jul 7, 2014 3:15PM
Workedout you said it .If the professor has any of his gold for sale at $800 an ounce I would gladly be willing to purchase as much as he has and take it "off his hands" no problem.....PS If he has any silver at say $11-12 an ounce As well, I will take it all TOO!!
Jul 7, 2014 2:10PM
i wonder if this article is worth it's weight in gold.
Jul 7, 2014 2:39PM

The price of gold, like the price of stocks, is an illusion.  It is worth what potential buyers "think" it is worth, not what sellers wish it was worth.

I recall three years ago, those who "held" gold were laughing at those invested in the stock market.  Now the shoe is on the other foot.

It simply means that folks are pessimistic about gold and optimistic about the market, for whatever voodoo system they might have used to reach their conclusions..

Jul 7, 2014 4:25PM
Gold will probably never see $800 an ounce again , too many investors are in it for the long run . But I still believe that silver has a much greater chance for a higher growth percentage  since the demand , due to it's many commercial uses ,  is greater than gold . And because of it's lower value than gold , it COULD be used as currency again more easily than gold . It would be much easier to use a one ounce coin worth $25 than one worth $1300 , right ? jmo 
Jul 7, 2014 2:00PM
It  must be remembered that much of Gold buying is emotional buying and thus will not fit into the professors formula. 
Jul 7, 2014 3:18PM

Gold at 800 dollars an ounce?.  What kind of financial mind does he have.  The US Dollar/including the Euro has very little value.

This is true attention getting propaganda.

Gold is the ONLY true metal that is worth more than the dollar. It always will be.  Predictions fluctuate, but it always has been going up since the 1960's/30 dollars per ounce/70's---and it is predicted it will eventually hit $2500.00 per ounce.  It is a hedge against all the Global Markets Collapsing or will Collapse.

Jul 7, 2014 3:14PM
Stock is proportional ownership of the future profit stream of a company.  It has a real defined value.  Gold provides no return and therefore its value is what we (the market) perceive it to be. This does not mean that gold can not go up or down in value.  The cost of mining gold is only relevant as to whether more gold will be mined, it has no impact on the value of the current gold supply.  Buying gold is true speculation.  Speculation is neither good nor bad.  I own some gold, but I know I have no way of knowing its future value.
Jul 8, 2014 9:57AM
I have some pre 1964 quarters that were made out of silver. in 1964 that quarter could buy 25 cents worth of product. now that quarter is worth five dollars. I think that's a good comparison for inflation.
Jul 7, 2014 2:18PM

Remember what happened when the big tidal wave hit Japan in 2011?  The price of gold plunged as people sold their gold to buy tangible property. That's the problem with using gold as a hedge - it has no more tangible value then currency. Both are symbols that facilitate commerce and little more.



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