Setting A Minimum Gold Price Target

Source: Thomas Tan  (9/17/07)

From a CPI standpoint, how high can gold go? If we conservatively only use the monthly close of peak gold price in 1980 at $700 (treating $887.5 as outlier and noise), we will get $1,650 (not $2,100). This $1,650 is the minimum price I am looking for in the not distant future.


A 15-year market veteran, Thomas employs a combination of fundamental and technical analysis in searching for the most promising sector in the market then investing via diversification.

Early this summer, in several of my blog posts, I discussed the relationship between gold and gold mining companies (represented by the HUI index), which acts as a very long- term option to gold. In this post and maybe future ones, I would like to focus on gold itself, mainly from fundamentals but also touch briefly on technicals.

Since gold decoupled from US dollar at $35 in 1973, gold briefly touched an all time high of $887.5 in 1980 then suffered 20 years of bear market until 2001. Such a long bear market knocked all the confidence out of gold investors and by the time 2000 came around almost nobody treated gold as an asset class anymore and saw little value in holding it. Even the central banks (CBs) have been net sellers of gold and held historical low level of gold in their reserves. For example, Central Bank of Taiwan had over 90% of its reserves in gold in 1970s, but since 1990s, over 90% have been in US treasuries. Another example: Bank of England suddenly dumped 60% (415 of 715 tonnes) of their gold reserves in 1999 at rock bottom prices, the reason for which I will discuss in the future.

All of these pessimistic perspectives and actions caused gold to touch the $250 mark twice (1999 and 2001). Just when everyone lost hope and saw no value in gold, like in every other market, year 2001 became the exact turning point from bear to bull market. Since then, we have seen gold up almost 3 times while gold miners represented by HUI are up 1000%.

Are we close to the top here or there is more upside? What will be the future development on the gold market?

I feel from 2001 until now has been only the first phase of gold development. Another new chapter for gold, especially about its monetary and investment functions, is yet to unfold before us. The current credit crunch actually is bullish for gold in the long run. Let's compare gold with some major indexes from a long term historical perspective.

First of all, Gold vs. CPI. We know gold provides excellent inflation protection, especially during a hyperinflationary period. If we use just the government published CPI data, adjusted for the $887.5 peak price of gold in 1980, it is equivalent to today's price of about $2,100. Using the same methodology, today's gold price of $700 is only equivalent to $300 back in 1980. From this adjusted real gold price standpoint, today's gold price is definitely not at a historical high.

The government modified the CPI calculation in 1998. Due to this change of algorithm, according to economists, the new CPI formula basically underweights those goods with fast price growth and overweights the goods with slow price increases. As a result, it effectively underestimates the real inflation impact on people. If we use the pre-modified CPI formula prior to the change in mid-1990s, the average difference is about 3% higher (please refer to http://www.shadowstats.com).

Currently the CPI shows about 2-3% inflation, while the actual is around 5%-6% - basically double the published figure by the government. Compounding for last 10 years after adjustments were made, the real gold price is probably at the $2,500 range to be comparable to $887.5 of 1980 dollar. This is why I am not a big fan of the TIPS - I feel investors in TIPS are taking higher inflation risk than they think and TIPS offer less protection than they claim.

Many of us also don't feel inflation only at 2.4%. Even we take the energy (gas pump at $3/gallon) out of the picture, our grocery bills (food & beverage) don't seem to grow only 2.4% while many items are doubled in price such as milk. Another thing I notice is wheat price has been double since May this year, and my understanding is wheat is a very common and popular ingredient in many goods, however this historical high in wheat somehow hasn't been reflected in the CPI data, at least not yet. It is either the lagging or something wrong with the CPI algorithm. I see we are already into an inflation period, and it will become persistent and difficult to be tamed, especially if Fed lowers rate later this month.

From CPI standpoint, how high can gold go? If we conservatively only use the monthly close of peak gold price in 1980 at $700 (treating $887.5 as outlier and noise), we will get $1,650 (not $2,100). This $1,650 is the minimum price I am looking for in the not distant future. Magically the legendary gold trader Mr. Jim Sinclair, very well known and respected in the gold community, also gave the same minimum price target, derived from a totally different and unrelated methodology which has something to do with the Treasury International Capital [TIC] report.

Personally, I feel this target is too conservative and too low, and I fully expect that at the end of this gold bull market gold will reach a peak far higher than $1,650. To be continued.

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