Understanding Gold: Currency? Investment? Commodity?

Includes: DGZ, DZZ, GLD, GLL
by: Larry Trefz

A recent CNBC survey of 800 Americans found that gold was named as the best investment choice. The yellow metal was ahead of real estate, stocks, savings accounts and bonds with 35% of survey participants choosing it.

Gold has had a spectacular rise over the last decade as the global economy has reeled under uncertainty and concerns over unprecedented central bank monetary easing action.

Many Americans have invested significant amounts of money, often retirement funds, in gold over the past few years and the price of gold in U.S. Dollars has increased about five times over the last decade.

Given the dramatic price increase, many gold investors are asking where the price of gold is going now. Many, even in the financial media, are confused as to exactly what gold is, from an investor's perspective.


Most of us have heard financial professionals and wall street media personalities call gold a currency. If we were to view gold as a currency we would see that there has been 80% deflation over the last decade. Meaning, you can now buy five times as much with the same amount of gold as you could ten years ago.

However, if you were using gold as a currency over the last 18 months you would have experienced about 20% inflation as the price of gold has dropped over that time, as measured in U.S. Dollars.

Definition of 'Currency': A generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. Used as a medium of exchange for goods and services, currency is the basis for trade. --Investopedia

Generally, price stability is a foundational aspect of any currency that is to be a lasting basis of trade, as stability inspires confidence. It seems that gold is quite lacking in this element of stability which makes it a poor choice of a currency and thus a poor choice as an efficient medium of exchange.


Definition of 'Investment': An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or appreciate and be sold at a higher price. --Investopedia

Since gold is not an income producing asset, the remaining reason for holding it, from an investment perspective, is the hope that it will appreciate in value. Clearly, gold has appreciated in value over the last decade as measured in U.S. Dollars, as we can see in the chart above.

The question is-- Will gold continue to appreciate in value?

To gain insight on this we need to determine whether we are in a long-term inflationary cycle or a long-term deflationary cycle. For more on this see: "Understanding The Fed, The Super Bubble And Your Money"

Clearly, the U.S. economy was in a long-term inflationary cycle, starting after WWII and culminating with the 2008-2009 financial crisis. Now, however, things are quite different. Central banks around the world are creating money out of thin air at an unprecedented rate, in an attempt to fight deflation. Anyone who doubts that monetary easing and deflation can go hand in hand for a long period of time, need not look any further than the economic situation of Japan over the last couple of decades.

Japan was the inventor of the modern version of quantative easing (QE) back in 2001.

U.S. Dollar/Japanese Yen:

Historical Data Chart

As we can see in the chart above, the Yen has increased almost 300% over the last three decades. This is in the face of a huge debt load (Japan's debt to GDP is over 200%). Japan also has interest rates near zero--another sign of deflation. It is clear that gold would likely be a poor investment choice if it is measured against a currency that is gaining in value.

U.S. Dollar Index:


Definition of 'Commodity': 1. A basic good used in commerce that is interchangeable with other commodities of the same type. Commodities are most often used as inputs in the production of other goods or services. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade.

2. Any good exchanged during commerce, which includes goods traded on a commodity exchange. --Investopedia

Clearly, gold is a commodity. It is used in the manufacture of jewelry and for some limited industrial uses. It is largely valued for its rarity and beauty.

Commodity prices are notoriously volatile, generally following the laws of supply and demand and the perception and expected perceptions thereof.

Many commodities have been used as currency throughout history as they are (or have been perceived as) a store of value. These include: silver, gold, copper, wampum, sea shells, precious stones, grains, etc. However, the currency element that is assigned to the particular commodity is then subject, to a greater or lesser extent, to the fluctuations in supply and demand of that particular commodity.


It is likely obvious that, in my view, gold fits into the commodity category and is a poor fit in the currency or investment categories--strictly speaking. That is not to say that a commodity cannot be a good investment--clearly it can, but its potential as an investment is constrained by its own nature.

It is also my view that a generally deflationary environment, or one lacking significant inflation, is a poor environment for a significant and lasting price increase in gold. This is especially true after gold has increased five times over the last decade on fears of hyperinflation which have not materialized and are unlikely to do so, as long as wages and incomes are declining.

Real median household incomes have been dropping over the last few years. --WSJ

In order for real inflation to take place, people have to have enough money to spend to the point where they can bid prices up. The opposite is when people have less and less money and contract their spending as a result (deflation). The latter case seems to characterize the average consumer's financial position as of late.

My thought is that the decision to buy, sell or hold gold at this point should be based on a thorough understanding of the global monetary forces currently at work and whether we are facing a long-term inflationary period or a deflationary one.

ETFs that can be used to trade and invest in gold include: (NYSEARCA:GLD), (NYSEARCA:GLL) (NYSEARCA:DGZ), (DZZ).

Disclosure: Nothing in this article is to be taken as professional financial advice, nor is it a solicitation to buy or sell any type of securities. All financial decisions are your own, seek professional advice before taking action.

Disclosure: I am short GLD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.