Gold – Is It A Commodity, A Currency, Neither or Both?

To answer the question “what drives the prices of gold” we have to determine the nature of gold. Is it a commodity, a currency, neither or both? This article does just that. Read on.

The edited excerpts above and below are from an article* by Przemyslaw Radomski CFA (sunshineprofits.com) originally entitled Is Gold a Commodity or Currency? which can be read in its entirety HERE.

Is gold a commodity?

It is, from the physico-chemical point of view, a precious metal, which is mined just like any other commodity. In that context, it is therefore not a security, but a tangible, hard or real asset.

It is also a unique commodity behaving more like a monetary asset. From the investment point of view, the inverse relationship of gold with the U.S. dollar is practically the sole feature it has in common with other commodities.

While gold is very weakly correlated with other commodities (except silver) the yellow metal, according to the World Gold Council:

• is less exposed to swings in business cycles,
• is typically exhibits lower volatility,
• tends to be significantly more robust at times of financial duress than other commodities,
• is less used in industry and, therefore, is also less exposed to the business cycle,
• has production that is geographically diversified,
• its sources of demand are more diverse, which makes gold less volatile and less exposed to specific risks than other commodities,
• it is much easier to store than other commodities because gold is one of the densest elements,
• the yellow metal is almost indestructible – practically all gold that has ever been mined still exists in some form. Thus, the ratio of stocks to annual flows is much larger for gold than for other commodities (see chart 1 below) and, thanks to this feature,
• gold is much less prone to production shocks as the price of gold does not depend so much on current production. Any shortages can be relatively quickly fulfilled by recycled gold from the above-ground stocks. Contrarily, any positive supply shocks (sudden increase in mining output) affect the gold prices in a limited way, because the annual mining production is only a tiny fraction of the total gold holdings. Hence, the gold price is mainly driven by demand and changes in reserves rather than by the supply from the gold mines.

Chart 1: Approximate stock-to-flow ratios for gold (yellow), silver (blue), wheat (green) and crude oil (black)

Is Gold A Currency?

The unique features of gold:

• durable,
• easily recognizable,
• storable,
• portable,
• divisible
• and easily standardized

explain why this precious metal has been used as money for thousands of years, until 1971. This is, incidentally, another distinct feature of gold compared to other commodities (except silver)…and gold – again unlike other commodities – is still held by central banks and governments as a reserve asset (In fact, it is after the U.S. dollar and euro the third largest reserve asset in the world, according to the World Gold Council).

To complicate matters even more, gold differs not only from other commodities, but also from other currencies. The yellow metal:

• is a tangible asset, so it cannot be printed like fiat currencies.
• has a relatively inelastic supply which preserves its purchasing power, thus serving as a hedge against governments’ madness and as a safe haven during financial turmoil.

In a sense it is not a currency, since we cannot buy goods and services with gold coins or bars, but is rather an anti-fiat currency, bought when the trust in central banks and governments diminishes…In other words, gold does not depend on any single government or central bank, hence its price is not influenced by political decisions or the solvency of any institution. Thus, gold is a global monetary asset, which reflects global developments and which is heavily traded on the spot market (unlike commodities traded mostly on the futures market, but similarly to currencies).

Conclusion

Gold is neither commodity nor currency. It combines the features of both making it commodity money, (i.e. a commodity which historically has been chosen as money) and still remains a global monetary asset. No arbitrary political actions can increase its supply, and it has no counterparty risk (this is why it has no yield), hence it is still traded like currency or insurance against fiat currencies and market instability inherently connected to paper money.

*http://www.24hgold.com/english/news-gold-silver-is-gold-a-commodity-or-currency-.aspx

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