Why is gold valuable?
Gold is relatively unexciting and useless compared to other metals and yet it demands sky-high prices. So why is gold valuable? We have a look at what gold is used for and what impacts the price of gold.
'A fetish for gold is deeply embedded in the human psyche' – author John Kay.
Gold has held a unique place among humanity and been a source of value since it was first mined in the days of King Croesus in Lydia in 550 BC. Civilisations of past have associated gold with qualities like immortality and enlightenment, and today’s society still treat it as a symbol of perfection, whether it’s by competing for a gold medal or abiding by the ‘golden rule’. It has been gifted to gods, created mythical golden cities like El Dorado and created real-life gold rushes across the world, spanning from Canada to South Africa. The metal has been the driving force behind the rise and fall of empires, inspired wars that left permanent scars, and become part of people’s national identity, such as the people of Ghana and Mozambique which both feature gold in their flags as a symbol of their mineral wealth.
But exactly why is gold so valuable?
Facts about gold and the properties of gold
Gold, chemical symbol Au, can be found in mineral veins and alluvial deposits around the world, and often produced as a by-product of other metals such as copper and lead (although there are many large mines primarily producing gold). It is harder to find a single one-ounce nugget than it is a five-carat diamond.
Gold, soft to the touch with a satisfying weight to hold, boasts some unique qualities compared to other metals, predominantly its indestructible nature and resilience. It is chemically inactive, meaning it is anti-corrosive and resistant enough to remain unchanged for thousands of years.
Gold’s ever lasting abilities means it takes unworldly forces to form. Theorists believe none of the gold that has ever been extracted was formed on Earth, and is instead the creation of exploding supernovas or from inside colliding neutron stars.
It is a good thermal and electrical conductor. It is ductile, meaning it can be stretched without breaking, and malleable to allow it to be spread into thin sheets without cracking. Just one gram of gold can be hammered out into a metre-wide sheet or pulled into a 165 metre long wire.
Due to the softness of gold it is often alloyed with harder metals like silver or copper to improve strength. The purity of gold is measured in carats, with 24 carats equal to 100% pure gold and 18-carat gold representing an alloy with silver containing 750 parts gold per 1000.
Why is gold valuable?
The perceived value of gold has been gradually ingrained in the mind of society over thousands of years. The importance of gold in forging the world’s first coinage gave it a long-lasting role that saw the metal remain the backbone of the world’s currency markets until just 50 years ago.
Original payment systems required physical units that could be exchanged between traders and merchants, and precious metals were perfect for the job. This meant goods could be traded in principle without the need for immediate delivery, and acted as a mutually-recognised unit of exchange that was directly comparable on a like-for-like basis.
Gold and silver quickly became the metals of choice for governments looking to create currency. The malleability and low melting point meant they were ideal to forge into coins. The unique colour and shine, combined with the fact it doesn’t tarnish, gave gold a unique edge over other metals and the rarity installed confidence because people could have faith it would hold its value as the difficulty in mining gold meant no-one could try to devalue the metal as a currency.
The world’s first currencies were therefore underpinned by gold and, surprisingly, remained this way for centuries. Virtually all countries stopped pegging their currencies to the amount of gold they had stashed away in their vaults by the early 1930s, apart from the US which kept the dollar fixed at $35 per ounce for four more decades. The dollar remained pegged to the price of gold until 1971, but because most currencies were in turn pegged to the dollar it essentially meant gold retained its role as the backbone of the global forex market until then.
The decision to stop underpinning currencies with gold was necessary. The production of gold and the amount each government had stored away did little to represent what was going on in national economies and ultimately held back forex markets.
Today, gold plays a different role. Although technological developments have opened-up new use-cases for gold as a metal rather than a monetary instrument it still plays a role in forex and financial markets. Because gold doesn’t need the backing or guarantees of a bank, government, or anyone else, the metal is treated by investors as a ‘safe haven’ asset that can hold its value when other assets can’t. It is also hoarded by central banks to act as a reserve currency or an internationally recognised asset that can be wielded in times of need. It was not too long ago that Vietnam required all housing transactions to be paid for in gold because the Vietnamese Dong was simply too volatile.
Its use in jewellery, technology and financial markets creates several arms of demand for gold and these diverse uses help to provide support at different times throughout commodity and economic cycles.
Why is gold more valuable than silver and copper?
Silver has far more industrial applications than gold, copper is easier to find and is a better conductor of electricity, and platinum offers its own resilient characteristics and is as difficult to discover. So why does gold demand a premium value over these other metals?
Surprisingly, it is the fact gold is so chemically uninteresting and impractical to use compared to other metals that gives it a premium value. All three will tarnish to some degree over time, unlike gold, and it is these ever-lasting characteristics that gives gold such a premium over other metals. They also change the supply and demand dynamics of the gold market, which is unlike other commodities. Whereas metals such as copper are produced and then consumed, all the gold that has ever been produced still exists.
How much gold is there in the world?
According to the World Gold Council - an international trade body that has some of the largest miners as members including Agnico Eagle, AngloGold Ashanti, Barrick Gold, Newcrest Mining and Newmont Mining– just over 190,000 tonnes of gold has ever been mined. That equates to over 6 billion ounces, which may sound like a lot but still accounts for less than one ounce of gold for every person on earth. Notably, over two-thirds of this gold has been mined since 1950.
Its indestructibility means virtually all the gold that has ever been produced remains in circulation in one form or another today, whether in the form of a gold bar, crown or computer chip. Further demonstrating the scarcity of the metal, if all the gold ever produced was melted down it would fit into a crate of 21 metres cubed or fill just over three Olympic-size swimming pools.
Global production adds somewhere between 2500 to 3000 tonnes of additional gold to existing supplies each year. The metal can be found around the world and is geographically diverse, but the top ten countries account for almost two-thirds of all new gold produced annually:
Top ten gold producing countries in 2017
|% of world share
The new supply of gold, however, has not historically been enough to satisfy demand. Newly-produced gold accounts for around 75% of worldwide supplies each year, with the other 25% sourced from recycling. The World Gold Council estimates jewellery makes up 90% of all gold that is recycled, with the remainder being extracted out of technological applications such as electronic or medical devices. Recycling plays another important role in the gold market because it is the most flexible to price changes. While discovering a new source of gold and building a mine can take over a decade, those looking to cash in on a spike in prices or severe supply deficit can quickly recycle or sell on existing supplies.
It is not certain how much gold is left in the ground but grades and production have been on a downward trend. The US Geological Survey has forecast there is just 57,000 tonnes left to be mined which, compared to the amount extracted so far, is tiny. Importantly, the amount of gold left in the ground is different to the amount deemed to be viably and/or economically extractable: higher gold prices means more expensive extraction can take place but lower prices means more could be left in the ground as it couldn’t be mined at a profit. New technology and methods can change the economics of gold deposits. Plus, new discoveries are still being made which add to possible future supplies over the longer term.
Further out, the world’s miners could head out to sea to find new sources of gold. The cost would be extortionate, and estimates of how much gold the world’s oceans could contain varies wildly, from 15,000 tonnes to over 8 million.
Uses of gold: what is gold used for?
There are four predominant markets for gold: on one side, it is used to create jewellery or as a component in technological applications, and on the other it is stored by central banks or traded by investors.
Roughly half of all gold is made into jewellery. Eastern countries are the modern hub for gold jewellery, with India and China accounting for up to half of all demand worldwide.
Less than 10% is used in technology. Gold is used as a conductivity metal in common devices like smartphones and tablets (each smartphone is thought to contain around $1.00-$1.50 worth of gold), but is also a key material for higher end applications. For example, the mirrors on NASA’s new James Webb Space Telescope are coated with a super-thin later of gold to make use of its reflective qualities. The amount of gold used in technology is set to rise in the future as more applications are found, such as in ground-breaking areas like medicine.
Central banks accounted for 12% of overall demand for gold in the first nine months of 2018. Long-term trends show that central banks sold more gold than they bought between 1987 and 2009 but have been increasing them since the financial crash, when gold’s role as a safe-haven asset was amplified. The US Federal Reserve’s (Fed) gold hoard is currently valued at over $310 billion.
Investment markets accounted for 27% of all gold demand in the same period. That represents the lowest proportion of overall demand since 2015, and well below the levels seen during the height of the financial crash between 2008 and 2012 when up to 40% of all gold demand came from trading. As financial markets began to recover in 2013 the share fell to just 18% and then went on to rise to a its most recent peak of 37% in 2016, dropping to 30% in 2017.
What affects the price of gold?
There are numerous factors that drive the price of gold, although many of them are interlinked:
- Gold as a safe haven asset: Gold is not as exposed to market or political factors like foreign exchange or other commodities such as oil. This is why many believe gold is better at holding its value over longer periods, making it attractive for investors searching for a port in a storm when stock, financial or commodity markets are volatile. Uncertain times generally supports a higher gold price.
- The impact of geopolitics on the gold price: Rising trade tensions, escalations of conflict and even governmental changes can spook investors that are unsure how it will all impact their investments. As a safe haven, gold is a main beneficiary of any geopolitical tensions that break out.
- The impact of the US dollar on the gold price: The dollar may no longer be pegged to the price of gold but there is still a relationship between the two. As the international reserve currency, gold is mostly traded in dollars. Generally, a weaker dollar translates into higher gold prices and vice-versa.
- The impact of inflation on the gold price: Because inflation generally leads to central banks expanding the supply of money as a counteract the price of gold tends to rise in times of higher inflation and fall when economies are in a deflationary state.
- The impact of interest rates on the gold price: Lower interest rates are better for gold prices than higher interest rates. This is because investors can get better returns from other alternatives (such as a savings account) when interest rates are higher, which takes money away from the gold market. When interest rates are low, however, the appeal to gold is greater because the returns on offer elsewhere are also low.
- The impact of supply and demand on gold prices: The supply-demand dynamics of gold are not the same nor as influential as other commodities because it is not consumed. Trends show sectors looking to use gold as a metal, in jewellery or technology, try to ramp $up their purchasing of gold when prices fall and step-off when prices rise. These fluctuations in supply and demand, in turn, drive fluctuations in the gold price.
These feed into wider drivers of the gold price: economic data and monetary policy play their role in guiding it higher or lower. It is also vital to remember that correlation between gold prices and these drivers is not guaranteed: prices and interest rates only move in the same direction about half of the time, for example. That is because the price is swayed by a number of variables, all of which have to be taken into consideration by investors.
At the bottom-line, gold is one of the first ports of call for investors looking for safety in times of uncertainty and volatility, ultimately used as an insurance policy to help diversify and protect portfolios from widespread downturns.
This information has been prepared by IG, a trading name of IG Australia Pty Ltd. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.
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