How Fear and Uncertainty Drives Demand for Gold

How Fear and Uncertainty Drives Demand for Gold by  for Mises

Even those in the nonfinancial media have noticed the skyrocketing price of gold this year. Some partially identify, but don’t quite understand, some of the many (and more measurable) intermediary effects in the chain of causation such as a “weakened US dollar” and “low bond yields.” Those in the financial press add to these factors ones like “central bank reserves” management, along with mining production and “jewelry and industrial demand.” One mainstream headline surprisingly hit closest to the mark regarding the few (and lessmeasurable) underlying causes: “Fear and Cheap Money Send Gold Price Soaring.”

But the chief cause for this and all major rises in gold prices is not “fear and” but fear of cheap money.

In a 2013 interview titled “What Is Key for the Price Formation of Gold?,” Robert Blumen makes the following seven key points, not only for then, but for today and the foreseeable (fiat money) future:

  • “There might be a statistical correlation between, for example, a net inflow into one sector and higher (or lower) prices. If someone has a statistical model that works, that is great. But it’s not causal. But it seems to me that even if someone has discovered correlations like that, they will be coincident with the price, rather than predictive. In order to forecast the price, you need an indicator that moves in advance of the price.”
  • “[There] is [a] vast amount of brainpower that goes into quantifying gold flows into market segments, such as industry, jewelry, coins, and funds. These quantities may be interesting for some purposes, but they’re not really that relevant if what you’re trying to do is understand the gold price, because there is not a connection between quantities and price in the way that most people think there is.”
  • “The gold market is not segregated into one market for the gold that was mined this year and another market for gold that was mined in past years. The buyer doesn’t care whether he’s buying a newly mined ounce of gold or buying from somebody who had purchased gold that was mined 100 years ago. All of the buyers are competing to buy and all of the sellers are competing to sell.”
  • “Gold is primarily an asset. It is true that a small amount of gold is produced and a very small amount of gold is destroyed in industrial uses. But the stock to annual production ratio is in the 50 to 100:1 range. Nearly all the gold in the world that has ever been produced since the beginning of time is held in some form.”
  • “In an asset market, consumption and production do not constrain the price. The bidding process is about who has the greatest economic motivation to hold each unit of the good. The pricing process is primarily an auction over the existing stocks of the asset. Whoever values the asset the most will end up owning it, and those who value it less will own something else instead. And that, in in my view, is the way to understand gold price formation.”
  • “Most of the market research about gold deals with exchange demand, which has the advantage that you can measure it. But reservation demand is far more relevant to the price. The profile of reservation demand among people who own gold is the main determinant of the gold price from the supply side….Reservation demand is where you demand something by holding onto it rather than selling it….I have reservation demand at the moment for an auto, a dining room table, a couch, a mobile phone, and so forth.”
  • Thus: “The gold price is set by investor preferences, which cannot be measured directly. But I think that we understand the main factors in the world that influence investor preferences in relation to gold. These factors are the growth rate of money supply, the volume and quality of debt, political uncertainty, confiscation risk, and the attractiveness (or lack thereof) of other possible assets.”

The 2015 book Austrian School for Investors: Austrian Investing between Inflation and Deflation serves as an important complement to Blumen’s work on gold price formation. The four authors are not just Austrians in an economic sense, but literal Austrians from the country of the same name. What follows are seven key points from the “Precious Metals” section of chapter 9 on “Austrian Investment Practice”:

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