Why is gold a currency?


A look at who the major players are in the gold market. We also examine the behavior of central banks over the past 30 years with respect to holding/selling gold for their reserves. We explain why the constituents of gold demand makes it sensible to look at gold as a currency in today’s market.

In this video we’re going to talk about the present-day gold market and who the participants in this market are. All the gold that’s never been mined still exists in the world in one form or another so the first thing we’re going to do is we’re going to look at where all the existing the gold in the world is.


The World’s Gold

By the end of two thousand ten there were an estimated 165,000 tons of gold in the world and out that 165,000 tons, 50% is in the form of jewelry, which is by far the largest segment. After jewelry, the official sector owns 18% of all the gold in the world. By the official sector, I mean the central banks of different countries and organizations such as the IMF (International Monetary Fund). After the official sector, private investors own another 18% of all the gold and 4% of the gold in the world is used in some form of industrial use such as dentistry, electronics, etc. Finally, about 2% of the world gold is unaccounted for.

Gold Mining

Now this covers all the existing gold in the world, but every year more gold is mined from mines all over the world and is added to this existing stock. If you look at the past 10 years on average about 2,600 tons of gold are added to the existing stock of gold in the world. The chart on the left [Slide 2] shows the mining production over the past ten years and you can see that the amount of gold that’s been mined on a yearly basis ranges from a high of about 2,650 tons and a low of 2,450 tons and that range has been relatively stable.

The big picture here is that is a fixed amount of gold in the world that’s been around for a very long time and every year new mining adds to it the little bit

Gold Demand and Supply

Every year there are people who buy gold and there are people who sell gold. Let’s take a look at who these people are.

The bar chart of the left [Slide 3] shows the components of gold demand and the bar chart of the right shows the components of gold supply. In any given year for a certain number of transactions to happen the total demand has to equal total supply. For example if people want to buy 100 units of gold in a given year someone has to sell them those 100 units so in that sense the gold demand must equal gold supply. Both the charts are expressed in percentages, so each of them adds up to one hundred percent and they represent the total amount of gold demanded and the total amount of gold supplied in 2010.

Gold Supply

On the supply-side 62% of the supply came from mining and the remaining 38% of supplied came from gold scraps. These scraps for the most part just refer to recycled jewelry and are likely made up of people who own jewelry and who needed cash, or liked the price of gold at the time and decided to sell their jewelry for cash, thereby supplying gold for the market.

Gold Demand

On the demand side a full 53% of global demand is for jewelry and if you are wondering who is buying all this jewelry the chart to the left [Slide 4] shows jewelry demand by country. One thing you notice is that in 2010 India, China and the Middle East are the sources for some of the most demand for jewelry. In fact if you take the jewelry demand from India, China and the Middle East and you add them up you get 70% of all jewelry demand in the world. The reason I am calling out these three regions is because Gold has a different cultural significance in these places. Often when people in these regions have some extra money, instead of putting in the bank, they buy jewelry as they see the jewelry as a store of value. The Gold in India, China and the Middle East tends to be of a much higher purity the new gold elsewhere in the world. The reason is because people are really seeing it as a store of value.

The next largest source of demand from gold is for bars and coins and these are typically bought by private investors who are also looking for store of wealth. The same is true for demand coming from ETFs ( ETFs are exchange traded funds which are an easy way to buy gold). The next largest source of demand for gold is for industrial uses which covers dentistry, electronics things like that. Finally the last source demand for gold in 2010 was the official sector and we’re going to talk about this a bit more.

Currencies are no longer linked to Gold

However, first we’re gonna go over some history very quickly. In previous video we talked about how Britain went off the gold standard in 1931. The US went off the Gold Standard two years later in 1933 and after World War II the world went on something called the Bretton Woods System. In this system the US Dollar was backed by gold at a certain price and other countries had their currencies tied to the US Dollar at a fixed exchange rate and this continued for a while but then the US abandoned the system in 1971 because they had spent too much money on the Vietnam war and Johnson’s great society programs and so by 1971 all world currencies were no longer linked to gold it was simply backed by the word the federal government in each country’s case.

The Official Sector and Gold

This graph [Slide 5] shows the official sector gold reserves held by central banks the in all countries in the world across time. The time series starts in 1971 right after all currencies became unlinked from gold and continues to a 2010 or so. After all the currencies became unlinked from gold the central banks have all this gold lying around which was no longer explicitly linked to their currency. Most of them kept these reserves constant for about twenty years and starting around 1991 began started selling the gold. In fact in 1989 an agreement called the Central Bank Gold Agreement (CBGA) was reached that specified how much of gold could be sold in any given year.

So why did the central bank starts selling all this gold? Part of it might have had to do with the fact they wanted to diversify their reserves so instead of having all of it in Gold, they wanted to have some of it to be in the currencies of other countries. It probably also helped that by 1999 gold has seen a 20 year secular decline in its value. The point is is that the central banks started selling their gold and started diversifying into the currencies of other countries: mostly US Dollars and some Euros. Now here is the same chart but I’ve changed the time frame to start from 2000 and end in Q1 2010 [Slide 6]. As you can see the central banks are sellers of goals until about 2008 when they are neither sellers nor buyers and then in 2009 they become net buyers of gold.

So what’s going on? Well, one thing we can do is we can take this snapshot right around here [Q1 2010] and we can look at that time what percentage of countries’ reserves were held in gold versus currencies. We when do that we see [Slide 7] that the IMF Advanced economies (made up of the US, UK, most countries in Europe, Taiwan, Singapore etc.) basically had 23% of their total reserves in gold meaning they had another 77% of their reserves in other currencies. On the other hand, developing countries such as India and China only had 3% of their reserves in gold and had the remaining 97% in other currencies, but mostly US dollars and some Euros.

So if we take the chart which shows the officials sector gold holdings across time and we break it out into the official sector gold reserves for advanced economies and the official second gold across developing economies we see a graph that looks like this [Slide 8]. So we see that the advanced economies in blue has steadily been selling gold as can be shown by the declining line and then in about 2009 they stop selling gold and are now neither sellers no buyers. On the other hand the developing economies have been re-balancing their reserves and had been buying more gold shown by this pink line over here and the fact that it’s spikes up in about 2009. Now this change in developing economies behavior of buying gold and trying to re-balance their reserves coincides with a loss in the value of the US dollar which is what they were mostly holding.

The big point here is that the official sector such as a Central Bank of the world look at buying and selling gold as a way of storing value. You could argue that the reason they are buying gold now is to preserve the value of the reserves which is highly dependent on the value of the US Dollar.


Out of all the people who are demanding gold, Jewelry owners, Private investors and Central Banks are looking for store of value and when they are looking for a store of value they will compare gold to other currencies and this is why it mostly makes sense to think of gold as the currency.