Gold bugs will be beside themselves as the precious metal pops above $3,400 an ounce, taking its one-year gain to 46% (in dollar terms), and tries to set another all-time high in response to ongoing worries about inflation, government debt and now fresh tensions in the Middle East.

Having spent years shouting about gold and its protective qualities, holders of the metal may soon have a different decision to take if it keeps going. The more investors who buy in, the more of a consensus position it becomes, and the more of a consensus position it becomes, the fewer incremental buyers there are to drive up the price.

True believers will continue to warn of the dangers of debt, inflation and geopolitics. Others may at least think about a portfolio rebalancing to ensure they do not become over exposed.

The trick is how to assess fair value.

The all-in-sustained cost (AISC) of production can perhaps help to gauge what the downside may be. This is around $1,400 to $1,500 per ounce for major producers such as Newmont (NEM:NYSE) or Barrick Mining (GOLD:NYSE).

However, that does not help judge any possible upside. And, gold is inert, so there are no earnings, and it generates no cash so there is no yield.

Those issues support Warren Buffett’s view that the precious metal has no role in portfolios, but gold has been money since time immemorial and the latest rounds of central bank stockpiling imply this latter view still holds currency at the highest level. So, where to begin?

PAY AND DISPLAY

One crude way may be to measure how much gold the average pay packet can buy. If the metal moves beyond the reach of the average worker, that could at least crimp jewellery demand and one source of incremental buying.

Consistent wage data with real longevity is hard to find, but the US Federal Reserve offers nearly 60 years of figures for ‘production and non-supervisory employees’.

In plain English, this sounds like factory-floor jobs, for want of a better phrase, so it should do nicely.

Before president Nixon took America off the Gold Standard and smashed up the Bretton Woods monetary system in August 1971, it took a blue-collar American worker 12 hours to earn enough to buy one ounce of gold.

That figure peaked at 97 hours in late 1980 and 94 hours in 2011. In this context, the current score of 105 hours could be seen as ominous for gold’s affordability, since the best cure for high prices is high prices – they stoke supply and suppress demand, prompting the search for an alternative.

Gold bugs will counter by saying inflation – and central bank money printing to cover monstrous government debt – can drag wages along for the ride, so they may not budge, especially as the metal’s gains still pale compared to those of the inflation-wracked 1970s when uncertainty in the Middle East was also a key global issue.

SUPER-SUBS

Gold miners have lagged gold, and that may be an option as they should start to generate plentiful profits and copious cash flow if gold prices stay elevated and they suffer no meteorological, geological, political or regulatory mishaps (admittedly, that is a big ‘if’ in some cases, and some jurisdictions, as Barrick Mining will attest).

Equally, it may be no coincidence that other commodity prices are starting to motor, particularly those which look cheap relative to gold. For example:

Since 1970, one ounce of gold has on average bought 17 to 18 barrels of oil. It currently buys 46 barrels.

Since 1976, an ounce of gold has on average bought one ounce of platinum. It currently buys 2.7 ounces.

Since 1970, one ounce of gold has on average bought 60 ounces of silver. It currently buys 94 ounces.

Since 1970, one tonne of gold has on average bought nearly 5,700 tonnes of copper. It currently buys just over 11,100 tonnes.

RAW DEALS

These historic, price-relative trading ranges offer no guarantees for the future at all. Those advisers and clients who fear higher inflation may like to maintain a bias to raw materials relative to ‘paper’ ones like cash and bonds, but diversify their exposure to ‘real’ assets beyond gold.

Those advisers and clients who fear a slowdown, recession or even debt deflation, may take the entirely opposite view.

One way portfolio builders may be able to judge current market thinking is by using the gold-to-copper relationship.

The stronger gold is relative to copper, the greater the worries over inflation and central bank loss of control.

The stronger copper is relative to gold, the more upbeat markets may be feeling on the economy and corporate earnings.

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