Gold: Not Quite A Regular Commodity

To some, the point Robert Blumen makes may be obvious - but many gold analysts seem to be unaware of it. Gold is often treated as if it were a regular commodity, but it has one crucial differentium from the real thing: commodites are consumed, while gold hardly is. Although jewelry can be seen as consumption, the gold isn't destroyed as part of the fabrication. Normal commodities are destroyed as they're used.

As Blumen himself explains in an interview with Jay Taylor:

[T]here are two ways of looking, or there are two different kinds of markets, there is commodities and there are assets. I'm going to define these in an idealized way, nothing really is perfect. But for the purpose of discussion, a commodity is something where there are no accumulated stockpiles of it.

So in the case of a commodity whatever gets produced also gets sold, it gets purchased and it gets consumed. And by consumed I mean it's destroyed. It's transformed into a form where it is taken off the market permanently.

An example of that would be gasoline or any agriculture, something you eat. You buy it and you destroy it. So for a commodity the supply and the demand have to be very tightly balanced and if one of them changes the other one has to change. And the way that is accomplished in a market economy is through price. You would have more supply the price has to go down.

The other type of market is what I am going to call an Asset Market. And let's say for the moment an asset market in an idealized way is the market in which there is a certain stockpile of the asset, which doesn't change. And in asset market, you can't really look at quantity supplied and quantity demanded, because the quantity is the same. In asset market, the quantity of the existing stockpiles is traded around among different people. So gold is an asset.

Now the gold supply does grow a little bit each year, it's between 1% or 2%, but the market is dominated by trade among the existing stockpiles of gold, and that's how the price is formed.

Blumen goes on by explaining that an increase in supply doesn't matter all that much to the gold price if added demand is there to absorb it. (By corollary, a shrink in production doesn't matter all that much if demand to hold is dropping.) This follows from the fact that a large majority of the potential supply is gold already dug up from the ground.

As an asset, gold's main use is to protect against fiat debasement. When that debasement is increasing, gold tends to go up. In times when the debasement is letting off, gold tends to decline. Increases in fiat currency ultimately trump increases in supply.


He also says there's no hard-and-fast way to value gold. Some like to use the U.S. money supply, but such analyses essentially discount a future gold standard. That may well come, but "eventually" is quite different from "imminent." The metric that the new goldbugs have settled on is real interest rates. Below-average, particularly below zero, real interest rates melt away the opportunity cost of holding gold.