r3volution 3.0
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- Mar 6, 2014
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Gold's going up; it will eventually go down.
You don't want to ride it back down, you want to sell at some point - but when?
Gold does not produce an income stream and so it cannot be valued like equities or debt. When shares are trading at a P/E of 37, we can say they're overvalued by historical norms; when long bonds have a yield to maturity of 77 basis points nominally, which is deeply negative in real terms, we can say that bonds are overvalued. But how will we know when gold is overvalued, i.e. when it's time to sell?
We have to understand what factors cause the gold price to rise and watch for any change in those conditions.
Two key bullish factors are(a) real yields on debt being very low, and (b) real potential yields on equities being very low. The first point is well known, the second less so. I would define "real potential yield" for equities as earnings per share divided by the current share price minus the rate of inflation. This represents the maximum amount of money that a company can return to its shareholders through dividends and/or share buybacks. As far as actually tracking this figure, take the inverse of widely available index-level P/E ratios and subtract the inflation rate. For example, the P/E ratio of the NASDAQ 100 is 37.62. The inverse of that 2.65%, which is the nominal potential yield. Subtract the latest CPI inflation rate (2.47%) and you have the real potential yield: 0.18%.
Index-level P/E data can be found at:
(https://www.barrons.com/market-data/stocks/us/pe-yields)
CPI can be found at:
https://fred.stlouisfed.org/series/CPIAUCSL#0 (you need to edit the graph and set unit to compounded annual rate of change)
As for real yield on debt, this is simple; just go find the current yield and subtract the inflation rate.
In addition to those two factors, I would follow two others: (c) nominal debt as a % of nominal GDP, including federal, state and local, corporate, and household debt, which is a proxy for the amount of malinvestment and so the amount of monetary inflation required to prevent liquidation, and (d) changes in foreign holdings of USD denominated securities, with declines signalling weakness in the international position of the USD. The former is available at the FRED website posted above; the latter is reported monthly by the treasury (https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx go down to section B.1).
Day to day, the most important metrics are real yields on debt and equity. Longer term, debt to GDP is very important, as it largely determines how much money will be printed, which drives everything else. TIC data is a wildcard. Gold could rise against the dollar for a long time even as the dollar rises against foreign currencies, so this isn't essential to predicting the price of gold, but, if there's a large and sustained decline in foreign holdings of dollar assets, that could a massive tailwind for gold, so it's something to watch.
So what's the prognosis for gold right now, using these metrics? Real yields for the 10 year treasury, which is probably the single most important debt instrument in the world, are deeply negative at -1.69%; real yields for major US stock indices range from 1.51% for the DJIA to 0.18% for the NASDAQ 100; nominal debt to GDP is at a record high of 260%, up from 212% just last year; and TIC data shows foreign holdings dropped during the partial liquidation in March but have since recovered, indicating no imminent collapse of the USD in forex markets. Altogether, this is extremely bullish for gold and I think it's more likely to become more bullish, e.g. via higher debt levels and higher stock and bond prices without earnings growth, before it starts moving the other way. In any event, a fundamental turn in the gold market, whenever it comes, should appear in these data, hopefully far enough in advance to allow us to act.
You don't want to ride it back down, you want to sell at some point - but when?
Gold does not produce an income stream and so it cannot be valued like equities or debt. When shares are trading at a P/E of 37, we can say they're overvalued by historical norms; when long bonds have a yield to maturity of 77 basis points nominally, which is deeply negative in real terms, we can say that bonds are overvalued. But how will we know when gold is overvalued, i.e. when it's time to sell?
We have to understand what factors cause the gold price to rise and watch for any change in those conditions.
Two key bullish factors are(a) real yields on debt being very low, and (b) real potential yields on equities being very low. The first point is well known, the second less so. I would define "real potential yield" for equities as earnings per share divided by the current share price minus the rate of inflation. This represents the maximum amount of money that a company can return to its shareholders through dividends and/or share buybacks. As far as actually tracking this figure, take the inverse of widely available index-level P/E ratios and subtract the inflation rate. For example, the P/E ratio of the NASDAQ 100 is 37.62. The inverse of that 2.65%, which is the nominal potential yield. Subtract the latest CPI inflation rate (2.47%) and you have the real potential yield: 0.18%.
Index-level P/E data can be found at:
(https://www.barrons.com/market-data/stocks/us/pe-yields)
CPI can be found at:
https://fred.stlouisfed.org/series/CPIAUCSL#0 (you need to edit the graph and set unit to compounded annual rate of change)
As for real yield on debt, this is simple; just go find the current yield and subtract the inflation rate.
In addition to those two factors, I would follow two others: (c) nominal debt as a % of nominal GDP, including federal, state and local, corporate, and household debt, which is a proxy for the amount of malinvestment and so the amount of monetary inflation required to prevent liquidation, and (d) changes in foreign holdings of USD denominated securities, with declines signalling weakness in the international position of the USD. The former is available at the FRED website posted above; the latter is reported monthly by the treasury (https://www.treasury.gov/resource-center/data-chart-center/tic/Pages/ticsec2.aspx go down to section B.1).
Day to day, the most important metrics are real yields on debt and equity. Longer term, debt to GDP is very important, as it largely determines how much money will be printed, which drives everything else. TIC data is a wildcard. Gold could rise against the dollar for a long time even as the dollar rises against foreign currencies, so this isn't essential to predicting the price of gold, but, if there's a large and sustained decline in foreign holdings of dollar assets, that could a massive tailwind for gold, so it's something to watch.
So what's the prognosis for gold right now, using these metrics? Real yields for the 10 year treasury, which is probably the single most important debt instrument in the world, are deeply negative at -1.69%; real yields for major US stock indices range from 1.51% for the DJIA to 0.18% for the NASDAQ 100; nominal debt to GDP is at a record high of 260%, up from 212% just last year; and TIC data shows foreign holdings dropped during the partial liquidation in March but have since recovered, indicating no imminent collapse of the USD in forex markets. Altogether, this is extremely bullish for gold and I think it's more likely to become more bullish, e.g. via higher debt levels and higher stock and bond prices without earnings growth, before it starts moving the other way. In any event, a fundamental turn in the gold market, whenever it comes, should appear in these data, hopefully far enough in advance to allow us to act.
