Is gold a commodity?

October 17th, 2006

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One of the interesting fallacies that we had noticed is that gold is currently being classified as a ?commodity? by the market. Thus, this has produced very interesting results that can be exploited by a shrewd long-term investor.

First, what is the definition of a ?commodity? in the financial world? In the Wikipedia, a commodity is described as

things of value, of uniform quality, that were produced in large quantities by many different producers; the items from each different producer are considered equivalent.

As such, the word ?commodity? has a wide range of meaning. There are agricultural commodities like wheat, corn, sugar and orange juice and industrial commodities like oil, gas, coal, copper, iron, zinc and nickel. For the purpose of this article, we will stick with the industrial metal commodities.

Now, let?s go back to the original question. Is gold an industrial metal commodity in the same league as zinc, copper, iron and nickel? Up till now, the financial market seems to think so. Gold more or less move in the same direction as the other metals. Whenever there is a sell-off in the industrial metal commodities, chances are, gold will be sold off as well. But do we think gold is an industrial metal commodity?

No, we don?t.

Let?s us look at the fundamentals. When we look at the non-gold industrial metal commodities, we see a common denominator among them?they are all mainly for industrial use. For example, copper is used for electrical wiring and iron is used for making steel and so on. That is, they are the raw materials that are used to make other things.

Gold, on the other hand, is different. Since the beginning of human history, gold had always functioned either as money or as a store of wealth. Today, despite the breakage of its relationship with the US dollar back in 1971, there is limited industrial use for it. Therefore, the common denominator among the non-gold metals does not apply to gold.

What is the implication of this?

This means that the dynamics behind the demand for gold and the demand for the other non-gold metals are completely different. Therefore, the market is fundamentally wrong to treat gold as if it is an industrial metal commodity. In the short term, this can result in good buying opportunities for gold when it follows the prices of the other metals downward. In the long term, gold will eventually separate itself from the rest of the metals.

We do not know when it will happen, but we are pretty confident it will be within our lifetime, perhaps in the near future. Meanwhile, if you are to buy gold today, please make sure you know the right reason for doing so and buy from a position of financial strength. As Keynes said, ?The market can remain irrational longer than you remain solvent.?

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