Gold starts 2006 well, but this is not a 25-year high!

It is understandable that investors might become a little concerned at news of a 25-year high in any asset. However, in the case of gold this is just about the most misleading statement that you can make.

The first way to approach this is to turn this statement on its head. How remarkable that gold is selling today for what it cost 25 years ago! Should it gold not have risen in value along with just about any other asset or service that you care to think of?

Then you can make an adjustment for inflation which has raged over the past 25 years. The wage packet of a new graduate has quadrupled in this period, for example, and house prices have risen by a higher factor than that.

Gold cheap in real terms

Even if we take consumer price inflation as an index, and most statisticians agree that it understates inflation, then the gold price today should be $1,400 an ounce just to equal where it stood 25 years ago in real terms. Or if we adjust to the money supply growth, which is perhaps more relevant to gold, then we get $2,300 an ounce.

Now we can begin to understand the potential upside for gold. The previous record price for gold was $850 an ounce in 1980, that translates into $2,200 on the CPI and $3,500 adjusted to the money supply.

There is no other major asset class where such a massive undervaluation exists. Gold needs to more than double or even quadruple to regain its 25-year high in real terms, it is not there yet.

Upside potential

The upside is also clearly much higher if gold is to retrace its previous price movement. Many of the circumstances that drove gold higher in the 1970s are present today: fear of inflation, higher interest rates depressing bond prices, and high oil prices which are bad for profits and therefore equities.

In 1980 gold spiked to its all-time high after the Iranian Revolution and the supposed threat to world oil supplies. Given the rumblings over Iran's nuclear ambitions, is there not a sense of history repeating itself?

Of course nothing is ever exactly the same, but a 20-year bear market for gold ended in the year 2000, and gold has been on the way up ever since. Who is to say that this is not a bull market with much further to go, or at least heading back to where it was 25 years ago when adjusted for inflation.