September 27, 2022

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Why Does Gold Have Value

A lot of people wonder why gold is valuable at all. And while the internet is abundantly rich in highly technical and complicated articles about the yellow metal, very few discuss why it is valuable in the first place! Here’s a simple explanation.

When did it all begin? A long time ago, actually. The roots of gold as a store of value can be traced back to an ancient system of exchange that preceded the fiat currency that we use today – that is, in the barter system. Say; I had an extra pair of clothes and you had a vegetable garden. I needed vegetables and you needed clothes. We shook hands and exchanged items. All good.

Around the same time, humans started getting enamoured by the glittering yellow metal. It was nice to look at, after all. And it wasn’t exactly abundant – there are only about 200,000 tons of gold in circulation even today, of which roughly 50 per cent is jewellery, 35 per cent is held as investments in the form of gold bars and biscuits, and the remaining 15 per cent is part of industrial components and other products – maybe even the Chyawanprash that you eat! We learned that we could enjoy gold by smelting it into beautiful items AND convert it back to coins or bars whenever needed; without it losing an ounce of value. What’s more, it didn’t rot or corrode even after many years unlike many other metals.

So, what gold seemed to have, was an unbeatable combination of beauty, durability and rarity that no other metal had. And what people started doing was to use it to conduct barter exchanges in place of goods. So, to build on the previous example – I had clothes and you had vegetables. You needed clothes but I did not need vegetables. So, what I did was give you clothes in exchange for a sufficient and mutually agreed upon amount of gold that was determined by ancient market forces “of yore”!

But what about other rare & beautiful metals like palladium (30 times rarer than gold)? Why were they not considered as valuable? Simple – because they were TOO rare. In fact, so rare that not enough people owned enough for them to be considered a “fiat” medium of exchange at all.

Over time, people started worrying about stashing gold coins and bars in their homes – so they deposited it in banks, which issued them promissory notes stating that “this piece of paper represents ‘n’ gold coins”. And voila, paper currency was born! That’s what the “gold standard” of currency means. Great Britain was the first country to adopt the Gold Standard in 1717. Unfortunately, most countries ditched the gold standard over time and started “printing” money without having enough gold to back it up, but that’s a different matter.

Anecdotal evidence suggests that the value of gold (adjusted for inflation) hasn’t fallen at all over hundreds of years. That is, one gold coin would buy me almost the same number of potatoes as it would have hundreds of years ago when it was first adopted as a means of exchange. That’s quite an incredible fact when you think about it – and this is why gold is often considered an “inflation hedge” and a fairly reliable store of value. 

Even oil prices move somewhat in sync with gold – the long term “gold-oil ratio” hovers between 10 times and 30 times, meaning that you can purchase between 10 and 30 barrels of crude oil with one ounce of gold, with the long-term average being close to 16. Even today, gold is trading at USD 1988/oz and Brent Crude at around USD 115. Divide the two – and you get 17!

Some people call Bitcoin the “new gold”. That is fallacious on multiple fronts, because although Bitcoin is “rare” in a sense, it isn’t much to look at. And is it “durable”? Time will tell.

So, to sum up, why does gold have value? Because it’s got a uniquely balanced combination of beauty, rarity and durability – but more importantly, because a sufficient number of us human beings agree that it has value! A few hundred years hence, gold could be replaced by something else altogether. But we’ll leave that debate to the futurists. 


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