Gold, Energy, and the Problem of Capital Storage

One of the reasons that gold retains its competitiveness as a capital-storage unit is the rather slow and plodding rate at which supply is brought to market. Since 1900, compound annual growth of world gold production comes in at 1.098%. That is below the increase for a number of other natural resources but in particular it’s well, well below the rate of credit production–the “resource” which now plagues the developed world. Indeed, the over-production of credit the past twenty-five years has once again driven capital back into hard assets such as gold. This brings up an intriguing subject: the conversion of resources into financial capital, and the conversion of financial capital back into resources. First, let’s take a look at the chart: World Gold Production in Metric Tons 1900 – 2008. The migration of capital, between the world of natural resources and the world of finance, has been addressed by any number of thinkers, one of the more compelling being Harold Hotelling. Writing in the Journal of Political Economy in 1931, Hotelling proposed that a rational producer of resources would only be inclined to extract and sell that resource if the investment opportunities available with the capital proceeds were greater than simply leaving that resource to appreciate in the ground. So, given Hotelling’s theory of resource extraction, what has happened to gold production since the year 2000? Does the chart reflect geological and cost limits to increasing gold production, even as the price rose from $250.00 to $1000.00 per ounce? Or, has there been some moderate yet gathering decision on the part of global gold producers to extract gold more slowly? After all, why extract gold to merely convert gold into paper currency, beyond the need to pay for the cost of production and provide, say, a dividend to shareholders? In other words, at the rate at which the price has been rising, why hurry to extract the gold?

These same questions have long been asked in the world of energy extraction as well. Why did global oil production advance so quickly into late 2003 as price was rising towards the high thirties, only to peak out for the past 6 years as price skyrocketed? Well, we can safely assume that oil producers in the West, governed mostly by for-profit enterprise, was doing everything possible to lift production. In short, they couldn’t. But in contrast to BP, Shell, Exxon, Total, Chevron, and Conoco, what about the NOCs–the National Oil Companies? Is it possible they were inclined to apply some form of scarcity rent, holding back production slightly? Echoing statements made at least twice last decade, King Abdullah of Saudi Arabia repeated himself this Summer when he remarked about future Saudi oil production: “I told them that I have ordered a halt to all oil explorations so part of this wealth is left for our sons and successors God willing.” | see: Global Crude Oil Supply 2002-2010 in kbpd (this is updated with the latest data through July 2010)

As the United States has now embarked on a massive dollar devaluation program, in part to bust the CNY-USD peg, but mostly to mitigate the next leg down in real-estate and debt deflation, we should consider how resource extractors might behave. Clearly, given that both gold and oil production are now either flat or falling, what should a producer of these two commodities do with the proceeds of their sales? Furthermore, is it possible that individuals and institutions may also gain insight with their own capital allocation decisions, by taking a cue from resource producers? Two obvious possibilities are as follows. First, oil producers rather than chasing higher prices in dollars or holding back oil production might start to demand full or partial payment in gold. Meanwhile, gold producers might consider banking some of their capital not in cash, but also in gold. And yes, both oil and gold producers could simply leave more of the stuff in the ground. What may become more clear is that, beyond the need for operational cash, turning excess production of resources into paper currency will increasingly become, per Hotelling, a losing proposition.

  • Anonymous

    Gold is of not much value intrinsically, and currently people are willing to swap it for lots of useful stuff. So gold miners are wise to make hay while the sun shines. There is a limit to the value of oil also, which is more or less the cost of coal to oil conversion, and the price may well be above that now. Better to build Nuclear Power infrastructure than leave the oil in the ground.

  • The value of oil is limited only by how attached you are to the modern lifestyle, rks987.
    And gold appears to be the only thing keeping it flowing.

    This leads me to somewhat different conclusions than yours.

  • Angel Eyes

    Insightful post, Gregor. Thanks.

  • Last Contango

    As I recall, major Canadian gold miner GoldCorp (GG) under McEwen was accumulating and kept very significant amounts of refined bullion in vaults, instead of bank deposits. Beyond their operational needs, of course. At least, this was the case a few years ago, when I used to be a share holder. Then I came to conclude, if for a smart operator like GoldCorp, unencumbered physical gold in the vault is preferable to any kind of currency or paper promise which is subject to all kinds of risk. For example, exploration, energy and operational costs rising faster than the COMEX paper-gold. So I learned a lesson from the smart GG guys and nowadays I accumulate all available savings like GG did. A gold coin in the hand is worth a dozen in the vault of somebody else.

  • Anonymous


    There’s only a shortage of credit because we imagine that credit intermediaries are still necessary to create it, backed by a small amount of proprietary capital.

    Using a dis-intermediated market architecture, that is no longer the case, and we will IMHO see a transition of banks from credit intermediaries to service providers. This is in the interests of banks, since their capital requirement is then limited to that necessary to cover operating costs.

    To a degree, the crude oil market has seen IOCs disintermediated as NOCs take back ownership, although the greater problem of financial intermediation has since evolved so that the crude oil market at least is now entirely financialised and dysfunctional.

    In my view it is possible – through the simple device of the creation and issue by producers of Units redeemable in payment for their production – to reinvent finance capital itself within a ‘clearing union’ framework.

    That was the subject of this presentation in Rotterdam last year outlining a global market in natural gas.

    Energy is only a small – but crucial – part of value in circulation. More than two thirds of money in existence was created by banks as mortgage loans and hence is deficit-based but land-backed.

    It’s a bit off-topic, but this presentation last week to the top 20 UK housing associations covered in passing a sustainable development financing model, but focused on a new long term funding approach by ‘unitisation’ of rental values.

    As rks987 is getting at, you can’t live in gold; heat your house with it; power your car with it; or type e-mails with it; listen to it; or watch it

    Therefore as a basis for credit it is IMHO less credible than Location/Land: Energy; and Knowledge, all of which have a value in use over time.

  • This is hilarious. Why not stock up on helium, or lanthanum, or Florida real estate? You are talking about commodity speculation, pure and simple. The traditional patina of gold shouldn’t blind people to the fact that it is a commodity just like any other, though perhaps a bit more durable. In an era of dollar deflation, I’m not sure that gold looks like a better store of value at all.

  • PM

    Instead of leaving the gold in the ground, wouldn’t it make more sense to borrow money now to mine and refine the gold, hold the gold off the market, and then pay back the loan in devalued dollars? If this was happening, would the mined and extracted gold show up in the production stats?

  • Freikyd

    The substance best found suited for supporting trade during human civilization has no intrinsic value…

    5 billion years of toxic waste is surely worth 50 years worth of electricity


    Yes indeed. But, this requires (generally) that one can be confident of paying back the loan. This may be why we’ve seen some large global gold miners take part in the corporate financing wave.



    No Burk, you are talking about commodity speculation. Not I.

    “The traditional patina of gold shouldn’t blind people to the fact that it is a commodity just like any other, though perhaps a bit more durable.”

    Even a person who has no interest in gold but who is informed about gold’s history would likely disagree with this statement.

    “In an era of dollar deflation, I’m not sure that gold looks like a better store of value at all.”

    In an era of dollar deflation? Burk, you are once again outdoing yourself .