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“The supply and demand dynamics gold is that it trades more like a currency than a commodity“–Paul Ebeling
The Key difference between gold and perishable commodities is their stock-to-flow ratios, measured by the above ground stock divided by annual production. Gold has a very high stock-to-flow ratio, while commodities like wheat have a low stock-to-flow ratio.
Thousands of yrs ago people started using gold as money, because gold is immutable, easily divisible, and scarce. Gold is the most marketable commodity. Its long tradition as store of value means extremely little gold has been wasted over history. The vast majority of all the gold ever mined is still with us. Consequently, annual mine production adds about 1.7% to the above ground stock of gold.
Today, the total above ground stock of gold is 205,000 tonnes and global mine output in Y 2021 accounted for 3,560 tonnes. The stock-to-flow ratio (STFR) is currently 58 (205,000 / 3,560). Gold’s high STFR and the fact that most above ground gold is held for monetary purposes is what makes it trade like a currency.
1st we will have a look at supply and demand dynamics of a perishable (soft) commodity. Then show how this differs from the gold market.
Based on data from the World Agricultural Supply and Demand Estimates (WASDE), the STFR in the wheat market is 0.35 (278 million tonnes in stock divided by 776 million tonnes of production). A low STFR causes the price of wheat mainly to be determined by what is annually produced Vs what is used up. Existing stocks can only smooth a surplus or deficit in the market: calculated as production minus consumptio.
Wheat stored in a warehouse starts to rot after several years, so a surplus cannot be entirely absorbed as stock: it must be sold, which lowers the price. Market deficits, in turn, cannot be fully drawn from stock supply, and thus increase the price. In addition, because wheat’s sole application is consumption, for which fixed quantities are needed, the price is set between what is produced Vs consumed.
The gold market is very different.
Because gold is not used but is primarily used as a store of value, the gold price is not set between what is produced and consumed.
Due to its high STFR, gold supply mainly consists of inventory. And because virtually everyone buys gold as a store of value, demand consists mainly of inventory too. The gold market can be seen as all sorts of trades moving metal from one inventory to another. Or the gold stays in the same vault but changes ownership.
Plus, gold’s use for monetary purposes does not require fixed quantities. People do not buy gold because they need it. What they need is whatever amount of gold in exchange for how much value they like to invest at the prevailing price. The gold price can be too low or too high, but there cannot be a surplus or deficit. This is what makes gold trade more like a currency than a commodity.
The above ground stocks dwarf annual mine output, neither does mine production drive the price of gold in the short and medium term. Academic research confirms this statement: The [high stock to flow ratio] of gold implies low market power of gold mining firms and thus an inability to significantly influence gold prices. . . . [Mine] production thus follows gold prices.Gold miners have low market power and are likely to be price takers rather than price setters. . .
Annual mine output reacts to the gold price, not the other way around. When there is a Bull market, new mining projects are initiated, them 10yrs later these mines start producing and elevate total mine output. But in the long run mine supply does influence the gold price, as it increases the above ground stock over time.
An accurate gold supply and demand overview would cover global physical gold trading volume, but not a net balance. After all, for every buyer there is a seller. There cannot be a surplus or deficit as with soft commodities.
Have a healthy, prosperous day, Keep the Faith!
