Have you heard about the Everything Bubble? Some analysts believe that after the dot-com bubble of the 1990s and the housing bubble of the 2000s, we are in the middle of a price bubble in virtually all asset classes simultaneously caused by the Fed’s unusually easy monetary policy with ultra low interest rates. Although we agree that the US central bank maintained federal funds rate too low for too long, the narrative about a dangerous bubble inflating in a wide variety of countries, industries, and assets does not make sense. The bubble means that the price of an asset deviates from the fundamental value, increasing excessively, to a much greater extent than on other markets. It should be now clear that the existence of overvalued assets necessarily means that other assets are undervalued, so there can’t be the ‘everything bubble’. Sorry, but those who wait for the total asset apocalypse might be disappointed.
OK, but what about gold? Is its price too low or too high relative to stocks and bonds? Let’s examine it and find out who is right: gold bulls or bears? The chart below displays the ratio of gold prices to the S&P 500 Index.
Chart 6: Gold to S&P 500 Index ratio from April 1968 to September 2018.
As one can see, the ratio is now around 0.41, which is rather low. The historical average amounts to 1.14, almost three times higher. It may indicate that gold is significantly underpriced compared to US stocks. However, let’s note that the inflationary decades of the 1970s and 1980s strongly affect the results. Gold enjoyed a tremendous bull market in the 70s and early 80s., as the next chart shows. When we remove that period from the analysis and start from the 1990s, the average drops to 0.64 – still higher, but not so much. The chart below also suggests that the current low level of gold-to-stock ratio results not from mediocre gold prices, but rather from elevated stock valuations.
