Money supply vs. Gold

One of the interesting things I attempted last summer was to determine a fair value for gold based on the total world supply and historical prices. This exercise became difficult because until 1971, the dollar was officially tied to gold. Nixon broke that link and since then, fiat currencies and gold have floated freely.

As I began thinking about it, the best approach seemed to be comparing the total amount of above ground gold vs. the total face value of all world fiat currency. It is not sufficient to compare it with only the U.S. money supply because it is an international commodity that trades in all markets. Few governments publish numbers of their total fiat money supply, and those that do may not be publishing accurate numbers for various reasons. Due to the lack of information, and despite the crudeness, I decided to limit my comparison of the money supply to dollars since I could get numbers on the money supply from the Federal Reserve, and also since the U.S. dollar is still the world reserve currency.

A further limitation to any comparison is that most gold is not in investment form (bars or coins). The bulk of it is in jewelry. This is one reason why gold coins typically carry a premium over the spot price of gold on commodity exchanges.

Still, I soldiered on, collecting world gold supply numbers from the Gold Council and Kitco, then adjusting the numbers going from 1959 to the present assuming a average 1.6% increase in gold supply from new mining each year. I loaded all this data into a spreadsheet to crank out a fair value price and some interesting ratios.

Here are the MZM numbers as of 1/19/2009:
MZM (billions, St. Louis Fed, not seasonally adjusted): 9411.8
Gold supply (oz, estimated): 5,856,520,091
Gold price in USD: $840
MZM/oz: $1,607

Here are the M2 numbers as of 1/19/2009:
M2 (billions, St. Louis Fed, not seasonally adjusted): 8229.7
Gold supply (oz, estimated): 5,856,520,091
Gold price in USD: $840
M2/oz: $1,405

Even looking at the narrower M2 money stock, gold looks a bargain to me.