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A proven indicator says gold could jump 600% - Views on News from Equitymaster
 
 
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  • Mar 20, 2013

    A proven indicator says gold could jump 600%

    What do you think foreign reserves of central banks comprise of? Well, they have to have the world's safest and most liquid currencies, isn't it? But is any currency safe these days given the unlimited printing it is being subjected to. Certainly not we believe. It is thus imperative that these banks diversify into a currency that cannot be printed at will and the one that has stood the brutal test of time. And what better option here than the yellow metal gold.

    In fact, such a move of central banks making gold a greater percentage of their forex reserves is already underway for quite some time now. Thus, the ratio of central banks forex reserves to central bank gold reserves gives us an indication of how far the gold diversification exercise has gone. However, a gold analyst who answers to the name of James Turk believes that the ratio serves another very useful purpose. In fact, he prefers to call it the Gold money index and is of the view that the ratio is a very reliable indicator of the fair price of gold.

    Fair price of gold? Isn't this the 800-pound gorilla in the room when it comes to gold buying. We've known since ages that gold should be a must have in one's portfolio. But unlike stocks and bonds, we've never been able to get a handle on what the fair price of metal looks like. And if this indicator proves as reliable as it is claiming to be, we will have solved the problem of exiting from the metal as soon as it reaches its fair price.

    The Gold Money Index
    Source: kingworldnews.com

    So, how exactly does this gold money index work? Well, as per Mr Turk, the fair price of gold is nothing but the ratio of central bank forex reserves to its total gold reserves. And as evident from the chart, gold's fair price was way higher than its actual price back in June 2011. Since forex reserves have only swelled since then, it will be fair to assume that the gap would have widened further or at least remained as it is.

    The best is yet to come though. Gold doesn't become overvalued the moment actual price goes above fair price. Past data suggests that it starts coming down only when the actual price has become two times the fair price. For us though, even the convergence to fair price will be more than sufficient we believe. Simply because this event would alone make possible a 600% percent jump in gold price from the current levels.

    Of course, there are people who would argue that we live in vastly different times and thus, the past data is of absolutely no use. But as Mr Turk rightly points out, the central planners are indulging in the exact same buffoonery that led to disasters in the past. And they seem to be using the exact same excuses for their alleged bubble building. But for those who would rather rely on numbers, the gold money index suggests that it is still not too late to buy gold.

      Rahul Shah (Research Analyst), Managing Editor, Microcap Millionaires has led the team from the front in developing some of our most stringent and rewarding research processes. As per his own admission, the turning point in Rahul's life as a financial analyst came a few years back when he got introduced to the works of Warren Buffett and Charlie Munger. From Buffett, he understood the value of investing in good quality business with powerful moats and strong management teams. Charlie Munger on the other hand inspired him to be a lifelong learner and use mental models in order to arrive at the crux of matters across most disciplines. Rahul firmly believes that in order to be successful at investing, you have to do the big things right and possess a great temperament and a contrarian streak.

     

     

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