Feb 25, 2008 – During the fourth quarter of 2007, the gold price rose a healthy 12.4% from US$742.80 to $834.90. Obviously there was strong demand for gold during the quarter for it to achieve this gain. So I was somewhat bemused when I read a recent headline on Mineweb.com announcing that “Gold demand falls 17 percent in fourth quarter”. How is it possible that demand fell when gold’s price rose 12.4%?
Price is of course a function of supply and demand, but the supply of gold didn’t drop during the quarter and make gold more scarce. Its supply actually rose by approximately 620 tonnes, which is the amount of newly mined gold added to its aboveground stock. It is therefore self-evident that for gold’s price to rise during the quarter, demand rose too.
I therefore ‘clicked’ the article to read Mineweb’s analysis to see how it reached its erroneous conclusion about demand. It turns out that Mineweb was just reporting information from a press release of the World Gold Council.
Gold is one of the world’s most misunderstood asset classes. This press release by the World Gold Council no doubt added to that confusion, which arises because so many people – including many people within the gold industry – refuse to acknowledge that gold is money. They attempt to analyze gold as if it was a mere commodity with some jewelry fabrication and unimportant industrial application instead of what it really is – money.
Any good, service or commodity has value if it is useful. Gold’s value derives from its usefulness as money. In other words, gold’s value arises from its usefulness in economic calculation. This point is self-evident from the following chart, which presents a Base-100 analysis of the price of crude oil in terms of US dollars and goldgrams.
When viewed in terms of gold, the price of crude oil is essentially unchanged throughout the six decades presented in this chart. It is the dollar that is volatile, not gold. Economic calculation becomes sensible when prices are viewed in terms of gold, which provides a stable purchasing power over long periods of time.
So what makes gold money? In a nutshell, we do. Each and everyone one of us who recognize gold’s usefulness in economic calculation makes it money. We therefore hoard gold. It is accumulated, in contrast to all other commodities as these are consumed. But gold doesn’t disappear. All the gold mined throughout history still exists in its aboveground stock, except the minute amount lost along the way in shipwrecks, coin abrasion and the inconsequential weight of gold used in industrial applications which is not recycled. Gold’s supply is therefore its aboveground stock because newly mined gold is indistinguishable from gold mined hundreds or even thousands of years ago.
On the other side the equation, the demand for gold comes from each and everyone of us who hold it because of its usefulness. That usefulness arises – as shown in the above chart – from gold being money.
Given the above, there is only one way to determine gold’s price. It requires analyzing four forces. These are the aboveground stock of gold, the stock of national currency, and the respective demands for gold or currency. The interaction of these four forces determines the price of gold, or to be precise, gold’s rate of exchange to a national currency.
Gold is free-market money, which stands in marked contrast to national currencies which circulate by force of legal tender laws and similar heavy-handed government edicts. It isn’t governments that make gold become money – we do that. Collectively we give gold its value, and given its rising price, we know that the demand for national currencies is falling while the demand for gold is rising. I expect that relationship to continue, which means that rising demand for gold will continue to drive its price higher in the months and years ahead.