Reader Question: Going Up, or Down?

Reader Ray Boyd asks, "How does one determine if a certain commodity or item is going up in value priced in mg or grams of gold?"

This is a foundational question. When you buy any asset, you are either selling gold to pay for it, or getting the funds from elsewhere and passing up the opportunity to store those funds in the form of gold. Either way, the asset purchased has a "gold cost".

You can calculate this cost by taking the fiat currency price of the asset, and dividing it by the fiat currency price of gold. Note that you want to match these prices as closely in time as you can. For daily pricing, I usually use the London PM fix, but if you can narrow the price down to the moment of the transaction, that would be best.

Let's look at an example, using the Dow Jones Industrial Average on Friday May 27th, 2016. On that day, gold was quoted in London at \$1,216.25 per ounce. Since one troy ounce of gold weighs 31.1035 grams, the price of one gram of gold would be 1216.25/31.1035 = \$39.1033. But more importantly, the price of one US Dollar would be 31.1035/1216.25 = 0.02557 grams of gold. This could also be written as 25.57 mg of gold.

On that day, the Dow closed at \$17,873.22, and since each of those dollars was worth 0.02557 grams of gold, the price of the DJIA was 17873.22*0.02557 = about 457.1 grams of gold.

On Wednesday June 8, 2016, the Dow closed at \$18,005.05, 0.74% higher than the close on May 27th. But gold was also higher, fixed in London at \$1,263.00 per ounce. This means that each US Dollar was worth 0.02463 grams of gold (31.1035/1263). Thus the price of the DJIA was about 443.4 grams of gold – 3% lower than its price on May 27th.

In other words, you would have had to sell 457.1 grams of gold to buy the DJIA on May 27th, but if you sold those shares on Jun 8th, you would only be able to buy 443.4 grams of gold with the proceeds. This is a 3% loss.

Technically, when you buy an asset, you pay the seller's asking price to get it. And when you sell your gold to raise those funds, you take the highest bid price for it. In some assets, there is a big difference between these bid and ask prices; in gold however, the spread between bid and ask is usually very small because of the massive volumes and tremendous liquidity of the gold market. During normal times, it is safe to ignore this spread for pricing purposes… but keep in mind that in a true currency crisis or panic, markets will not be functioning normally, and spreads – even for gold – could become significant.

What is really happening in this case is not uncertainty about the value of the gold, but uncertainty about the value of the dollars! In fact, gold holders may not be willing to part with their metal for any number of dollars. This is exactly what happened a few years ago in Zimbabwe, and it can happen here, too – for any value of here!

It is easiest to see these changes when the numbers are plotted on a chart. Then it's obvious that prices are rising or falling (or more or less staying the same) over time. I use a spreadsheet containing historical gold prices and asset prices to draw the charts on this site. You can do the same, or you can use a web service like stockcharts.com to plot the ratio of a stock symbol to \$GOLD. This will chart the prices in ounces, which for low-priced stocks will be very small numbers, but the shape of the chart will be exactly the same as it would be if measured in grams or milligrams. Example: DJIA in ounces of gold