We are used to hearing about gold as a very valuable element. This value comes in part from its physical and chemical properties, from its applications for industry, jewelry, technology, medicine. But also the fact that it is a very scarce element in the earth’s crust, compared to others. In the field of investment, gold is also highly appreciated by its comparison with other assets.
To determine that gold is a very valuable element, it is necessary to compare it with something, to establish a measure that indicates where it is compared to others.
One of the ways to do it is by its price, which is nothing more than its comparison against a monetary unit, in this case the US dollar. By convention, the official price of gold is established in dollars per ounce, although each country compares it with its own monetary unit, which, in turn, fluctuates with respect to the model currency.
Thus, at the end of the year, gold may have appreciated more in one currency than in another, depending on what this currency has done with respect to the dollar.
Apart from the price, which is still a comparison of the metal with a currency, gold can be compared with other precious metals (silver or platinum), with other raw materials (oil) or with other investment assets (the stocks or treasury bonds).
Gold comparisons or ratios
These comparisons can be made because gold shares a series of qualities with them: its status as a precious metal, as a raw material or as an investment asset. Your assessment, higher or lower, will depend on what you can do with respect to the rest of the elements with which you are compared.
When analyzing the prospects for the evolution of gold, analysts handle these comparisons of the precious metal with other elements or assets. They are called ‘ratios’.
By ratio we understand the quantified relationship between two magnitudes, which reflects their proportion. One of these magnitudes is always gold, and the other varies depending on what you want to compare.
As Andrew Lane points out from the Investing.com blog , “the yellow metal is one of the oldest standards when it comes to measuring the price against different financial instruments” and points to the three most important ratios that can shape the trajectory of gold in the near future: gold/silver ; gold/Dow Jones ; and gold/debt .
There are other ratios that are also used, such as the gold/oil ratio, which we’ve already talked about in this blog , or even the gold/beer ratio , devised by Incrementum , a Liechtenstein-based wealth manager.
However, we are not going to dwell on them in this post, since they are less influential when it comes to assessing the future trajectory of gold.
We have also dealt with the gold/silver ratio in another post , although it does not hurt to return to it, due to the interest it has recently acquired.
This ratio measures the number of ounces of silver needed to purchase one ounce of gold. As they point out from Investing.com, it is the best known and used of all gold comparisons.
It is estimated that gold is extracted from the earth’s crust in a proportion of 1 to 8 with respect to silver , although it must be taken into account that, unlike the former, only 30-35% of the annual production of the latter is extracted directly; the rest is obtained as a by-product of the extraction of other minerals, such as gold, copper, lead or zinc.
At the time of writing this post, the gold/silver ratio was around 68 ; that is, it takes 68 ounces of silver to buy one ounce of gold. Its historical minimum was in 1980, with only 15, while the maximum was registered last year, in the midst of the Covid-19 pandemic, with 125.
Throughout the 20th century, the gold/silver ratio has averaged 47, so compared to today’s level, silver is still very cheap when you consider that the price of gold is only $180 off its all-time high. Silver, for its part, is trading at 40% less than its maximum price.
Given that silver tends to appreciate at a higher rate than gold in bullish periods like the current one (47% in 2020 compared to 28% for gold), analysts believe that the gold/silver ratio will decrease as silver goes up appreciating relative to gold.
Gold/Dow Jones ratio
One of the investment assets that gold is often compared to is stocks. For this reason, for many years the gold/Dow Jones ratio has been used to relate both elements. This ratio measures the number of ounces of gold needed at a given time to match the Dow Jones Industrial Average , an index that measures the price of the 30 largest corporations on the New York Stock Exchange .
As Andrew Lane explains, “it is an excellent scale to compare two magnitudes that have been used as a scale of the economy and that have almost always maintained an inverse relationship. In good times, when the economy is booming, the Dow Jones is very attractive and there is little incentive to invest in gold. On the contrary, in times like the present, gold is the most convenient asset to own, while the Dow Jones is undervalued .
In 2020, it took just 15 ounces of gold to equal the Dow Jones index, while at the moment the ratio has risen above 18 ounces.
The third ratio relative to gold that we are going to see is the one that puts it in relation to debt and that, from Investing.com, is the most relevant at the moment.
Currently, the average debt of the countries of the world stands at 300% of their Gross Domestic Product (GDP) . Taking into account that the gold/debt ratio has historically been between 20 and 40% of global debt , this means, according to Investing.com, that the current level of debt could cause an explosion in the price of gold, That would bring it to $6,000 to $12,000 an ounce .
It must be taken into account that, of the three ratios exposed, this is the one with the least mobility. Variation in the price of silver or gold causes the gold/silver ratio to rise or fall rapidly; and what to say about the volatility of the Dow Jones.
However, in the case of debt, the situation cannot change decisively in a short period of time, but rather in the very long term.