Wrinkles Of The Swiss Gold Referendum

How Relevant is the Swiss Referendum to the Gold Price?

Regular readers will already know the answer to this question, while readers not familiar with our previous discussions of this particular topic should take a look at a recent post by Mish that does an excellent job of explaining the issue in the context of the gold demand potentially exercised by the SNB if the referendum succeeds.

To quickly summarize: gold is quite different from industrial commodities and therefore cannot be analyzed like an industrial commodity. This is in spite of the fact that renowned gold institutes like the World Gold Council (WGC) and numerous other “experts” are doing just that. For instance, the WGC publishes annual statistics on mine and scrap supply, central bank supply/demand, jewelry and industrial demand, and from this “infers” investment demand.

Superficially this exercise may appear to make sense, but in reality it doesn’t. Contrary to e.g. copper or oil, gold is not “used up” – most of the gold ever mined still exists above ground, in various more or less usable forms. As a result, gold is the commodity with the largest stock-to-flow ratio. This is a major reason why gold is so useful as money – its supply is relatively stable (it increases only by about 1.4% per year, and the trend is falling) and a very large amount of it is available. There is therefore no point in e.g. trying to divine the effect of a 10% change in annual mine supply on the gold price. All we can say about such a change is that it will almost certainly have no effect whatsoever (since it would only amount to 0.14% of the total supply).

Gold must be analyzed like a currency. Its price in terms of fiat monies is affected by the expectations of market participants about the future evolution of a range of macro-economic data and events, such as real interest rates, credit spreads, the steepness of the yield curve, the desire to increase savings, the growth rate of the fiat money supply, confidence in the economy, expectations regarding the growth of government debt and how it will be funded, and perhaps most importantly, the degree of faith in the monetary authorities.

If one thinks about gold in terms of supply and demand, the important point to keep in mind is that the total supply is essentially all the gold ever mined. Since supply and demand are always in balance, the total demand (including its most important component, namely reservation demand) is just as great. Thus, when the WGC reports that “investment demand” was 600 or 800 tons, it is simply proving that it doesn’t really know how the gold market works. The vast bulk of gold demand is in fact investment, or monetary demand.

For a detailed explanation as to how the gold price is formed and what the role of reservation demand in this process is, readers can review Robert Blumen’s timeless article “What Determines the Price of Gold”, which we have published back in 2011.