Pricing the SP 500 in Gold – Curiosity or Actionable Information?
Written by John Lounsbury
There is an excellent web site (Priced in Gold) which presents valuation data of various entities priced in ounces (or grams) of gold compared to the usual metric of observation, the U.S.dollar. The article they have posted on stock market valuations over a timeline longer than 130 years is very informative. There have been three huge stock market bubbles, each one almost exactly double the previous one.
Click Read more >> for further discussion of this graph.
Priced in Gold (PinG) suggests that one interpretation possible for this chart would indicate that stocks were fairly priced at the present time. They wrote:
Over the period from 1880 to 2012Q1, the average price of the S&P is 29.4 grams, and the median price is 14.8 grams. Recent prices around 25 are in this region.
PinG compares the above valuation to the Shiller PE valuation based on CPI (Consumer Price Index) as the deflator and finds some parallels.
Econintersect would suggest that there are some further thoughts to be considered. The first of these is to consider whether the bubble years should be included in the average and median used to establish a basis of comparison. (Actually the median would not be effected that much by excluding extreme high values, only the average.) The second is to ask whether the relationship between stocks and gold before the end of the last gold standard currency agreement in 1971 should be considered separately from the years since 1971.
Are Bubbles ‘Different’?
The following annotated graph shows the boundary lines which cap various percentages of the last 133 years. This would question whether including the relatively few years of bubble extremes might not be misleading. Perhaps the reference averages and median values would be better taken without the top 5 or 15% years which could be argued to be “fat-tail” distortions with abnormally high values. If such calculations were done the relative valuation of the current market would be much less favorable.
With all of the values included in the chart above, the current market valuation is higher than more than 75% of all values over the last 133 years. This suggests that the current market is overvalued, although not by as much as in 23-24% of all 133 years.
Valuations During Different Gold/Money Regimes
The chart below has been segregated into three different eras of gold/dollar relationships.
There is a possible argument that the era before 1934 is substantially different in character than the two eras since, simply based on the levels of the 85% lines. If this argument is valid then the valuation judgment should be made using only data 1934-2013 to calculate average and median values. If this were done the current valuation level of the S&P 500 would be significantly lower than the one for the entire 133 years quoted by PinG. In this case the conclusion would likely be that the current market is either fairly valued or undervalued.
We have looked at the gold pricing data through two different lenses and come to two different conclusions. Econintersect is of the opinion that the exercize of pricing the stock market in gold, while interesting, may not be all that valuable as a stock market timing tool.
However, this discussion does suggest that the analysis may have value in timing for those who consider going long or short stock with opposite positions in gold as a paired trade. To judge the potential for this would require study of an extended history with consideration of risk management strategies. Looking at the short-term volatility in the chart, risk management would not be a trivial task. We can envision many whip-saw losses possible for each big gain.
Hat tip to John O’Donnell.
- S&P 500 (Priced in Gold, not dated)
- Shiller Explains How to Use his Trailing PE Ratio (Jeff Miller, GEI Investing)