In “Holding Physical Bullion Really Is Investing,” I argued that holding physical bullion was actually investing. I pointed out that gold has grown in value at an average rate of 5.7% over the past half century or so. But I did not address why it increases in value. That was really beyond the scope of the article, and beyond what Seeking Alpha really is about. But it is important to explain why gold, and other precious metals, do increase in value over time.
Over 2,000 years ago, Aristotle came up with a list of characteristics of a good form of money. We can start there. According to Aristotle, money must be durable, portable, divisible, and it must have intrinsic value. These criterion are a good starting point, but there is more to good money, and gold has all of those properties. These additional properties are “recyclability” and “suppliability.”
Gold is very durable. In fact, the only true way for it to be destroyed is through a nuclear reaction. Of course, it can still be broken down by the elements, and can oxidize. But unlike iron, the gold oxide actually forms a protective barrier against further decay. Gold is certainly divisible. Theoretically, it can be divided down to the level of a single atom, and some applications actually use only a few atoms at a time. Of course, for practical purposes, we are really talking about divisions from kilograms down to a single gram. Gold is portable. Sure, it is a bit heavy, but it really is not that difficult to carry around a few troy ounces or to ship larger quantities across the country. It also requires little special treatment to move around. And Gold is scarce. If it were as abundant as sand, it probably would not be worth nearly as much.
As for intrinsic value, I do not really consider there to be such a thing. Something’s value depends on the environment it is in. Gold is valuable because it provides utility. Certainly one can create a for of money which is used solely for the purpose of being an intermediary of exchange. However, such money has the potential to quickly lose all of its “value.” If the chosen form of money has other uses, then it holds its own value. Essentially, when someone buys a product with gold, they are bartering. We just call the it “money” and so we do not think of it as bartering. The metal also has value because it is used in jewelry, electronic equipment, medical technology, and much more. For instance, in 2012, roughly 320 tons of gold were used in electronics ranging from desktop computers to smart phones. Even assuming that usage has not increased since then, that would still be over $11B per year, based on current gold prices.
Additional Qualities of Gold
As added components, I would like to address recyclability and suppliability. Now onto qualities that make gold even better, even though they are not included in Aristotle list. While durability is important, so is recyclability. Even though gold can be transformed into many different products, such as coins and jewelry, most of that gold can be recycled and used again. Smaller amounts can also be combined together to create a single larger piece: reverse divisibility. Even the small amount of gold in a single electronic device can be reclaimed. However, at current prices, it may not be cost effective. Still, that brings the discussion to the next quality: “suppliability.”
While scarcity is an important quality of money, being able to increase supply, as demand increases, is also important. When supply and demand do not match, inflation or deflation occur. Fiat currency has the ultimate ability to match supply with demand. But it suffers from other issues. When it comes to gold, supply, while not inexpensive to provide, will be matched as demand increases. This is because there are reserves within the Earth which can be mined, if the demand increases sufficiently to warrant it. The balance between supply and demand, created by changing rates of mining as the price of the metal changes, is essentially what the Federal Reserve tries, or should try, to mirror when it sets monetary policy.
So not only does gold have every quality of a good form of money, as expressed by Aristotle, it also has two other important related qualities, recyclability and suppliability, which make it an even better candidate. Therefore, while part of gold’s appeal is that we find it pretty, its value really does go way beyond that. It is for this reason that the metal continues to increase in value, at a faster rate than the USD, and why it will continue to do so. Finally, while I did not mention them in this article, silver, platinum, and other precious metals have similar qualities.