How is Gold "Priced?"

[moda0306]

How is gold "Priced?"  Stocks and bonds seem to have a very mathmatical and often efficient way of being priced based on inflation risk, default risk, PE, etc.... how does one "price" gold? 

[Wonk]

In a fiat world, the gold price is a giant pendulum.  When times are bad and getting worse, investors increasingly want nearly all of their currency backed by gold.  When times are good and getting better, investors become increasingly complacent about protecting purchasing power and tend to favor higher yielding assets such as stocks and bonds.

For what it's worth, stocks go through the same types of secular cycles, but typically opposite gold.

[Wonk]

I realized I didn't answer your question moda.  The answer is "it depends."  There isn't an exact answer all the time.  Just like with stocks, there are times when gold is cheap and times when gold is "expensive" relative to other assets.  If the market was totally efficient, we wouldn't see stocks trading at a PE10 of 5 in 1921 and 44 in 2000.

[guineapig]

I think I read somewhere that gold should always worth "a decent man's suit with accessories like tie and pant" or something like that, which is due to its function as "hard money". Together with Wonk's pendulum theory, the price can swing around that value, high or low.

[KevinW]

As my mom used to say: it's worth what someone will pay you for it.

That's it; the price of an ounce of gold is whatever someone out there will pay for it.  Of course a lot of variables factor into that figure.

[AdamA]

How is gold "Priced?"  

No one knows.  Have you ever heard a gold analyst try to predict future gold prices?  It's almost comical (even more so than stock market predictions), and basically just guessing.  

[MediumTex]

I always feel like over longer periods of time production cost enters the equation.  For example, if it costs $400 to mine an ounce of gold it seems unlikely that gold prices would stay under $400 for an extended period of time.

OTOH, at $400 an ounce in production cost, there is not necessarily any upper limit on the price of gold.  In that situation, the miners just become one of those huge margin businesses like tobacco or software.

[Pkg Man]

I always feel like over longer periods of time production cost enters the equation.  For example, if it costs $400 to mine an ounce of gold it seems unlikely that gold prices would stay under $400 for an extended period of time.

OTOH, at $400 an ounce in production cost, there is not necessarily any upper limit on the price of gold.  In that situation, the miners just become one of those huge margin businesses like tobacco or software.

I would think that the demand for gold would be the fundamental driver of price (what drives that may be more to the OP's question).  I assume that the cost of extraction also varies across different mines, just as it does for energy. 

If 400 is the cost of the cheapest mine, then as long as the quantity demanded was at least equal to the quantity supplied by those mines, 400 would be the floor.  But demand could theoretically drop below that level, in which case the market for new gold would disappear but previously mined gold would still trade in the market.  Unlikely, but not impossible.

[MediumTex]

I always feel like over longer periods of time production cost enters the equation.  For example, if it costs $400 to mine an ounce of gold it seems unlikely that gold prices would stay under $400 for an extended period of time.

OTOH, at $400 an ounce in production cost, there is not necessarily any upper limit on the price of gold.  In that situation, the miners just become one of those huge margin businesses like tobacco or software.

I would think that the demand for gold would be the fundamental driver of price (what drives that may be more to the OP's question).  I assume that the cost of extraction also varies across different mines, just as it does for energy. 

If 400 is the cost of the cheapest mine, then as long as the quantity demanded was at least equal to the quantity supplied by those mines, 400 would be the floor.  But demand could theoretically drop below that level, in which case the market for new gold would disappear but previously mined gold would still trade in the market.  Unlikely, but not impossible.

Your point about different costs at different mines is very important.  OPEC oil, for example, is a lot cheaper to produce than non-OPEC oil. 

Ultimately, of course, you are right about it being a matter of supply and demand.  Part of what makes gold's price so volatile is that it is a relatively small market compared to other financial assets like stocks and bonds, so a small change in demand against a more or less static supply can create a lot of price action.  By static supply, I mean it's easier to issue new shares of stock than it is to mine new ounces of gold.

I think, too, that part of what creates demand for gold is a fall in demand for other financial assets like stocks and/or bonds.  I don't think it's any accident that when one PP asset is in a secular bear market one or more of the other PP assets will be in a secular bull market.