Gold Prices: Little Correlation with Its Utility

National Geographic Magazine's January 2009 issue has an article about gold:

While investors flock to new gold-backed funds, jewelry still accounts for two-thirds of the demand, generating a record $53.5 billion in worldwide sales in 2007. For all of its allure, gold's human and environmental toll has never been so steep. Part of the challenge, as well as the fascination, is that there is so little of it. In all of history, only 161,000 tons of gold have been mined, barely enough to fill two Olympic-size swimming pools. More than half of that has been extracted in the past 50 years. Now the world's richest deposits are fast being depleted, and new discoveries are rare.

I cannot understand why people and central banks are willing to pay so much for gold. It has less utility than platinum and silver. Most items that rely primarily on scarcity to attract consumers eventually lose demand and their high value. With gold, however, consumers can't seem to get enough. At least gold's value is not artificially inflated, as with diamonds (see DeBeers litigation). Yet, I cannot think of a single other product whose attraction has such little correlation with its utility.

With platinum and gold selling at similar prices, I would probably go for the platinum. For now, my only precious metal is silver, which I own through a silver trust ETF (SLV).

Update: The print edition of the National Geographic piece has two charts on page 42 and 43 that are worth a look. One is called, "What it's worth," and the other is called "How it's used." If readers find a link to the charts, please let me know or please post a comment.

Comments

[ManAboutDallas:]

Yet another example of knowing the price of everything, and the value of nothing. Repeat this to yourself several million times a day: "Gold is the ONLY honest money." Pray to your deity of choice the repetition finally brings about the epiphany you so desperately need.

2008 Dec 23 10:00 AM

[kelvin8:]

I am not a gold bug, but the old line about gold not having any utility and therefore not being valuable always makes me laugh, especialy coming from someone who is a supposed investment professional.
So by your reasoning, paying a premium for beach front property is rediculous because it is in an iconvenient location. The Mona Lisa is just colored paste on canvas-I can buy those componentsd for pennies, what pay more? You can't eat it or use it for fuel.
Read your own title- Gold Prices: Little correlation with its utility

2008 Dec 23 10:25 AM

[Scared Stiff:]

Better yet, what is the utility of Apple stock? Why would anyone pay anything for a stock which serves, literally, no purpose? Gold and non-dividend paying stocks are nothing more than a bet that people will at some point be willing to pay more for it than what you paid for it. At least gold doesn't depend on the honesty of clearly dishonest people to maintain its value.

2008 Dec 23 10:34 AM

[GMiki1:]

DUH! Gold is a store of value. DUH. Its use is as a hedge against the collapse of currencies around the world. DUH. I'm not an innate gold bug, either. I just want to protect my savings. DUH, DUH, DUH,

2008 Dec 23 11:27 AM

[lark:]

You know what, I can t understand how people can buy treasuries, when dollars are just printed paper, and the economy is broken.

2008 Dec 23 11:45 AM

[MellowGuy:]

Gold has had costs of production that has matched the costs of labor for over a thousand years. So it is a measure of value, not a store of value. There isn't enough gold for most people to buy with more than a few percent of their life savings.

I buy the GLD ETF shares and write options against them hoping that the price of gold won't fluctuate too much.

2008 Dec 23 11:54 AM

[Albert Ling:]

I have a theory that prices are INVERSELY correlated with utility. If prices were all correlated with utility, the most expensive goods in the world would be water, salt, rice, wheat, etc. and the most inexpensive ones would be artworks, diamonds, gold, fashion items, caviar, etc.

Did you know caviar is bad for your health, and that when lobster was plentifull at the ocean, they were served for prisoners at penitenciaries and everyone thought of it as fishermen's waste product, then suddenly its rare and they are serving it at french cousine

2008 Dec 23 12:02 PM

[DiggerUK:]

You seem perplexed why people invest in gold when a 2/3 of it is used in jewelry.
What you fail to understand is that in many areas of the world you can only hold gold in the form of jewelry. When you buy the jewelry it is by weight that you pay.
This is how they store their savings with confidence.
It's utility is as a store of value, just like your silver.

2008 Dec 23 03:26 PM

[Matthew Rafat:]

I appreciate all of your comments, but the only one that makes sense to me is Albert Ling's. He says that expensive products are expensive precisely because of their lack of utility. Although he doesn't expand on his hypothesis, it makes sense. The low utility of products, including gold, reveals an important trait--namely, that their buyer can afford useless objects, confirming the buyer's high disposable income, and therefore status.

I don't disagree with the ultimate end of the gold bugs, which is to establish a hard currency. But once central banks moved away from gold and into fiat currency, gold was no longer an agreed-upon unit of currency. If we return to the days of hard currency, then gold will have value because of its utility in determining currency. Until that day, its value seems to be linked to consumer demand and perception only rather than utility.

Other people argued that almost no other products have prices relating to their inherent value, citing beachfront property; Mona Lisa; and Apple stock. Those examples are somewhat inapt.

1. Beachfront property has value because it is something that is necessary--shelter. It can also be used every day. Gold is not necessary, while shelter is required for most people.

2. The Mona Lisa has value because it is a unique historical artifact. Unique historical items tend to be valuable, despite their lack of utility, because history has value to most human beings. Therefore, I have no logical hangup with a historical painting connected to Leonardo da Vinci and the Renaissance having value. The Mona Lisa's value is inherent in its existence, which links it to a specific time period that will be studied as long as human beings exist.

Other paintings, however, such as modern art, may have no value in the future. I would never buy a MoMa painting.

3. Apple stock is a harder one to analyze. It has no utility at first glance, because it does not pay dividends. (Many value investors avoid non-dividend paying stocks, because they don't see any definite return.) Yet, Apple stock has utility because it is easily traded, like currency, for other things, which do have utility. Gold is _not_ easily traded for cash all over the United States. Apple stock, on the other hand, once liquidated, will buy a farmer in a rural area as well as a NY banker in a big city *immediate* utility. Therefore, its utility lies in its quick, convenient conversion into a unit that confers utility.

2008 Dec 23 04:45 PM

[GMiki1:]

I don't actually think it's 2/3rd jewelry now. I think it's much higher for investments at this point in time.

2008 Dec 23 06:43 PM

[GMiki1:]

Central banks moved away from gold? No, they moved away from allowing the citizens who own their currency to share in their gold. Central banks still hold gold and central bank selling of gold--well, how much took place this year? Moreover, central banks are now buyers of gold.

You can certainly more easily change gold into currency anywhere in the U.S. than you can change Apple shares. Or, believe me, someone will take the gold for barter. An Apple share? Never.

You don't understand something, so you presume that the world is only true to the limits of your understanding? That puts you in a precarious situation in a very quickly changing world.

2008 Dec 23 06:49 PM

[jfoster99:]

Matthew,

You missed the point completly regarding the Beach Front Property. Such an oversight make me question the rest of you logic.

Beach Front Property sells for 10x the value of the same property across the street. Not to mention building on the beach has 10x the risk of loss due to weather.

2008 Dec 24 10:48 AM

[User 195787:]

I am reminded of Sir Thomas More's "Utopia", wherein the perfect society scorns precious gems and metals as mere children's baubles. But as long as human nature remains what it is, the sparkly stuff in short supply will be in great demand.

2008 Dec 24 04:18 PM

[secmaven:]

For the citizens of nearly every country of the world except Japan, China, the US and Saudi Arabia, gold has been an outstanding investment in 2008! Look at it. Gold in dollars is even with the beginning of the year. But nearly all currencies are way off compared to the dollar, hence gold has had a nice run in terms of all of those currencies. And the stock markets in every country has tanked, many worse than the US as our BRIC investors have turned tail and run.

Say you live in a country where gold was a winner. Do you sell your gold and buy US Treasuries that yield 2% on the ten year note? Where will the US dollar be in 10 years??? OUT OF BUSINESS. Will gold be out of business? It has been around for 6,000 years and it ain't going anywhere at this point but higher in terms of fiat money. That is my view.

2008 Dec 24 05:17 PM

[Reserved Fo...:]

Matthew:

It is like faith in Jesus Christ. It is a revelation and you either see it or you don't. And like most Americans, you obviously don't. We are in the launching move of gold in replacing paper currency, and with or without you, gold is going into the thousands of dollars as fiat paper becomes worthless.

2008 Dec 24 09:10 PM

[Mark Anthony:]

A physical metal's price has very little to do with its utilization, but everything to do with marginal cost of production. Read here to understand the concept:

seekingalpha.com/artic...

Gold is not an investment, but a mere store of value. Gold is the ONLY precious metal with a huge above ground stockpile. The effect of the big stockpile is that its value remains relatively constant, which makes it suitable as an exchange media. That's why gold is money.

But investment is to seek value appreciation, not constant value. It's much better to buy platinum at similar price, because platinum's inherit value is about twice gold's. Palladium is an even better buy than platinum, as palladium is even rarer than platinum and costs no less to produce.

2008 Dec 26 01:48 AM