Is Gold Overvalued?

The problem many investors have with gold is that it is very difficult to analyze its fundamentals. It doesn’t pay income, have a book value, or even have much industrial use. It’s hard to point to what moves gold prices. In response to this, a couple of recent papers recently addressed gold’s price. Two sets of researchers, working separately and using some different tools, reached very similar conclusions. You can find a good summary of the papers and conclusions here.

Many investors will be surprised by the results. Inflation and the dollar aren’t good indicators of what’s happening with gold’s price. But gold tends to move higher as U.S. unemployment rises and falls as oil’s price rises. Keep these papers handy when you’re thinking of investing in gold.

Patterson briefly reviewed gold’s price history over the last couple of hundred years, pointing out that there have been price spikes at times of crisis, such as the American Civil War. He added that the common statements that gold protects against inflation and against a weak dollar are not obvious from casual observation of the time series of prices. This disconnect between commonly cited wisdom and past performance was a motivation for his and Ma’s and Erb and Harvey’s research.

Patterson and Ma began their research by asking broker-dealers and others how they forecasted the price of gold. These dealers and analysts had models based on supply and demand and on sentiment, but these were not econometric models, and their forecasts were very widely dispersed. All the same, Patterson said, there is an upward bias in the consensus estimates. They supplied some of the data series that Patterson and Ma needed. These discussions also defined and narrowed Patterson and Ma’s choices of explanatory variables for their model.