Whither Gold
September 15, 1989 - Morgan Stanley

Lewis E. Lehrman

Is there an objective measure by which one can compare and forecast the relative values of portfolio assets as different as gold and U.S. eguities? In our early-l988 research study, "Gold in a Global Multi-Asset Portfolio," we proposed such a benchmark and spelled out an objective methodology for selecting it. By calculating the percentage divergence between the market price of each asset and its actual replacement cost (or the cost of its production), one can obtain an objective value-based ratio that can be used to estimate the relative under- or overvaluation of gold and U.S. equities.

Has that measure proven to be a useful indicator of relative performance? On January 11 1988, the S&P 400 was trading 19.5% below the estimated replacement cost of the eguity of its component companies, whereas the price of gold was 52.7% above the metal's estimated all-in average cost of production (approximately $300 an ounce) in the United States. On the basis of our cost-of-production/ price test, therefore, gold was substantially overvalued at the beginning of last year relative to U.S. eguities. The model thus implied a relative decline in the price of gold and/or a relative rise in U.S. eguities. From January 1, 1988, to September 8, 1989, the price of the metal has dropped almost 21% and the S&P 400 has risen 12.5%.


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