A Reminder of How Different Gold Is

Courtesy of Sandeep Jaitly @ Fekete Research:

Should gold be considered an ordinary commodity like copper or lead? At first blush, this might be a reasonable assumption to make, but on closer inspection it doesn’t quite hold up.

Gold has constant margin utility. This means that, for any individual, the satiation point is so far removed as to be infinitely far away. Each ounce of gold is accepted on the same terms as the previous ounce of gold already owned was accepted. A consequence of a substance having constant marginal utility to us will be a large ‘stock to flow’ ratio. The stock to flow ratio is the ratio of global (above ground) finished inventory to annual primary production.

Assuming a total gold inventory of around 150,000T in 2002, it can be seen that this as a multiple of annual primary production is currently in excess of 65X. According to the World Bureau of Metal Statistics (WBMS), primary production of copper was 19.8Mt in 2011 and total copper inventory was around 0.78Mt. This puts the stock to flow ratio for copper at 0.04X (in 2011) – over 1,600 times less than gold’s stock to flow ratio. What about wheat? Total global wheat inventory (from United States Dept. of Agriculture) was around 175.6kt at the end of 2011. This compared to primary wheat production that year of 418.5Mt giving a stock to flow ratio of 0.05X.

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The following is a (not exhaustive) list of common views on gold:

1. Gold is a useless commodity compared to, say, oil.

2. Gold is a rare metal.

3. Backing money with gold prevents inflation.

Each of these statements will be examined for their merit.

1. Of course, ‘use’ is a strictly subjective concept and to say that one commodity is ‘useless’ and another ‘useful’ adds nothing to a discussion. If gold is a useless commodity, then why does humanity continue to accumulate it – year in, year out – even though there are hundreds of times this amount available already? Is the act of mining gold useless?

2. By the above, it can be seen that on the contrary, gold is an abundant metal. ‘Rare’ as a concept cannot be restricted to what can be seen or felt, but attempted to be rigorously defined. Comparing the amount of copper available in inventory at any one moment to the amount produced annually, we can see that it’s a very small fraction, whereas for gold it’s a large multiple. Because copper, oil and wheat etc. are consumed, at any one moment in time, there isn’t much around compared to the amount produced annually. The same is also true of platinum and palladium. By these metrics, gold is the least ‘rare’ metal on the planet.

3. This is a superficially innocent statement but ‘money’ has a very strict definition: the most marketable good (leaving aside differences between in the small and large.) ‘Most’ is a superlative that denotes a singular. Therefore any claim to money, even a real bill, isn’t money. The management of a state-ordained fiat number (the ‘money’) against gold – known as the classical gold standard – is nearly as ridiculous a concept as fiat itself.

The ‘most marketable good’ will always exist and it seems, over the course of recorded history, to be gold. What if gold were confiscated by the authorities? The ‘most marketable good’ as a concept still exists and silver would shift from being second to first. Silver would be treated as gold would have been prior to its confiscation. In this situation, copper would move from third to second in terms of marketability. Marketability as a concept cannot be confiscated by any authority, nor can it be grafted on to any particular object.

Excerpt from ‘Course of The Exchange,’ fourth quarter 2013.

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