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Friday, July 29, 2011

Is GOLD money? Or is it a commodity?

Nice article for reading.

If gold were simply bought for its industrial use things would be much simpler...

IS GOLD money? Or is it a commodity? asks Julian Phillips of GoldForecaster.

If gold is a commodity then it rises and falls as a result of the ebb-and-flow of the economies that use it. If so, it will move in synch with the financial markets cycles and remain subject to their dominance. But when it comes to gold and silver, nothing is that simple!

If the bulk of the demand for a commodity is contracted to buyers, then the only influence these contracts have on the price of the commodity is through the referencing of that supply to the market price.
The supply of the metal in the open market outside of contracted amounts is the quantity of that metal that determines the price of the metal. Call it the 'marginal' demand or supply. This supply is sent to the open market for buying by non-contracted buyers. It could be just to top up for unforeseen demand, or it could be to sell overbought amounts. This determines the liquidity of the market.

On top of that, speculators frequently enter the market taking a view on demand and supply expectations, taking off supplies to force prices higher or introducing them, to force prices lower. In a pure commodity market, these views are based on industrial demand/supply expectations.

But gold is not so simple or predictable. Most buyers of gold do not Buy Gold for its industrial use. Where it is used in industry it is done so for hi-tech purposes, which is relatively price-insensitive. So the price of gold has little bearing on the demand from industry.

Gold is used to decorate people in its Western jewelry application. There is little sense of showing off the extent of your wealth when wearing gold in the West. Additions of jewels and artistic presentations add so much to the cost of such jewelry that the price of gold in such jewelry is a minor factor. This type of jewelry demand does fluctuate with the state of an economy, but such demand is a small component of the gold market.

In the past it has been an influential one, particularly before the eastern markets 'emerged'. Add to this the determination of the jewelry trade to extend Buying Gold down to poorer people's levels by lowering the purity of the gold sold. This increased the vulnerability of the Gold Price to the state of the developed world economies. Such demand became the 'swing' factor in the Gold Price.

This too was at a time when central banks were not only out of the gold markets but encouraging a heavy increase in supply. As a result, analysts' studies placed great emphasis on western jewelry demand.
Then at the turn of the century, the gold market changed its shape. Asian markets 'emerged'. The driving force behind their buying was totally different to western attitudes. They followed the maxim, "One buys gold, not to make money, but because one has money."

The gold bought was nearly pure. It was bought because it was treated as money and money of a higher quality than currencies. When used in jewelry, it was a statement of the financial security of the wearer. Nothing could be more different than the Western view of jewelry. Central banks changed their attitudes to holding and selling gold then too.

These structural changes altered the dynamics of the gold markets. Over time, investment demand grew to become by far the greatest source of demand for gold. In addition, central bank-inspired supplies (through their encouragement of increased supplies) stopped and gold producers became a source of demand. This happened for a while as they bought back previously sold gold. Central banks cut back on their supplies to the market until they stopped selling and other central banks began buying.

But more was changing in the gold markets. As the ability of currencies to give an accurate measure of monetary values decayed, gold began to fill the hole they left. This aspect of value grew to the point that the Robert Zoellick, head of the World Bank suggested that gold be used as a reference for value measurement. The concept has taken hold again, but as a banker, Mr. Zoellick has remained silent since then. His silence, while deafening, has reaffirmed gold's inherent value. After all, as Alan Greenspan, the most famous Fed Chairman said, 'Gold is money in extreme times'.

Its monetary value lies in its remarkable quality of being both an asset and liquid cash, globally and in all circumstances.

Currencies can't be this. They remain the obligations of one nation or another, dependent entirely on the reputation of the nation printing them. Gold is considered money, without the strings that are attached to national money. Investors from central bankers to Indian or Chinese rural farmers believe that gold is a counter to unbacked currencies issued, at will, by national governments all over the world.

Gold has no nation.

It carries nobody's obligations.

It's what enemies will accept from each other.

The concept of consuming gold is no longer a part of this gold world. These structural changes cut gold off from being just a commodity.

Gold is not a commodity!

Julian D.W. Phillips, 21 Jul '11


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