The Approximity Gold Price Model is based on the MZM (money with zero maturity; read more) money supply measure as provided by the U.S. Federal Reserve and the U.S. Federal Gold Reserves.
The rationale of the model is fairly simple. MZM, i.e. financial assets redeemable at par on demand, is what the Federal Reserve system has to underwrite in the case of a banking crisis to avoid panics. If the central bank fails to underwrite sufficiently large parts (potentially all) of MZM, a panic might ensue where money could be withdrawn in such large amounts that it could become systemically dangerous. The Fed therefore has no choice: it has to underwrite MZM.
However, what is MZM backed by once it has been underwritten by the Federal Reserve? Since the U.S. Dollar is a fiat currency and therefore intrinsically worthless, MZM is essentially backed by the most liquid (and in fact, the only real [i.e. non-Dollar dependent]) asset the Federal Reserve holds: gold. The size of the U.S. Federal Gold Reserves is therefore the second critical component of the model.
The equilibrium price is now straightforward: divide MZM by the amount of gold ounces owned by the Federal Reserve.
On October 19, 2009, this equilibrium price is exactly $36,253.04 per ounce of gold.
At Approximity, do we believe that this price will be reached anytime in the near future? It seems unlikely unless we experienced some kind of hyperinflation in the United States. It should also be said that during the last 50 years this equilibrium price has in fact never been reached (there have been no major bank panics either).
The highest gold price to MZM equilibrium price ratio was established in January 1980 when spot gold reached approximately 25% of the MZM equilibrium price. At the time of writing (October 19, 2009), the spot gold price in the London Bullion Market stands only at 2.91% of the MZM equilibrium price (see chart below).
A repeat of the 1980 spike at current money supply levels would mean a gold price close to $10,000/oz. It is therefore no exaggeration to say that the current price of gold is very cheap in terms of money supply.
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