As we discussed in last week’s Story Time Thursday, gold is on one of its occasional streaks; today we will take another look at its current price by comparing it to the S&P 500. We show you this analysis a few times a year, and it seems to have become fashionable again as investors search for paradigms to explain where gold “should” trade. Here’ the background on the comparison:
- Both gold and the S&P 500 have a market-based reference price denominated in US dollars.
- Therefore, even though one number measures investors’ confidence in future corporate earnings and the other is the clearing price for a commodity, you can divide the price of an ounce of gold by the S&P and get a ratio which is at least somewhat apples-to-apples.
- The ratio itself tells you very little, but a long run analysis lets you see shifts in market sentiment.
Here is the gold/S&P 500 price ratio back to 1970:
Three points on this:
#1: You’d think this chart would show an ever-decreasing ratio, but it clearly does not. S&P 500 corporate earnings are the result of human ingenuity at America’s largest and best companies, but gold never changes. Yet the price of an ounce of gold and the S&P 500 were exactly the same in mid-1973, and in early 1991, and most recently from 2009 – 2013.
In fairness to the S&P 500, there’s more to the story. Interest rates also drive stock prices and those are in part motivated by inflation expectations. The whole period from 1973 to 1991, when an ounce of gold was worth more than the S&P 500, saw high interest rates (curtailing stock valuations) and the first 10 years also had rising inflation. Throw in the geopolitical troubles of 3 oil shocks (1973, 1979, 1990), and gold had a decent story to tell.
Summing up: gold and S&P prices have a long history of swapping leads in terms of absolute value and seeing gold prices ahead of the S&P 500 is hardly ancient history – the last time it happened was March 2013.
#2: Using an arbitrary but reasonably long run timeframe, 1990 – present, yields the following analysis:
- On average, gold trades for 63% of the S&P 500. The current ratio is 61.6%, so we’re basically spot-on the long run mean.
- The standard deviation of the gold/S&P ratio is 0.31. That means gold could reach a 0.94 ratio to stocks and still be reasonably valued by historical measures.
Summing up: a gold price of $3,125 – 94% of the S&P 500 today – is certainly within the normal bounds of the long-term relationship between these two assets.
#3: Negative real interest rates are a cornerstone of the current chatter around gold, but history says they are not a requisite for higher prices. Most of the commentary you’ll read on this topic anchors on recent experience. Yields on US Treasury Inflation Protected Securities (TIPS) briefly went negative in late 2012 (-16 basis points). This coincided with gold at +$1,700/ounce, until recently its all-time high.
But a look at longer-run real US interest rates shows gold did just fine in the late 1970s – early 1980s (all-time high of $900/oz in January 1980) with very high real rates.
Here is a World Bank Chart for annual average real US rates from 1961 to 2019 which shows they peaked in 1981, and gold’s 400% run from 1978 – 1980 came as these were rising, not falling:
Summing up: the reason gold worked so well in the late 1970s was that negative rates in 1975 (visible above) ignited inflation and Fed Chair Paul Volcker had to wage his famous campaign against it by raising real rates to record levels (also clearly visible above).
Final thought: yes, markets clearly see the threat of future inflation in today’s negative real rates and that’s providing gold its momentum just now. The long-run gold/S&P ratio says that can continue for a bit, with $3,000 being the spot where things start to look abnormal. But, and this is a big “But”, any long run bull case for gold (or calls for its price to rise past $3,000), is predicated on inflation actually becoming a problem for policymakers. That did not happen after 2012, and gold declined by 30% in a year.
Our bottom line: gold is still worth owning here because both the Federal Reserve and Congress have to continue to support the US economy for at least the next year, and that will continue to drive fears of future inflation.