Sunday, May 19, 2013

Gold Arithmetic

There is a lot of commentary about where the price of gold is going and even what the "correct" price of gold should be now.  I certainly do not have many answers to this whole subject, but I wanted to provide some perspective on gold's place in wealth holdings as well as its place in the financial system.

My own personal view is that FOFOA's numbers are likely to be seen when all of this (the distortions and contortions in our financial system) are addressed, whether deliberately (unlikely) or the events precipitating the gold reset (transition to Freegold) bring about much higher gold prices.  The numbers most kicked around at FOFOA's blog and comments are a range roughly between $55,000 to $100,000 per oz.

As I write this, however, we are currently in a bear market for the price of gold, now at about $1360 per oz off about 25% off its all time high.

I contend that, for the moment, the price of "paper gold" and physical gold are fairly close, with a premium of physical to paper of between 3% and 20% (depending on the form of gold and the size of a purchase).

The most dramatic effect of Freegold will likely be the divergence of paper gold to physical gold, FOFOA has explained that the paper price of gold will eventually be zero as investors flee paper and want the real thing.  This article explores some of the themes and issues associated with revaluation of gold.

Please note that all of this arithmetic is approximate, and is really only exploratory in nature.


One way of looking at a gold price reset, at least from a US-centric viewpoint, is to look at our national debt vs. the value of our gold reserves.  Most observers (myself included) believe that the USA indeed does have the 8130 (or so) tonnes of gold that the Treasury claims (most at Ft. Knox, lesser amounts in Denver, San Francisco and at the Federal Reserve Bank of NY).  Our arithmetic lesson starts here:

8130 tonnes = 8100 * (1000 kg / tonne) * (32.15 toz / kg) =  262,000,000 toz

262 million ounces * ($1360 / toz) = $356,000,000,000 ($356 billion)

[$356 billion dollars is not all that much money...  That would be a little over $1000 worth of gold for every man, woman and child in the USA (315 million) or less than ONE oz per capita.]

Compare to our current national debt of (approx.) $16.75 trillion.  That $356 billion worth of gold works out to being only about 2.1% of our national debt!

An idea floated by FOFOA is that the Treasury could just unilaterally revalue the price of our nation's gold to an arbitrary high price, he suggested that it could be in the $5000 - $10,000 range.  The Treasury "would put out the call to buy any and all gold for $10,000 / oz (say)".  The idea here would be to allow our gold to better offset our national debt by revaluing the gold (by essentially devaluing the dollar).  Well let's look at that a moment:

($10,000 / $1360) * $356 billion = $2.62 trillion, value of our nation's gold at $10,000.

OK, $2.62 trillion is a "better" number, but would we trade our nation's gold just to eliminate less than ONE FIFTH of our debt?  No way.  FOFOA then went on to write that this arbitrary revaluation would likely just be a stepping-stone to even higher numbers.  What if we wanted pay off our entire debt using our gold?  What would the price have to be?

$16.75 trillion / 262,000,000 oz = $64,000 per oz

And this (again) assumes that we would use all of our gold just to pay down the debt, which of course will not happen.  That $64,000 per oz falls squarely within FOFOA's target price range.


If we look at how other countries would fit into all of this, here is some more information.  Total gold held by central banks is estimated (2010) to be some 30,500 tonnes, but many consider that figure to be too low for today, the information is old, and it is thought that China and perhaps Russia & Saudi Arabia hold more than they claim.  So, "let's say" that the central banks of the major countries hold 45,000 metric tonnes (China claims only a little over 1000 tonnes held, but most informed observers think that number is really between 4000 and 8000 tonnes).

A quick scan over at wikipedia shows that most developed countries of size as well as a few developing countries (overall: "countries that matter") will have varying but mostly similar to the USA's debts in comparison to their GDPs (the figure for the USA is about 90% now, debt / GDP).

Let's "average this down" a little, as many (though smaller) countries have a significantly lower percentage of debt to GDP.  Call it 80%.  Total world GDP is around $83 trillion (wikipedia:  Arithmetic...:

80% (0.8) * $83 trillion = approximately $66 trillion of total national debts

45,000 tonnes gold = 1.45 billion toz * $1360 / oz = approximately $1.97 trillion worth of gold at today's price.

$1.97 trillion / $83 trillion of world national debts = approx. 2.3% value of gold vs debts.  There is not much difference between the world vs. the USA when it comes to gold holding as a percentage of national debts (part of this can be explained by the fact that the USA is almost 20% of world GDP and the fact that almost all of the major developed countries are all roughly in the same boat we are...).

So, by upwardly revaluing the world's gold to about $60,000 / oz would "cover" all national debts (gross) worldwide.

"FOFOA's numbers" still look about right...


A different way to look at "future price of physical gold" is to ponder the "quantity" of paper gold out there vs. the amount of physical gold.  An often-mentioned figure is that there are approximately "100 times" as much paper gold (futures, gold leases by/from bullion banks, etc.) as there is physical.  I am not in a position to know whether this is indeed true, but I have seen this mentioned many times.

Many derivatives (and that's what paper gold really is, a series of derivative products) have two parties, a "buyer" and a "seller".  Thus, it is not clear to me whether just multiplying the the amount of physical gold's price by 100 (and risk "double counting") or 50 is more correct.  Keep in mind my initial remarks, that these calculations are exploratory in nature, really a tool for thinking about this issue of "correct price in the future for physical gold".

Also, it is probably NOT correct to just multiply the price of gold times 50 or 100 to arrive at "correct prices" but it is likely that we would be approximately correct!

$1360 * 50 "paper claims" on each oz of gold = $68,000 per oz

$1360 * 100 = $136,000 per oz

My best guess, GUESS!, is that the $68,000 number is likely a better value.  If so, "FOFOA's numbers" again look good.


Still a different way to look at a future price of gold would be to think about wealth.  Gold is probably best thought of as a store of value, or as a form of wealth.  Wealth is possessed by whomever owns it.  Trying to calculate gold's portion of wealth is pretty tricky and full of arbitrary decisions, therefore I cannot make any kind of good judgements as to whether or not gold's present or future prices make sense.  Wiki again provides some insight into "wealth": (the wiki article shows as it FIRST picture several gold bars as a symbol of wealth).

Wealth is typically thought of as the net amount of land, personal property and money that someone (or a family) owns.  Personal property (cars, house furnishings, etc.) is clearly not as much as either land or money (money in its various forms, which include stocks & bonds, etc.).  Wealth, depending on the definition you accept, can include intangibles like education and health.

Wealth is unevenly distributed around the world.  The total measurable wealth per capita in the USA is about $130,000.Worldwide the average is about $23,000.

very rough worldwide total wealth would be about $150 trillion.  An even rougher estimate of the portion of total wealth represented by gold would be:

7 billion people * $1360 / oz = $9.5 trillion or 6.3% of world wealth is held in gold.  That number includes gold held by central banks and in jewelry form (the latter of course would count as wealth, but central bank holdings..., perhaps so, wealth of a nation).

Here in the USA, only about 1% of the population owns a significant amount of gold (one toz or more).

Gold's role in storage of wealth may vary through time as well.  Long ago (ancient Egypt), silver and gold each had about the same value per ounce!

So, due to the difficulty and arbitrary nature of defining wealth (note that we would have to subtract liabilities,  land for example -- borrowing), I really do not have a good feel what the future price of gold should be re gold's role as a Store of Value for the world's wealth.


This little exercise does hint that gold "should" be priced higher than it is, not even taking into account that gold has no counter-party risk and all of the other reasons why physical gold advocates suggest owning the metal.  But, the above do involve an unacceptable level of arbitrariness in order to accurately make a good prediction of future gold price.  Still, I would like to get more information on how others (especially FOFOA) arrives at HIS numbers..., would he tell us?


  1. RM
    good excercize but first I believe that $/Oz will soon become meaningless as the dollar cannot live with such high gold price. If the dollar hyperinflates the correct question is what will an ounce get you? I suspect that we will see a new dollar as the one we have cannot be supported by gold. So it will take some time for that to play out.
    Let say we get an initial Euro/ounce price of 45000. The dollar price is say 50000. But the dollar is then seen as weak.
    The Euro is currently backed by gold and treasuries. If gold is suddenly 95% and treasuries go to less than 5% then the dollar is a trivial part of any CB asset sheet is it not? The resolution of gold loans was discussed by fofoa recently. That resolution could crash the dollar.
    Then there is the matter of flow. If I'm suddenly gold rich I'm going to cash some in to enjoy life but a large part of the gold hoard is in the hands of those who do not need to spend it anytime soon.
    For now I'll stick with fofoa's $55,000 2009 dollar purchasing power. An ounce buys you a nice SUV. I just hope nice SUVs can still be had in that coming future.

  2. FOFOA is a very interesting site and community. They are too gold myopic for my liking however considering the cost to access it you have to love the information and service provided.

    I find it illustrative to measure AU in terms of the DOW or farmland somewhere with an extensive price history.

    Dollars are a fine measuring instrument but its a moving target subject to a myriad of interpretations.

    Very nice post

  3. @ Michael dV

    My understanding is that FOFOA has said two things re future price of physical gold and the dollar: that the $55,000 was in 2009 non-hyperinflated dollars and that he guesses (and we hope he is right!) that social conditions would still be OK. My term "social conditions" just above is equivalent to your thought re nice SUVs still being available...

    Also, and I should raise this over at his blog, why could the USA not decide to just go ahead and mark ITS OWN gold to market value as Europe has done? (But, my knowledge of the nitty-gritty mechanics of the euro are fairly weak).

    @ battleshipyamato

    Banzai! There are so many blogs out there that it is fitting that there is a narrowly-focused blog covering an important topic. If FOFOA is even close to being right, then the FOFOA blog and community become much more important in gauging world economic matters...

    @ both of you!

    Yes, a look at gold vs. other hard assets both before and after any big "reset" would be a valuable exercise as well. Price of Au in dollars might be very one dimensional, and not showing a more complete perspective and story.

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