Inverting gold to see more clearly

Everyone knows the gold price is going up.

And everyone can reel off half-a-dozen reasons as to why.

Investment banks are scrambling to upgrade their price targets in an effort to keep punters in the trade and believing in the bull.

I’ve been investing in gold bullion and gold stocks for more than 20 years. I’ve seen some highs and some pretty devastating lows.

But the last few months have been the best I’ve seen. I’m mostly out of gold now, with only a small allocation to one gold producer that I think remains good value at a gold price materially below the current price.

That’s not to say gold can’t keep moving higher.

But it’s now a very crowded trade. Thanks to the big bull run in recent years, gold stocks now make up a big portion of the smaller-cap indices (around 15–20%).

It’s been the only game in town over the past 12 months. Fund managers are pouring in so as not to fall behind benchmarks and deal with uncomfortable questions about why they’re not in the sector.

With this in mind, I wanted to show you a different way to think about the gold price rally and relative valuations. 

Because when you invert the gold price, you see that there are much better opportunities for the long-term investor.

Take oil priced in gold. WTI hasn’t been this cheap relative to gold since the COVID shutdown sent oil prices to historic lows. Outside of that anomaly, oil is the cheapest it’s been relative to gold in at least 35 years, and probably much longer.

Copper is an industrial metal that has been in the spotlight recently. It’s had a bullish run recently too. But as you can see in the chart below, it’s the cheapest it’s been relative to gold since at least 1986…

That’s a huge turnaround in relative value from 2006/07 when China fuelled growth sent copper prices soaring.

What about equity markets?

The chart below shows the ASX200 total gross return index (so including dividends) priced in Aussie dollar gold. Relative to gold, the equity market is as cheap as it’s been since the depths of the GFC.

The S&P500 has performed better than the ASX since the GFC so is still some way off its lows relative gold. The all-time low was in 1979/80 when gold went on a huge speculative surge while stocks were at the end of a decade-long bear market.

Could we head there again?

Never say never. The US market remains tech-dominated and materially overvalued on long-term, traditional valuation metrics. So there is room for this ratio to improve in gold’s favour.

The next chart, showing the NASDAQ Composite index priced in gold, paints a similar picture. The NASDAQ isn’t historically cheap relative to gold because of the huge run enjoyed by tech stocks in recent years.

If we go back to the ASX200 relative to gold chart, what is interesting is that the Aussie market is historically cheap on this measure compared to the major US indices. Given that global capital looks to be shifting into commodities, this suggests the Aussie market might do well compared to the US after years of underperformance.

And this could occur just as Australia’s large super funds and countless investors have increasingly upped their exposure to US stocks…

None of this is meant to detract from the fact that gold is rising on the back of fiscally irresponsible policies both here and around the world.

Nearly every major government is running deficits, creating inflation and destroying confidence in fiat currencies.

The Aussie dollar may have rallied sharply recently versus the US dollar, but in terms of gold, the purchasing power of our currency has plummeted in recent years.

The chart below shows the Aussie dollar relative to the Aussie dollar gold price. It’s not so much that everything has become expensive in this country. It’s that our dollar has become so weak.

The chart below is one of extreme economic mismanagement, otherwise hidden by inflation driven nominal growth.

Investors have always seen gold as a global store of value. Which it is. In the long term. But in the short term, it can produce losses and underperform. That’s especially the case when speculators get involved, as they increasingly are now.

If you’ve enjoyed the bull run, great. But the long-term investor should recognise that other asset classes and commodities are now historically cheap relative to gold, and have a greater probability of outperforming gold in the years ahead.

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