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Gold’s Downside Risk vs. Upside Potential

Based on America’s latest Real Money Supply (RMS) made up of total US checkable deposits, total US savings deposits, and US currency in circulation (currency component of M1) – and the historical ratio of the RMS to the price of gold – we are able to estimate gold’s fair value, along with its worst case scenario downside risk, and best case scenario upside potential.

In September 2011 when gold reached its record nominal high of $1,895 per ounce, the RMS was $8.007 trillion. Since then, the RMS has grown by 36.3% to $10.911 trillion vs. gold declining by 42.5% to $1,089.40 per ounce.

 

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The RMS/Gold Ratio has increased from a low in September 2011 of 4.23 to 10.02 today. Since 1975, the RMS/Gold Ratio has ranged from a January 1980 low of 0.675 to an April 2003 high of 12.91, with a long-term median of 5.70.

In NIA’s opinion, the 40-year median RMS/Gold Ratio of 5.70 represents gold’s fair value, the record high RMS/Gold Ratio of 12.91 represents gold’s worst case scenario downside risk, and the record low RMS/Gold Ratio of 0.675 represents gold’s best case scenario upside potential.

 

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Based on the long-term median RMS/Gold Ratio of 5.70, gold has a fair value today of $1,914 per ounce. Already, gold’s 2011 high of $1,895 per ounce with a RMS/Gold Ratio of 4.23, would equal a gold price today of $2,580 per ounce. In a worst case scenario for gold, if the RMS/Gold Ratio returned to the record high from 2003 of 12.91, it would equal a gold price today of $845 per ounce.

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While gold’s worst case scenario downside risk is $845 per ounce, let’s take a look at its best case scenario upside. When gold first reached $850 per ounce in 1980, the RMS was only $574 billion for a RMS/Gold Ratio of 0.675. If the RMS/Gold Ratio returned to 0.675 today, it would equal a gold price of $16,165 per ounce.

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Therefore, from gold’s settlement price yesterday of $1,089.40 per ounce, it currently has worst case scenario downside risk of 22.43% and best case scenario upside potential of 1,383.84%. Gold’s upside potential is 61.7X greater than its downside risk. Gold’s fair value is 75.7% above yesterday’s settlement price.

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