August 25, 1997 – In the last letter I discussed some basic tenets and related misconceptions about the supply and demand of Gold. Most importantly, I noted that Gold is accumulated and not consumed. Therefore Gold stands in marked contrast to soybeans, crude oil and other commodities, all of which disappear once used. These non-accumulated commodities disappear because they are either expended like foodstuffs and crude oil, or in the case of copper and other base metals, are widely dispersed by being placed into essentially irretrievable uses so that they in effect disappear.
My basic conclusion was that because Gold is accumulated, which means that nearly all the Gold ever mined throughout history still exists in readily marketable aboveground stocks, supply and demand analyses that lookonly at annual production are seriously flawed. I also concluded that because of this unique aspect that Gold does not disappear once mined, its annual supply is not a big factor in determining the Gold price, and that in this regard, the demand for Gold was all important. Finally, I noted that it is misleading to say that there is a ‘gap between supply and demand’ (popularly referred to as the so-called deficit) for the simple reason that Gold is not taken off the market forever. Because it is fungible, Gold mined years ago is perfectly substitutable for Gold mined today, and because it is accumulated (not consumed), that Gold mined years ago still existsso it can be readily dishoarded.
In response to a number of questions from readers, I would like to revisit the concept of Gold’s supply and demand. To do this, I would like to point out two glaringly incongruent statements inexplicably accepted today without questioning by nearly everyone. First, according to conventional wisdom, the demand for Gold is at record highs. Second, notwithstanding this supposedly robust demand, the reality is that the price of Gold is near a 12-year low.
Isn’t it logical and prudent to ask how it is possible for the Gold price to be so low in view of this reportedly record demand? Shouldn’t a record demand for any product also mean a record high in its price?
These two questions highlight the foolishness of most analyses that purportedly measure the supply and demand of Gold. They also highlight the fallacy of a basic premise widely accepted within the Gold industry today – that the way to higher prices is to increase the annual fabrication of Gold, mainly into jewelry. The industry mistakenly assumes that once this jewelry has been sold into the market, the Gold used in the fabrication of this jewelry will disappear as if it were copper, nickel or zinc. Conveniently overlooked are key facts that lay bare this delusion by revealing that fabrication is not important to the Gold price.
First, most jewelry is purchased for monetary value, not for fashion or adornment. Therefore, it does not ‘disappear’, but instead remains part of the aboveground hoard of Gold, which can be dishoarded into the market at a moment’s notice. Second, the annual fabrication of Gold has been growing for a decade – since Gold touched $500 per ounce in 1987 – while the Gold price during this period has more or less headed south. Third, historical evidence shows that the demand for fabrication increases when the price of Gold is low, and decreases when the price of Gold is relatively high. In short, the market treats Gold much like it were an equity of a large blue-chip company.
‘Strong hands’ accumulate good value (when the purchasing power of Gold is low, their exchanges of national currencies for Gold increase), and then distribute Gold when it is overvalued (when Gold’s purchasing power is high, their dishoarding of Gold in exchange for national currencies increases).
There are no earth shaking revelations from this conclusion. It just simply states what one would expect. There are always rational people buying low and selling high. Remember all the people lined up outside jewelry shops in January 1980 waiting to meltdown Silver heirlooms? They were acting rationally, which also explains why the purchases of Gold jewelry at the time slowed to a mere trickle.
The Gold industry is deluding itself into thinking that higher prices will result by annually increasing the fabrication of Gold. Higher prices will only come in one way. The demand for Gold as money must grow. There’s no mystery to this conclusion. It only requires acceptance of the politically incorrect notion that Gold is money, meaning that despite the pronouncements of governments to the contrary, Gold has not been demonetized.
The reality is that Gold no longer circulates current, but it still is money. Gold is money because it serves a useful purpose as a monetary unit of account. In order words, people – if not governments and political leaders – intuitively understand that Gold can be used purposefully to measure items of wealth. In other words, the purchasing power of Gold tends to be constant over long periods of time. Goods and services purchased today require the same weight of Gold in exchange as they did decades ago. For example, it requires as much Gold today to purchase a Colt-45 revolver as it did 100 years ago. A Ford Mustang convertible new on the dealer’s floor in 1964 cost nearly 72 ounces of Gold, about the same as a new 1997 Ford Mustang convertible costs today.
This revelation about Gold’s monetary usefulness is not new.
In the debates in London during the Napoleonic War when the redeemability of the British Pound into Gold was suspended, Henry Thornton observed: “We assume that the currency which is in all our hands is fixed, and that the price of bullion moves; whereas in truth, it is the currency of each nation that moves, and it is bullion which is the more fixed.” This observation was proven to be true by Roy Jastram in The Golden Constant (1977), which analyzed the purchasing power of Gold over long periods of time. Allowing for changes in the annual supply of wheat from drought or abundance, a bushel of wheat has cost the same weight of Gold over hundreds of years.
Therefore, the issue for the Gold market today is not central bank dishoarding, but dishoarding in general. Does it really matter whether dishoarding comes from central banks or from private hoards of Gold? No, of course not. Assume for the sake of argument that central banks owned no Gold. If the market does not value Gold’s usefulness as money, its price will still fall. Gold is near 12-year lows because the demand for Gold is near record lows. We know this conclusion to be true intuitively from Gold’s price, but it can also be proven by the Fear Index.
The Fear Index is a reflection of the fundamental elements that determine the price of Gold. Is the demand for Gold (the Fear Index) high? If it is, there is fear about the monetary and banking system. These fears include: inflation, bank failures, credit defaults, exchange rate fluctuations, devaluation, etc.
Alternatively, is the demand for Gold (the Fear Index) low? If so, confidence in the monetary and banking system is high, and if confidence is high, national currencies are naturally preferred in preference to Gold.
The Fear Index for the US Dollar at the end of July is 1.66% (261.7 million ounces of Gold in the Federal Reserve at its market price, divided by M3). The only time the Fear Index was lower occurred in 1971 when confidence in the US monetary and banking system was at a high because few people believed that the federal government would default on its commitment to redeem 35 Dollars for one ounce of Gold – but it did.
I estimate the Fear Index for the world (the market value of the Gold in all central banks, divided by the quantity – M3 – of all national currencies) to be less than 5%, a record low. Never before have people placed such a great trust in national currencies compared to Gold. Never before have people held so much of their monetary wealth in national currencies instead of Gold. Consequently, never before has the demand for Gold been this low, regardless what you might read in the papers or hear from the Gold industry. And consequently, because the demand for Gold is low, the price of Gold is near 12-year lows.
Therefore, forget what you hear today about what Gold supposedly is or is not. J.P. Morgan had it right. In testimony before Congress near the turn of the century, he stated that Gold is money – nothing else.
Most of the aboveground stock of Gold is still held for monetary purposes, nearly 80,000 tonnes of the total 108,000 tonnes (see our website for charts presenting the total aboveground Gold stock, www.goldmoney.com). Because it is useful as a monetary unit of account, most of the aboveground Gold stock is held as bars, coins and high-karat monetary jewelry (as opposed to relatively unimportant low-karat fashion jewelry). This usefulness gives Gold most of its value.
Admittedly, the non-monetary uses of Gold also contribute to Gold’s overall value and therefore its price, but only a relatively small part of the aboveground Gold stock is held for non-monetary uses, so its contribution is relatively unimportant. Until the Gold industry recognizes these basic truths, they will not understand why their mines are doing so poorly for their shareholders, compared to what would otherwise be possible if they actively and purposefully communicated Gold’s raison d’Ãªtre – that Gold is money.