Good Gold Article
Money Versus Currency
There is a difference between 'money' and 'currency', although the two terms are often used interchangeably.
To borrow a definition from James Turk, money is a tool of economic calculation that enables the
communication of value whereas currency is the medium that facilitates an exchange between participants in a
market. Put another way, money is conceptual whereas currency is physical - money allows the mental
calculation of relative value whereas currency is the thing that actually changes hands. Using this definition, the
US Dollar is both money and currency while gold is a form of money that does not circulate as currency.
Governments have not demonetised gold, they have prevented it from (officially) circulating as currency.
Furthermore, governments do not have the power to demonetise gold since money is in the eye (or, more aptly,
the mind) of the beholder.
In addition to being money gold is a commodity and, as such, its relative value would be expected to bear some
positive correlation to commodity prices in general. However, this correlation is not particularly strong and is
getting weaker all the time, probably because the amount of gold being used for non-monetary purposes at any
given time is miniscule in comparison to the 80,000 tonnes of above-ground gold that is being held for
monetary purposes. Gold's price can hence more appropriately be referred to as an exchange rate, with the
gold-USD exchange rate tending to move with the SF-USD and euro-USD exchange rates.
Although gold is no longer an official currency, over the past decade it has begun to unofficially circulate as
currency due to the proliferation of gold loans. The gold currency is not available to the average person, but it is
widely used as a medium of exchange within the banking community. In fact, low gold interest rates and a
long-term downward trend in the gold-USD exchange rate have made the gold currency very popular as a
means of financing mining operations and various speculative ventures. This growing use of gold as an
unofficial global currency has tended to further de-emphasise any positive correlation between the gold price
and other commodity prices.
The Importance of Investment Demand
Two logical errors we often encounter when reading analyses of the gold market are:
a.Large-scale lending and short-selling of gold has caused the major down-trend in the gold price or has,
at least, extended gold's bear market, and
b.The large gap between newly-mined supply and fabrication demand will eventually lead to a huge rally
in the gold price
Firstly, there is no doubt that gold-lending and short-selling have had a marked effect on the gold price,
particularly over the past 2 years, but it should always be remembered that these strategies that benefit from a
falling gold price have not caused the bear market in gold. A secular down-trend already had to be in place
before such activities could have ever become popular. The proliferation of gold-lending and short-selling is an
effect of gold's bear market that has acted to reinforce an existing trend.
Secondly, the deficit between newly-mined supply and fabrication demand is irrelevant to the gold price. A
falling gold price always leads to an increase in fabrication demand and the further the price falls the greater
the fabrication demand will become. Similarly, as the gold price rises fabrication demand will fall. Fabrication
demand is an effect of the gold price, it is not a driver of the gold price. If gold moves up to around $400, as we
suspect it will at some point during the next year, fabrication demand will fall substantially and may even drop
below newly-mined supply. Such a 'surplus' would be just as irrelevant to the gold price as today's so-called
'deficit'. In fact, during a gold bull market we would expect newly-mined supply to consistently be in excess of
fabrication demand. The bottom line is that investment demand, not fabrication demand, determines the gold
price.
Those who focus on newly-mined supply and fabrication demand are ignoring the fact that gold is money and,
therefore, that traditional commodity-market analyses are of little use. As we've said on numerous occasions
over the past few years the gold price will rally when the investment demand for gold increases and this, in turn,
is unlikely to occur until the investment demand for the Dollar wanes (something that now appears to be in
progress). It is worth noting that the total supply of US Dollars has increased by 30% over the past 3 years
whereas the total supply of gold has grown by less than 6% over the same period. Therefore, a much smaller
percentage shift in investment demand, from Dollars to gold, is required today to generate a particular increase
in the gold price than would have been required 3 years ago.
Steve Saville
Hong Kong
6 December 2000 |
