I have always liked the Swiss Franc. Even in high school I knew about the Swiss and their inherently future oriented and conservative society. For many people now the Swiss economic standards are the ideal.
It is interesting to go back 60 years or so and to see how the United States and the Swiss currencies have diverged and how is that reflected in the price of gold and to assess what does it mean. If anything?
- Prior to 1971 the franc was pegged to the US dollar and did not move far from 4.3 francs to one dollar. But, when the US relinquished their peg to gold, the franc moved sharply upward against the dollar.
- Using local CPI numbers, from 1955 to 1976, the franc inflated at the same overall rate as the dollar. In each case one unit of currency was worth 2.17 at the end of 1976. Despite the parallel inflation the exchange rate fell from 4.3 francs to the dollar and in 1976 the rate was about 2.5 to 1.
- The Swiss must be good observers, because the US dollar fell much more in value in the next 10 years. By 1986 the exchange rate was 1.8 to 1 and that is exactly where it should have been given relative inflation.
- After 1986 and until 1995 Swiss inflation was lower than American and the exchange rate widened. By 1995 the exchange rate was 1.2 francs to the dollar but based on inflation alone it should have 1.7 to 1.
- By 2002 the relative inflation and the exchange rate came back into sync with the franc at 1.56 to the dollar. But that soon changed.
- Over the next 10 years the franc grew in value compared to the dollar and is now at an exchange rate 0f .93 to 1 when based on inflation alone it should be 1.14.
Meaning please! The US dollar is overvalued by about 23% (should be more inflation showing) or there is speculative element built in to the Swiss franc. probably inflation expectations.
If we look at gold, we get the same story.
By the end of 1976, when the withdrawal from the gold backing seems to have settled out, gold sold for $134 per ounce. Tracking it since using CPI adjusted US dollars we find that gold has been both over-priced and under-priced. We can attribute that to the anticipation of the future at the time of measurement.
For example gold has traded at between less than 1.5 times its inflation adjusted price in 1976 to 1978, 1984 and 1985, and 1988 to 2006. 23 years. It has traded as high as 3 times and has traded at more than 2 times in 1979 and 1980, and in 2009 to the present.and 1982. Seven years. The other years are between 1.5 and 2. The current value is 2.15.
Suppose the Swiss are right and the dollar is overvalued. The dollar will need to drop by 20% or so for that to be true. And if it happens, what will be the price of gold?
If at the same time the ratio of gold price to inflation adjusted dollars becomes 1.20, then gold will sell for $725.
To believe otherwise one of two things must occur.
- The speculative mark up on gold must be higher than 1.2 or
- inflation must be more than 20%.
If inflation is a lot higher than 20% then we can expect that the speculative markup may return to even lower levels. Maybe not as low as 2000 and 2001 at .68% but lower. Say a ratio of .82 (2002 value) With inflation of 100% by then. Gold price would be $956
To get gold to $2,500 per ounce you need a inflation at 200% and a ratio of 1.4.
For me, gold is a bubble now and has been for several years. Previous bubbles have worked their way out and they may again. For those betting on gold as a speculative investment, I cannot see it at all. For those investing 15% or so of their portfolio against a catastrophe, then I believe just like with any other insurance, if the event does not happen I will be out money.
For a $1,000,000 portfolio with 15% in gold, and a complete wipe-out on the rest of the assets, you will need to have gold at $8,350 per ounce assuming no discount an the speculative side. If we use the 2001 ratio, then you will need $12,300 per ounce. (Annual inflation for three years at rates of 88% and 115% respectively) And either of those just maintains the present purchasing power of your portfolio.
I have, over the past, seen many presentations to justify buying gold. All used statistical deception in one way or another. If it makes you feel better, buy some gold. But as with the fire insurance on your house, you will be better off if you don’t collect on the premium. There will be many unforeseen consequences if inflation is at these levels for three years.
Don Shaughnessy is a retired partner in an international accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.