Weighing Gold

At The Economist’s Free Exchange blog, A.D. tries to figure out whether gold is in a bubble (excerpt):

Turning gold into dross

WHILE equity and bond markets have remained relatively sanguine regarding the impasse in negotiations on America's debt ceiling, gold nevertheless achieved another (nominal) high today, at $1,622. That’s one more milestone in an extraordinary run that began over a decade ago. As of Monday, gold’s 10-year annualised real return was 16.8%. By comparison, American stocks managed a return of just 14.8% during the 1990s, in a roaring bull market.

Those kind of numbers are naturally prompting some debate concerning whether or not gold is in a bubble. While identifying bubbles is often challenging, gold is particularly tricky as it produces no cashflows and therefore has no intrinsic value.

What gold lacks in fundamental metrics, however, it makes up for with a lengthy record of historical prices, which are helpful in attacking the bubble question...

...The numbers above suggest that gold’s rise in dollars is partially attributable to the shabby state of America's balance sheet, but that simply isn’t enough to explain all of it. Using the Swiss franc as a reference currency is particularly instructive, since, like gold, it is considered a safe haven during periods of political or economic risk...

...Even against the Swiss franc, gold is overpriced by nearly 60%.

Jeremy Grantham, the chief investment strategist for asset manager GMO and an experienced bubble watcher, defines a bubble as asset prices two standard deviations above the long-term trend (for a normal distribution, that represents roughly the top 2% of values). On that basis, gold is in a bubble in terms of American and Canadian dollars and the South African rand, and is getting close in terms of the Australian dollar.

He’s preaching to the converted here, but go ahead and read the full article. I don’t know how valid the methodology used here is, but I wouldn’t want to argue against it.