You'll find no shortage of media attention given to gold. The consensus is that gold is a steadfast inflation hedge in the face of a declining dollar, and yes, investors flock to it as a perceived refuge when they believe troubled times are ahead. When investor confidence gets back on track, the demand for gold gets replaced by the demand for “riskier” assets. Is that so wrong?

Gold as an Investment

Like most assets, commodities follow a pricing model based upon supply and demand. The equilibrium price of gold is unique in that the supply side of the equation is particularly steady.

Where oil, corn, and wheat are expended or consumed, this is not the case with gold, which is hoarded and subsequently distributed.

“It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” – Warren Buffett

There was a time when gold meant something, specifically as backing to the US Dollar during the gold standard, which was abandoned entirely in the early 70’s. In theory, the gold standard had a compelling story in that it forced monetary control through its limited nature.

Compelling but flawed.

The gold standard was destined to fail because humans create value at a nonlinear rate, and gold mining is linear. In fact, the more gold that’s mined, the less there is to mine.

Mathematically, it could never have worked. Silly economists.

Demand in the Driver's Seat

Gold pricing is determined almost exclusively by demand relative to a steady yet limited supply. So, what is fueling this demand? People love shiny objects, and gold is perceived to be rare, therefore we assign it value.

The same can be said for Mickey Mantle baseball cards. Or can I interest you in a non-fungible token perhaps?

Gold has no significant industrial utility, it pays no coupon, it declares no dividend, it does not solve problems, nor does it produce an output. It is shiny.

The fundamental nature of this demand function relies almost entirely on human perception.

Where have we seen this before?