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Gold: Whose Precious?

My Precious

My Precious

In recent newspaper articles and, for a long time, on the Daily Reckoning, gold has been touted as the Next Big Thing in commodities, that it is destined to return to glory as the chief component of a world reserve currency. It is, however, just a metal, albeit a pretty one. One has to wonder just why a substance which, truth be told, is in abundance compared to its utility in industry, is so sure to be the natural heir of our current, doomed fiat based monetary system.

The history of Gold is a fascinating subject which reaches back to the dawn of civilisation. A general timeline of the historical milestones relating to gold can be seen here (PDF), but in this article we address Gold’s more recent history in order to answer the question: Is gold a part of our monetary future? Is it a wise investment?

Technicalities

Gold is a metallic yellow substance of molecular weight 197. It is the most malleable of all metals and is more dense than lead (1 cubic centimetre weighing 19.3g at 20 degrees C). Its high electrical conductivity and corrosion resistance has made it a particularly useful metal in the electronics industry for the coating of electrical contacts and for wire bonding of integrated circuits to printed circuit boards, especially in situations where a low failure rate is desired. Other minor uses for gold have included reflective insulation (such as in the lining of McLaren’s Formula One engine compartments) and as a reflective surface of some of the more expensive CD’s. Gold also has some medicinal uses. Prior to the 20th century, gold was solely used for jewellery, decoration and as a form of currency. Even today, the vast majority of newly produced gold is used for jewellery (over 80%). That said, around 25% (30,000 tonnes) of the world’s gold is in the possession of central banks, particularly of the USA, Germany, the IMF, France, Switzerland and Italy. Privately owned bullion accounts for around 20,000 tonnes. It mostly just sits there, doing nothing, as far as anyone can tell.

Gold Producers

The rate of gold production around the world has risen steadily during the 20th century, with a peak attained around 2000AD. Its abundance (measured as ounces per capita) has increased, despite its function as collateral to the issuance of money entering obsolescence. South Africa produces the largest quantities (roughly 500,000kg per year), followed closely by USA and Australia. South Africa is also the world’s largest gold resource, but countries such as China, Indonesia and Canada produce modest quantities compared to estimated reserves.

Considering that the basic, industrial need for gold is rather small (around 500,000kg per year), it is the demand for jewellery and market speculation that can be said to have driven production to its current high levels. This is an important consideration. Were the jewellery industry less powerful, or if shiny metallic jewellery were to lose its fashionable status, there would be a glut of gold on the market in excess of demand. After all, gold is nowhere near as important to the world’s daily activities as, for example, oil, fresh water, arable land or food.

Retail sales of jewellery are an extremely important part of the gold riddle when it comes to considering gold’s potential future role as a monetary base. By becoming attached to the stuff, the populace shows its faith in gold as a valuable commodity, even though gold has only modest functional use. Even though central banks have shrugged off gold in the past and embraced fiat currencies, everyone else is still in love with the lustrous metal, particularly those in developing economies such as India.

The Gold Market

The factors determining the price of gold are many, and many of them are steeped in controversy. Like any commodity, price is determined by supply and demand, but each end is heavily manipulated (the purchasing of jewellery is far from a rational activity).

At the supply end, it can be rather difficult to determine just who owns the world’s gold mines. In Australia, for example, more than 70% of shareholders in gold mining operations are foreign companies. Most of the mining happens in developing countries, however, where the story of gold mining today is as sad as ever. It is typified by heavy labour, deaths from accidents, pollution and poisoning of water supplies, massive open cut mines which, after they are spent, become expensive environmental liabilities. Just a single ounce of gold requires the production of 30 tonnes of waste rock.

On the question of market price manipulation, one organization (the Gold Anti-Trust Action Committee) has managed to shed a significant amount of light. Their research suggests that an unholy alliance exists between the US Government, western central banks, acting in part through Wall Street investment ‘banks’ such as Goldman Sachs to push the gold price to artificially low levels:

While the people who formed GATA sensed as early as 1998 that something was wrong technically in the gold market, it took us a couple of years to figure out that the culprits were not the visible players in the futures markets — the New York investment banking houses — but rather the Western central banks, and that the investment houses were just their agents, their cover. A British economist, Peter Warburton, may have been the first to put it together comprehensively, with his 2001 essay, “The Debasement of World Currency: It Is Inflation, But Not as We Know It,”…

In essence, it is alleged that these banks, which manipulate interest rates as they see fit, as well as effectively fixing the international currency exchange rates, also rig the gold price in order to milk the market and increase their sphere of influence. A speech by Russian Central Bank deputy chairman Oleg Mozhalskov reveals some interesting insights as to why this might occur:

For the central bank, the gold stock is the international payment reserve for the whole country — for the state authorities, private companies and corporations, as well as individual citizens. Like any reserve, it needs to be conserved, in terms of both actual physical form and its value. To a lesser extent, we need to be concerned about its liquidity, or more precisely, market price developments.

The contemporary gold market has emerged as a byproduct of a series of agreements between governments, initiated by the United States and supported by the other major powers, in whose possession the bulk of all gold ever extracted lies.

The Horse’s Mouth has spoken. The term gold market is probably a misnomer, however.

Central banks currently issue fiat money, but they still keep gold reserves, by and large. This shows that they were never of the opinion that fiat based currencies were going to last forever, but it also seems that they all believe that gold will undergo a return to its former seat of power. They understand that the current approach of using US dollars as a reserve currency is untenable, since the US dollar is based on an empty promise, leading to a situation of undisciplined over-expansion of money supply (which, not surprisingly, we are now seeing). American central banks and the US Government would be well aware of this fact, and so it should come as no surprise to any reader to know that many accuse them of artificially suppressing the gold price to create the impression that gold is less valuable and that fiat money is a better vehicle for doing business.

usGoldn

Buy in the evening, sell in the morning.

Central bankers deny that they manipulate the day to day fluctuations in the price of gold, but it has been noticed by some that the 24h gold price follows a predictable pattern, day after day, which can be used to make a tidy sum over many years (in the order of doubling one’s money every other year or so), by buying in the evening and selling in the morning. A random snapshot of today’s gold price movements confirms this theory, which managed to raise at least one eyebrow. Unnatural patterns in markets are what they are.

The problem with gold, for central banks, is that it just sits there, doing nothing. They want it to move around so that it can rise and fall in value. For this reason the central banks have released some of their gold reserves. An added incentive to release gold is to lower its price to support the fiat currencies (the central banks’ main product). The suspicion, however, is that these banks have released too much of it (without admitting the fact) and so have less in reserve than they claim to have. If this guess is correct, then it may well be that some central banks (ie: the Federal Reserve) will not want to allow gold to become a reserve currency any time soon, as it may attract an audit of its true gold holdings. On the other hand, gold is likely to be more precious than it is currently priced. Unless, of course, gold gets dumped by central banks and some other element wins favour.

Whose Precious?

It is clear, then, that the gold market is made up of several extremely large players (central banks and other similar institutions) and masses of little investors. The likelihood of making a profit from fair trading, based on conventional principles, is rather small. Also, given that central banks may have much less gold in storage than they claim, there is just as much probability that a future gold based currency will end up being another ‘fiat’ currency. That is, banks will issue certificates of non-existent gold, and the population will have to simply trust the banks, because it’s highly unlikely that the piles of gold bricks will be on perpetual public display.

The only reliable method of owning gold (and being sure that you own it) is to have the bullion in one’s hot little hand, to gaze at and adore, or to keep it in the form of jewellery. Either way it is still a fanciful venture for most people, because it is not foreseeable that gold will be circulating in person, in a cash society, any time soon. Nobody will sell you a carton of milk and a loaf of bread in exchange for several grains of gold dust. Gold is not a practical metal.

Gold, therefore, is not our precious, because we feel that money and effort is better invested in productive projects which address the immediate needs of the people around us, such as food production, essential services and the trade in other tangible goods. As maligned as housing may be, for example, it is still a more useful thing to own than a gold nugget, since people will be willing (even forced) to pay you to live in a house, but they won’t be as willing to pay you to have a quick hold of a gold nugget.

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  1. gatkin09
    July 4, 2009 at 12:35 pm

    I always find it curious how people talk about gold holding value in a crisis when actually it does not. If things get bad enough that people start selling their gold so they can eat, pay bills etc. then actually gold prices will head south very quickly.

    As you say in the article you cannot take you bag of gold dust into the local supermarket and do you shopping…so at around $940 USD an ounce people are paying a lot of money to feel warm and fuzzy for something that is produced at around $500 ounce. (maybe less now?)

  2. July 5, 2009 at 7:00 am

    Gold used to hold value in a crisis when it was the basis of actual money. It’s not money any more, and this is the thing that some people still can’t get into their thick heads. It leads me to suspect that the peddlers of gold’s wonders are probably owning far too much of it and are nervous because of this.

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