Understanding Gold Price Movements
This is from a close associate and fellow investor and explains very succintly why gold prices have been behaving in an unpredictable pattern in recent months
The are some common misconceptions on gold price formation:
1) The emphasis on mine supply is misplaced; it has very little impact on the gold price.
2) Much has been written in terms of supply and demand quantifying gold flows into market segments, such as industry, jewelry, coins, and funds. There isn't a connection between quantities and price in the way that is commonly understood.
There are two different kinds of commodities, the price formation process is different for each one.
The first type is a consumption commodity. Ie something the value of which is realized when it is destroyed, eg industrial commodities that once used can not be easily reconstituted, or agricultural commodities that we eat; once consumed it is gone.
Supply and demand matters for price formation with consumption commodities because in any given period, a certain amount is produced and a certain amount is consumed. If there is a shortage, the market place bids up the price, if there is a glut the market discounts the price.
The second type is an asset commodity. An asset is a good that is purchased to be held. Its value is derived from holding onto the item not consuming it. Think about a Van Gogh painting or corporate shares.
Gold is an asset commodity. Pretty much all the gold that has been mined is still in existence. Mine production adds about 1% to the gold stock each year and so supply is relatively inconsequential in comparison to the existing stock.
Many analysts look at gold as if it were a consumption commodity. They look at annual mine supply and industrial fabrication as the determinants of price as if it were barrels of oil.
With consumption commodities, there is a close relationship between the stock and the flow, but with asset commodities, the flow is inconsequential to the stock.
Gold price formation occurs at the margin ie through marginal price theory. The price of gold is set by individuals as they trade off the amount of additional units of gold they want to hold against additional units of other assets or money they want to hold.
On the demand side, the calculus is do I value one ounce of gold more so than my $1500 of cash?
On the supply side, the calculus is do I value $1500 of cash more than my one ounce of gold?
And this was exactly Ed's point. The fear of systemic collapse, rampant inflation following 2008 caused many individuals to value gold more than cash on hand and more so than equities. The sold at the bottom and plunged into gold. At the margin this drove gold price up.
Today the same group have bought into more green shoots, recovery and are now valuing equities (even though they are selling at very high prices now) more so than gold.The same group is selling at the bottom now and plunging into the top in equities. At the margin this is driving the price of gold down.
The big picture is this...
The original thesis for owning gold, ie that of western indebted nation insolvency being forestalled by inflation of the money supply has not changed. In fact it has significantly worsened.
The weak hands holding onto gold are being shaken out. They never understood why they wanted to own gold.