Stock to Flow Ratio

I don't know why
You treat me so bad
Think of all the things
We could have had
--Talking Heads

Nice point about stock to flow ratio differences between gold and other commodities. Stock to flow ratio is measured here by taking above ground inventory and dividing it by annual production.

Unlike most commodities, gold's stock to flow ratio is high. Nearly all gold mined over thousands of years still exists in its stand alone, elemental form. Because physical gold is durable and inert, it remains with us. On the other hand, annual gold production is relatively low, constituting only 1.5% or so of above ground stock. Consequently, gold's current stock to flow ratio is above 50.

Compare this to wheat. Above ground wheat stocks are rapidly consumed. Wheat put in storage is subject to decay. In order to meet demand, about 3x the amount of wheat inventory must be produced annually. Inventory turnover is high, resulting in wheat's low stock to flow ratio below 0.5.

Of course, the properties of gold that elevate its stock to flow ratio, e.g., durability, scarcity, etc, make it attractive from a monetary perspective. In fact, it seems to follow that commodities with high stock to flow ratios would constitute a nice short list of plausible monies.

The article stresses that stock to flow ratio helps explain pricing differences between gold and other commodities. Whereas the price of wheat is driven largely by supply/demand dynamics of its stock to flow ratio components, the price of gold is less subject to short term volatility. Above ground inventories are high compared to new supply and consumer demand.

Instead, gold price should be driven more by changes in institutional demand. The more institutions demand gold, the higher the price--regardless of inventory levels or annual production.

While institutions are often regarded as large financial entities such as money center or central banks, in a broader sense institutions represent societal rules and norms.

Stated another way, when it becomes more 'societally correct' to own gold, then price will go up.

Stated another way again, changes in institutional rules are likely to coincide with changes in price of high stock to flow ratio commodities such as gold.