Gold as a Commodity

 

Hello there, this is tradingpedia.com and we continue our series dedicated to how to trade gold and what the retail trader should know before trading gold. As mentioned in the first video part of this series, gold is the only form of money that survived for thousands of years.

Overview

We should also cover what means money – as it has some specific functions. The only one that gold could not fulfil was unit of account, in the sense that you don’t have smaller fractions of it, like you have with fiat money. It was very difficult to carry gold coins in large amounts, due to the weight.

The importance of gold became obvious after the Bretton Woods system. Before that date, the world was engaged into a gold standard and acted as an anchor against governments debasing the currency. In a gold standard the central bank vows to keep reserves in gold at the equivalent of the notes in circulation. The standard differed from country to country, but after the Bretton Woods, the world leaders decided a new financial order.

The Nixon shock in 1970s refers to the United States dropping the USD convertibility to gold – or the gold standard, and so the free-floating currencies appeared.

“Gold is the anchor of trust for the financial system. If the whole system collapses, the gold stock can serve as the basis to build it up again” – this is a quote that shows the importance of gold to this day when central banks and governments are involved into extensive monetary policy, and so on.

Central Banks

Central banks, after the 2008-2009 Great Financial Crisis, what central banks did was to lower the interest rates to the zero level. By the time that the interest rates reached such a level, it was nowhere to go anymore. But then the Fed under Ben Bernanke’s leadership “invented” the quantitative easing, where basically central banks buy their own government debt with the intent of lowering the yields on the curve to make it easier for businesses and population to borrow. This ended up quite a popular tool, but QE was unprecedented, as no one knew what is going to happen. Many feared inflation, and here we are more than a decade later, and inflation is nowhere to be seen in the developed world.

After the Bretton Woods and the Nixon shock, the rest of the countries in the world dropped the gold standard. Therefore, one good question is what happened to gold in the meantime?

Well, central banks continued to buy gold. Gold as a commodity has strong demand, despite the fact that there is no gold standard. This slide shows the extreme length that humankind goes to find gold. Most of gold that laid down close to the surface, is already dug up. Australia is a big oil producer – this is why when you trade the AUDUSD pair, for instance, you should watch commodity prices, the gold price. There is a direct, positive correlation between the two.

Because it is a commodity, the price of gold depends on the balance between supply and demand. How much gold exists above the ground? How much is still underground? Because there is only one planet, we know that can live on, the scarcity of gold makes it a valuable resource. Gold can be melted and used multiple times without losing its properties.

Conclusion

I will end up this part with Bitcoin – we already mentioned it earlier, but I want to emphasize here something else. Have you ever wondered why Bitcoin is depicted as having the color of gold? Besides the B, you will almost always see the gold color. Because it was born on the same principles as gold (i.e. limited supply, strong demand) scarcity is the name of the game on Bitcoin too.

Let’s move on to the next video. Bye, bye.