Gold and bits, two sides of the same coin

Bitcoins plunged on Thursday, and gold prices plunged on Friday. Different as they are, the newest currency and the oldest are only worth what someone is willing to pay for them.
Gold had been on a multi-year bull run before running into trouble this year. Bitcoins, which one industrious investor has started minting with unique digital codes, have been on a similar ride. (Canadian Press/Reuters)

It was as if gold was taking a lesson from Bitcoin the day before, and for once you couldn't blame North Korea.

On Thursday, the electronic currency plummeted to about $50 after hitting a Wednesday high of about $260.

"What did they think?" chuckled someone at a business news meeting I attended. "Bitcoins have no real value. They are just an imaginary currency."

Fast forward to Friday. Gold plummets $30 before North American markets open and another $30 by mid-morning, bumping along around $1,500. That is a 21-month low and well off the $1,700 level it hit last October.

I did not say this at today's business meeting, though I should have:  "What did they think?" (Here I would have chuckled.) "Gold has no real value. It is just an imaginary currency."

"But whoa, hold on," you might respond. "Gold is a valuable substance that you can use for making rings and catalysts and electronic parts. It does so have a real value."

And you would be right.  Gold does have a real value-in-use. Estimating that value is hypothetical. But if you eliminated all financial trading of gold, and made available all the gold in vaults around the world for jewellery and industrial uses, the value of gold would surely be well below $300 dollars an ounce.

Gold has been on a multi-year bull run. (Duk Han Lee/CBC)

How do I know that? The reason is that even with most of the gold sitting in vaults at that time, gold sat at about $300 dollars for years before this recent explosion of speculation, and there was never any shortage. As an industrial metal alone — without jewellery — it would be worth far less.

The only reason people want to hold gold is because they think it will increase in value or at least retain its value.  As Burton Malkiel reminds us in his classic book on markets, A Random Walk Down Wall Street, many people buy into markets they realize may be over-valued, assuming they will simply be smarter than everyone else and sell out before the sharp decline. 

As I warned here and here there are good reason why gold is unlikely to hold its speculative value forever. And when it goes into its final decline, watch out. I won't repeat the arguments.

After plodding along in obscurity, Bitcoin prices took off, and then crashed this week. (Duk Han Lee/CBC)

While gold may indeed have a real value-in-use of $300 more or less, the price above that real value is no less speculative than that of the Bitcoin. The difference is that while bitcoins can fall tens of dollars to zero, gold can fall more than $1000 to its value-in-use price.

Bitcoins may indeed have a value-in-use as well. But what that amount is, we don't know. Their value is as an online trading tool. As a tool for online trading, gold is useless.

The Bitcoin market is new and uncertain and based on algorithms and cryptography most of us don't understand. Gold markets are old and established. We think we understand them better. But the trading value of both are based on one single thing — what people are willing to pay for them.

While the Bitcoin's wild swings are a great lesson for geeks and nerds in the working of real world markets, so is the electronic currency's gyration a reminder that any real world speculative investment can do the same thing. 

They are two sides of the same coin.