Gold’s value is its difference

There seem to be as many opinions today on the current price of gold as there are letters in the alphabet. Let’s look at the cold hard ABCs of gold for some clues on investment strategy.

Here are the facts, courtesy of Jason Ruspini of Conquest Capital Group:

  • There are 160,000 mined metric tons of gold in the world today
  • Current production is 2500 tons annually, about equal to annual industrial demand

At a recent spot price of $1387 per ounce, those 5.2 billion ounces of gold are worth more than $7 trillion dollars. For perspective, the entire market cap of US stocks is about $14 trillion, as measured by the Wilshire 5000 Total Market Index. (11-30-2010)

Some analysts use these numbers as a basis for predicting a rise or fall in gold prices. I see gold’s value driven by completely different factors.

The gold market is not a ‘fundamental’ market, in other words, a market where value can be calculated and compared to some intrinsic worth like expected dividends, earnings, or growth. Gold’s price is determined by simple supply and demand, meaning the price is determined solely by what the latest buyer and seller agree to. This distinction is crucial for individual investors, since most investors have fundamental portfolios of stocks and bonds. Any attempt to apply fundamentals to gold is a fool’s errand in my view, and misses the value of gold as a diversifier in a fundamental portfolio of stocks and bonds.

Precisely because gold does not operate in a fundamental market is the reason you may want to own some in your portfolio. How much gold you might own is the subject for another article, but the amount can be reasonably calculated, and is unique to each individual, in my view.

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