Gold has a specific indicator that you can include in your analyses for the price valuation. This indicator can also be used for the crypto currency Bitcoin, as many financial market observers attribute similar properties to Bitcoin as a store of value: It is the so-called "Stock to Flow Ratio". What is the Stock to Flow Ratio?
Stock stands for the stock of a raw material, i.e. the quantity potentially available on the market. Flow stands for the annual new production quantity of the raw material. The ratio, i.e. the ratio of these two values, describes the time it would take to reach the current stock level (stock) at the current production quantity (flow). The higher this ratio is, the more scarcity there is in the supply of this raw material. The definition of scarcity is that something in nature is hard to find or hard to produce. This is true for precious metals such as gold, for example, but also for Bitcoin, which requires a lot of computing power to produce (limited by the block chain protocol). What does the Stock to Flow Ratio (using gold as an example) say? Gold as a raw material
is not as rare as one might think, it is mined on a large scale and the industrial use is also small, i.e. a large part of the gold ever mined is still in circulation, because it has more the function of a store of value and was not consumed in an industrial process. Most of the other commodities that are mined are usually completely consumed for some industrial purpose or production. So gold does not have such a high price because it is such a rare, much needed commodity, but because the annual production is very low compared to the maximum stock. So there is a shortage in the supply of new gold. This creates some characteristics that make gold attractive as a store of value. It provides stability and security because a production shortage or sudden overproduction would have very little effect on the total stock when compared to other commodities. For example, if a significant portion of the world's copper production were to fail, this would have a massive impact on the copper price. The mined copper is not stored but used in industry, which means that the output is largely used to meet demand. If production collapses, the raw material will soon be unavailable for production because it is running out. Thi
s drives up the price. Of course, there are other factors that give gold its characteristic as a store of value: it is eternally durable; it has a high value density and thus low storage and transport costs compared to its value; it can be easily worked (and made into jewellery or coins, for example); it has quality characteristics that make standardisation possible. So while most raw materials are consumed, gold is hoarded. This creates trust due to the high stock to flow ratio and the resulting low price effects caused by changes in production, and thus a benefit as a store of value, which has been established for gold over thousands of years, also due to the now very high stock and long use as a store of value. The higher the stock to flow ratio, the lower the risk of inflation.
What influences the stock to flow ratio of gold the most? When the price of gold rises, for example, as a result of growing tensions in the trade dispute and the extremely tightening zero interest rate policy, another effect is that mining companies try to increase production as mining becomes more lucrative. The costs remain the same, the selling price is higher and the margin per gold ounce increases. The higher production also means that the inventory increases faster, but the production of gold increases at a higher rate than the inventory, because over an extremely long period of time it has reached an enormous size compared to the annual production volume. Due to this effect the stock to flow ratio decreases again. Increased production increases the supply that meets the increased demand. If overproduction is reached, the price falls again, production decreases accordingly and the stock to flow ratio rises again. In the case of gold, therefore, the key variable that influences the stock to flow ratio is the production quantity.
Stock to Flow Ratio for Bitcoin With Bitcoin, production is regulated completely differently. The protocol behind the Bitcoin block chain determines production and the maximum Bitcoin inventory, which is set at 21 million. A certain amount of Bitcoin is always produced for each stored information block (as a reward for the "miners" who enter the network). Today will be the Bitcoin Halving, (11.05.2020)