Basic Facts About Gold

There are about 5 billion ounces of above ground gold supply worth about USD 5 trillion at current prices. Perhaps half of this is in deliverable, investment-grade form. The above ground gold supply is growing at about 1.5% annually, the 300 year average.

New gold supply is price inelastic. If you double the gold price, production will fall as miners extend precious mine life by processing lower grades through fixed rate capacity. Building new capacity is the work of decades. Re-opening old mines is difficult and expensive and there are few worthwhile opportunities which have not been exploited. Meanwhile, discovery rates are declining, discovery costs are rising, mines are depleting and production is falling. Peak gold production was probably reached in 2000. The world's best gold deposits have been found and mined.

Gold's highest and best use is in a vault as a store of value. It is not a commodity. Jewelry 'consumption' of gold is a traditional store of value. The industrial/medical uses of gold are diminimus. If gold had important other uses, there would be less of it and the price would be lower because it would be valued as a commodity subject to substitution effects. No other substance has the unique properties and a supply sufficient to act as an ultimate store of value which is why gold has had this role for at least 6000 years.

Gold is therefore a financial asset in physical form and sometimes a currency. It goes up in price when confidence in other financial assets [stocks, bonds and currencies] is falling and falls when confidence in these alternatives is rising.

Other financial assets have the advantages of convenience and income. Gold's advantage is that it is final settlement anywhere in the world. Gold backs itself whereas other currencies and financial assets merely represent, and depend upon, the countries and companies which issue them and stand behind them. Gold is a currency without a country or central bank...there is no issuer to inflate supply or default on its obligations.

There are approximately USD 150 trillion in other financial assets world-wide so the current value of above ground gold is about 4% of this total. In 1980, when inflation weakened confidence in stocks and bonds, the ratio was greater than 25%. It currently requires about 9 ounces of gold to buy the Dow, down from 44 in 1999. In 1980, the ratio reached 1 to 1.

Gold has no P/E or other standard valuation metric. Its price can go where the market decides. How much will the owners of USD 150 trillion in financial assets pay to protect themselves from deflation, inflation or default?

James S. Anthony