Humble Money

It seems to me a fairer estimation of the worth of a stock market might be it’s relationship to gold rather than other measures such as PE ratios, what one generation is prepared to pay in terms of PE multiples for a market seems to change much more easily that the purchasing value of gold.

“WITH AN OUNCE OF GOLD a man could buy suit of clothes in the time of Shakespeare, in Beethoven and Jefferson, in the Depression of the 1930s,” according to one of the sources for our chart. That remained true in the 1980s, but it isn’t true in the late 1990s. The suit standard now implies a gold price of perhaps $1,000 per ounce. A really good man’s suit today can easily cost 4 ounces of gold - say, $1,250 at gold’s mid-April high for the year to date. And that’s without a vest, once standard.

Which is particularly interesting because the real gold price has been astoundingly stable since Shakespeare (born 1564). Even in the troubled 20th century, with inflation in the West on a scale unprecedented during the last 600 years (FORBES, Jan. 12, 1998), gold’s wild oscillations averaged at $612, very close to its $639 average for the tranquil 19th century. And comfortably within its historic range.

Interesting point: Gold will have to rise by about $300 just to get back to the $627 average of the last two centuries.

Edwin S. Rubenstein, written in 1998.

I have taken monthly closing price data for the ASX 200 from January 1987 onwards and measured it in terms of how many ounces of gold the index would purchase.

In January 1987 the ASX 200 closed at 1496, The price of gold was 732.3 $USD and the $AUD bought 0.6595 $USD. So the index bought 1.35 ounces of gold. Fast forward to the present day and the same index will buy you 6.75 ounces.

A graph of how many ounces of gold the ASX 200 purchased from 1987-2006. A distinct trend in favour of paper over rocks (or ingots).

What makes a market fair value? The following is a graph of the PE and Yield on the ASX since 1974, what makes people consider the market undervalued at the moment if the PE ratio was much lower in the 1970’s?

A graph of the ASX 200 CPI (inflation) adjusted from 1987-2006. Baseline set at 100% in January 1987. In terms of CPI measured purchasing power it took 17 years for the market to exceed the 1987 highs.

How does mean reversion work with fair value? Does it work at all? Is gold still the ultimate measure of value in the 21st century? Do all Fiat currencies return to zero eventually? How much of an Italian suit can you buy for an ounce of gold presently?

I don’t think I have any insightful answers, but I do like the questions I have raised.