Distrust with a slump...

The steady rise in the value of gold to a large extent reflects the eroding trust in the monetary authorities of the world, most notably those of the U.S. and Europe. Commodity prices have been following the same pattern until very recently. The price of oil, for example, has been surging on the back of speculation related to a potential constraint on the supply side, reflecting the ongoing conflicts in the Middle East. This speculation has also appeared on the demand side, reflecting the anticipation of more demand from emerging markets and, at a more distant future, greater demand from developed markets as their respective economies recover.

More recently, the price of oil has seen a sharp drop in value reflecting the economic turmoil that is brewing across Europe and the U.S. In the speculators mind, two things have changed on the demand side of the equation. Emerging markets, battling a surge in inflation are applying the monetary brakes more aggressively whilst the economic conundrum in Europe and the U.S. that seems to be showing signs of worsening is likely to postpone any sustainable recovery to a more distant future.

In summary, what these two indicators are telling us at this point in time is that the distrust in monetary authorities continues but that the global recovery is in peril.

Gold, the pseudo commodity...

Asset managers and investors typically classify gold as a commodity. After all it shares characteristics of commodities such as the fact that it is tangible, can be traded and is used in the production of goods.

Gold also has certain characteristics that is highly specific to it that really put it in a class of its own. The price of gold, for example, is not impacted by changes in demand and supply, unlike commodities. This is because annual demand and supply are only a fraction of the outstanding gold in circulation. This characteristic makes it curiously similar to paper money or stocks, with the big difference that gold does not produce any revenue or cash flow streams and therefore does not have an intrinsic value. The price of commodities, on the other hand, are very much impacted by current and expected demand and supply dynamics. Almost all of the supply of a commodity will be consumed in one form or another, only a small portion is stored indefinitely. In the case of food, this is pretty obvious whilst in the case of hard metals, it is converted to become part of something else in a production chain somewhere around the globe.

So what is it that influences the value of gold? There are several factors that have an impact on the price of gold. Amongst the most important is sentiment, more specifically how much confidence an investor has on monetary authorities. If confidence is being eroded, the price of gold is likely to go up as it serves as a refuge investment in the event of uncertainty in the financial system. This is also the reason why the price of gold rises when there is "money inflation", which is exactly what is happening in the U.S. today.

Gold is not only a surrogate for money, it is a powerful diversifier that softens the blow when monetary authorities get it so very wrong. This makes it a rather unique investment which is why any sound portfolio should contain some.