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The Basis for the Value of Gold


What is the basis for the value assigned to gold? The arguments for and against gold having high value fall broadly into two camps.

Camp 1 - The Gold 'Bugs'

The gold bugs argue that gold is a one of very few asset types that hold their value over long periods of time, extending beyond the lifetime of any fiat money system, nation or even civilisation. They argue that gold has a particular combination of tangible qualities that back its stable value.

Camp 2 - The Gold 'Bears'

The gold bears argue that gold has no or little inherent value due to its limited practical utility and that it should therefore be avoided as a serious investment asset. The gold bear argument is essentially that the value assigned to gold is based on subjective and/or intangible qualities and therefore liable to collapsing at any time through a large scale change of opinion.


A Pragmatic View

A pragmatic view would be that people as a whole clearly do assign value to gold and have done so more or less consistently for a considerable stretch of time, as is evident from the historic price record (e.g. see Measuring worth, The Price of Gold, 1257 - Present). Furthermore, archaeological records indicate that gold was a valued commodity in much earlier civilisations such as those of ancient Greece and Egypt. So the question becomes - what is it about gold that leads people on the whole to assign it such value? What qualities of gold back its continued and relatively steady valuation over historic time periods, across distant geographic regions and distinct cultures? And are these qualities tangible (objective) or intangible (subjective), perhaps the result of incorrect beliefs passed down through generations (see Dogma) and/or some form or forms of cognitive bias produced by evolutionary pressures? (see Evolutionary Psychology). Essentially, is gold at risk of significant devaluation through some kind of large scale enlightenment event?

As an aside, if gold's value is backed by intangible qualities the question for the pragmatist becomes whether those qualities (or their perception) are likely to persist into the future in a manner that maintains gold's value. Noting that much dogma has persisted over historic periods to the present day, significantly resisting erosion despite most populations having acquired widespread and cheap access to scientific knowledge (you can lead a horse to water, but you cannot make it drink). Such resistance to reason alludes to deeper cognitive, cultural and genetic causal roots rather than simple lack of access to sufficient knowledge.


Key Qualities of Gold

In my view gold's value is largely attributable to a number of tangible qualities each of which do not impart great value individually, but in unison become more than the sum of their individual worth.

Chemical Stability & Corrosion Resistance

Gold is one of the least reactive solid elements making it resistant to corrosion to the extent that it is often found in nature as elemental gold. Specifically, gold is unaffected by air, moisture and most corrosive reagents. Such stability is clearly a highly desirable quality for any material we would wish to use as a store of wealth, but also for any material to be considered for use as a unit of currency with intrinsic value (e.g. gold coinage). Gold remains as stable in shipwrecks at the bottom of an ocean as it does in vaults, and its weight generally means that it stays where it falls.

Scarcity

The amount of gold in the Earth's crust that is accessible sits within an advantageous range with respect to its use as a store of value (and in the past as widely used unit of currency). Too much gold and its ubiquity would make it worthless, too little and its scarcity would likely endow it with a high value per unit mass but it would be too rare to be useful as a large scale store of wealth for large populations or as coinage. Furthermore a very rare material is prone to large price fluctuations with small changes in supply and demand. The total amount of gold sits at something of a 'sweet spot' (or within a sweet range at least), being rare enough to justify significant value but ubiquitous enough to have practical utility as coinage, jewellery, etc. and to allow a significant portion of the world's population to each own a small but notable amount. Essentially, more than a microscopic amount that would be easy to lose, and less than a carload which would be impractical to keep and exchange.

Stability of Supply

In 2009 the total amount of mined gold in the world was estimated to be 165,000 tonnes, an amount that would form a cube approximately 20 meters on each side. Mining production in recent decades has been in the range of about 1000 to 2500 tonnes a year, therefore the upper level of that range represents an inflation rate in the total amount of gold (and thus a dilution of its per unit mass value) of about 1.5%. This is much lower than the long term rate for most fiat currencies, and is clearly limited by the significant amount of effort required to mine new gold each year and the steady depletion of high quality gold mining reserves over time (the amount of gold remaining in the ground that we can reasonably extract). This limit represents a guarantee of sorts that the quantity of gold will remain stable regardless of political and social events, and that therefore the value of gold will not be diluted significantly by an increase in supply. Furthermore, gold cannot be destroyed (realistically speaking) although it can be confiscated by governments and small amounts may be lost each year, e.g. through industrial processes. Most of the gold ever mined still exists in an accessible form such as bullion and jewellery.

In contrast to gold's supply stability, the supply of money within fiat currencies is controlled by people (governments, banks, politicians, public opinion, etc.) and is therefore prone to volatility related to social and political events. In fact the probability of total or near total devaluation of a fiat currency tends towards 100% for sufficiently long periods, and commonly fiat currencies have lifetimes of just a few years or decades before collapsing. Gold's stable supply implies that the price variations we observe are related to changes in sentiment and valuations priced in volatile fiat currencies. However, over sufficiently long periods this effect levels out and does not act to either increase or decrease gold's value over long stretches of time.

High Density - Difficulty of Faking

Gold's high density makes it hard to fake by substituting for gold coated bars or coins using a cheaper metal as bulk. For instance, the density of lead(Pb) at 11.342g/cm^3 is significantly lower than gold at 19.282g/cm^3. Most other elements with a sufficient density are either too rare, expensive, hard to acquire, dangerous (uranium and plutonium!) and/or just impractical for use as a gold substitute. A notable exception to this is tungsten with a very similar density at 19.25g/cm^3 and a much lower purchase value. Other methods of testing for authenticity exist but none as simple, quick and cheap as weighing and observing outer colour and malleability (e.g. biting a coin).

Malleability & Ductility

Gold is the most malleable and ductile of all metals (that are solid at room temp). This allows a high value gold coin to easily be cut into multiple lower value pieces, a process which does not destroy any of the original coin's value due to the intrinsic value of the gold. The pieces can subsequently be reformed by moulding molten gold back into a single coin. This quality of gold is important where gold is used as a currency.


Notable Subjective Qualities

In my view the key qualities listed above form the basis for gold having significant value, however gold's distinctive colour is clearly a major factor in its use for jewellery and ornamentation. Gold keeps its lustre because its corrosion resistance prevents it from tarnishing in the way that say silver does. In early communities before other metals were discovered gold would have been even more notable, its colour and lustre would likely have made it a very striking and novel substance to such people. Again, the reason why gold was known to such people at all was because of its existence in nature in its pure elemental form - due to its low propensity to react with other elements.

Gold's high density also gives it a quality 'feel' by way of its weight.


Final Points

Demand for gold for investment purposes is chaotic, reflecting the chaotic nature of global economics and politics. In times of prosperity demand flows into productive assets with positive real yields such as land, property and consumable assets. Secondary to this is a demand for interest yielding debt such as government and corporate bonds. In such a climate gold is often overlooked and its price tends to be suppressed as it does not yield any interest payment. What it does do though is remain in existence with a stable total quantity, such that at each occurrence of financial, economic, social or political turmoil gold's real value rises back to levels comparable to that achieved during all previous such events. Priced against real things that everybody needs such as property, food and clothes, gold has a remarkably stable price. Governments and their fiat currencies come and go, but the gold remains. In times of turmoil and uncertainty people will tend to look to gold as an asset that can be carried with them to buy food, transportation, shelter, protection etc. in whatever country or jurisdiction they may find themselves in regardless of that country's official sovereign currency. In that respect gold is a true universal currency and is widely recognised as such worldwide in a way that no other substance is.


Colin, November 2011



Copyright 2011 Colin Green.
This article is licensed under a Creative Commons Attribution 3.0 License