Archive for December, 2010

Gold isn’t a Commodity; Gold is the Universal Foreign Currency

Until recently, Gold was always classified as a commodity.  It is traded on the commodities exchanges using futures contracts.  It has “spot” prices like wheat and pork bellies, but Gold isn’t really a commodity.

Commodities get consumed:  Wheat gets eaten, corn gets fed to cattle which get eaten.  Oil gets burned.  Even silver is partially consumed because it is not yet so valuable that every ounce gets recycled.

Gold, however, is never consumed.  It has always been so valuable that except for minute amounts used in electronics, it is recycled.  Not much Gold has been lost in the trash.

Commodities can be hoarded.  If a speculator starts storing large quantities of coffee, sugar or wheat, thereby keeping them off the market, he is said to be hoarding these commodities.  If an exchange-traded fund buys and stores lots of Gold, they are investing, not hoarding.  Gold is not a basic requirement for life like food or energy.

Gold is really a currency, but not just any kind of currency – Gold is a “foreign currency.”  Unlike other currencies, it is foreign in every country.  In the USA, the euro is a foreign currency, but in France, it is money.  In England, the yen is a foreign currency, but in Japan it is money. Gold isn’t money in any country.  Gold is a foreign currency everywhere.  Gold is “the Universal Foreign Currency.”

What makes Gold a currency?  Before the Twentieth Century, Gold was a “real currency” or at least an “alternative currency” in many countries.  Money (coin) was actually made out of Gold (and silver).  Gold was money until all major countries adopted paper money that is not officially exchangeable for Gold.  This paper money is derogatorily called “fiat currency,” but it has, nevertheless, displaced Gold as money.

This heritage of Gold having been money is one quality that has led to its status as a currency.  Another quality is Gold’s heritage as being a store of value.  Many people consider Gold to be a better store of value than money – no matter which currency you call money.

By being a universal foreign currency, Gold can be valued in any “real currency” and “real currencies” can be valued in Gold.  Since Gold is a universal foreign currency, it can be a hedge against all currencies.  Gold can rise (or fall) in value as measured in any “real currency.”  Buying Gold using your native currency hedges against a fall in value of your currency without depending on any other currency to do better than your own.

We’ve heard of people buying Swiss Francs because the Swiss money often retains its value when other currencies fall.  But in these modern times, we can’t even depend upon the Swiss Franc to hold its value.

Like any other currency, Gold can’t be depended upon to always rise in value against the dollar (or any other specific currency).  But at least the value of Gold is harder to manipulate by governments.  Gold is a foreign currency everywhere, so no country can control it.  If a government sells some of its Gold reserves, the price of Gold will probably go down temporarily, but governments sell Gold to raise cash, not to try to drive down the price of Gold.  Governments also buy Gold when they have surplus cash, and this can temporarily drive up the price of Gold.

Today, the USA complains that China is manipulating the value of its currency (the renminbi or yuan), keeping it undervalued to give their exporters an edge against other countries.  Other countries assert that the USA is manipulating the value of its currency by “quantitative easing” which puts inflationary pressure on the dollar.  As countries race to devalue their currencies against all others, Gold stands out as a reference of value to all the currencies.  When investors flee any currency, Gold benefits.  Gold is a universal measure of wealth and a store of value.

Although the US Dollar is the world’s “reserve currency,” I think a case can be made that Gold is the world’s “reference currency.”

Gold isn’t a commodity – you can’t eat it or burn it for energy.  Gold doesn’t get used up and it doesn’t decay or rot.  In a previous post I discussed why Gold isn’t money, but it is a currency.  So don’t think of gold as a commodity, think of it as the universal foreign currency.

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I am not a registered financial advisor. I only offer opinions, and sometimes these opinions veer off at weird angles from conventional wisdom (That's probably why you are here). My advice is, "Don't take my advice." Read my sidelong glances at economic issues and form your own conclusions.

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