In a recent podcast episode, I analyzed three different scenarios where today’s expectations about future economic conditions can affect supplies and prices in the near term. Specifically, I analyzed this mechanism for three different goods: (i) US fiat dollars, (ii) barrels of crude oil, and (iii) ounces of gold. In the first installment of this blog post series, I covered the case of US dollars. In the second post I covered the case of a discovery of a new (future) supply of crude oil. And now in this final post, I’ll work through the example of an expected influx of new gold in the future.
Gold: The Story
Let me first set up the fanciful scenario we’ll be covering in this post: Suppose the gold market is in an initial long-run equilibrium, where the current market price is consistent with everybody’s expectations about new gold being mined, the “consumption” of gold (i.e. being used in industry or to make jewelry), and the amount of gold flowing into stockpiles being held as an inflation hedge.
Suddenly, the news leaks that Elon Musk and his associates have identified several asteroids that collectively hold as much gold as the available stockpile on Earth, including the gold that is still in Earth’s crust. The only hitch is, it will take Elon et al. exactly 10 years to move the asteroids into orbit around Earth. Further assume that once in orbit, the asteroids will yield gold that can be parachuted down to the surface, at the same price per unit as it costs to mine gold from the Earth’s crust.
In this simplistic framework, what can we say about the new equilibrium price of gold, immediately after the news has been leaked and the market adjusts to the new outlook for the yellow metal?
Equilibrium in the Gold Market: The Framework We'll Use
Loosely speaking, our gold scenario will draw on elements of our USD and oil examples. That's because people currently use gold for both purposes, namely as a "store of value" (like US dollars) but also as a commodity (like oil). Thus, the market's reaction to our hypothetical doubling of the identified supply of gold on Earth (not available for 10 years) will involve people holding "gold balances" based on expectations of its future price appreciation, but also involve the Hotelling model of exhaustible resources.
One wrinkle that makes gold more interesting than either dollars or oil is that gold is held simultaneously for both purposes by many of the same people. A central bank holds gold partly because as an “inflation hedge” (providing a form of insurance) and partly because it expects gold to appreciate over time. This dual demand is what makes the asteroid scenario so rich; the announcement affects both demand channels at once, and the two channels reinforce each other.
The Initial Equilibrium
Before the asteroid news breaks, the gold market looks like Chart 1 below. In any given year, newly mined gold (the upward-sloping green supply curve, reflecting rising extraction costs) gets split between two uses: industrial and jewelry demand (the downward-sloping purple curve), and hoard accumulation (the upward-sloping orange curve). Unlike industrial demand, the hoard accumulation demand actually slopes upward, because the more expensive gold is, the more attractive it is as a monetary asset: people treat it as "hard money" precisely because others do, a self-reinforcing network effect.
At the initial equilibrium, the price index is 100, and mine output of 5 units per year splits roughly 75/25: namely, about 3.75 units flow into industrial uses (jewelry, electronics, dentistry) and 1.25 units flow into hoards. The choke price — the price at which industrial quantity demanded goes to zero, because substitutes become viable — is 200, or double the current price. The mine shutdown price, below which high-cost extraction becomes uneconomical, is 50.
What ties this all together is the Hotelling principle: in equilibrium, mine owners must be indifferent between extracting an extra ounce today versus leaving it in the ground for next year, which requires that the real price of gold rises at the real interest rate (5% per year in our model). As the price gradually rises along this path over time, industrial quantity demanded slowly falls and hoard accumulation slowly rises, until the price eventually reaches 200 and both flows go to zero simultaneously. The in-ground gold reserves are completely exhausted at that point (about 14 years from now in the initial equilibrium).
Hoard Demand and the Monetary Premium
Before getting to the asteroid shock, it's worth elaborating on hoard demand, since this is what distinguishes our gold model from the pure Hotelling story I used for oil in Part 2.
The demand to hold gold in a hoard depends on two things: the expected rate of price appreciation (π), and the current price level itself. The π-dependence is standard: if gold is expected to rise faster, people want to hold more of it, just like they'd hold more of any appreciating asset. The price-level dependence captures something subtler: at $10 per ounce, nobody treats gold as "hard money." But at $3,000 per ounce, central banks hold it as a reserve asset and ordinary people buy coins as an inflation hedge. Gold's monetary credibility is itself a function of its value, which is why Chart 1's orange hoard accumulation curve slopes upward rather than downward.
We have calibrated the parameters in this model so that 25% of annual mine output flows into hoards in our baseline case. This is consistent with real-world data showing that investment demand (bars, coins, ETFs) has historically absorbed around 20-30% of annual mine output.
The Asteroid Announcement
Now the news breaks. What happens? Two things hit the market simultaneously, and they both push the gold price down.
Channel 1: Mine Owners Accelerate Extraction
Under the Hotelling rule, mine owners hold gold in the ground because they expect it to appreciate at the real interest rate. The asteroid announcement changes this calculation. With a massive new supply arriving in 10 years, the expected future price of gold is now lower than before. That means leaving gold in the ground is less attractive; the capital gain from waiting is smaller. So mine owners rush to extract now, before the price falls further.
This is the same logic as the oil example from Part 2. The announcement of future abundance makes current in-ground reserves relatively more valuable than they will be once the asteroid gold arrives, so the rational response is to accelerate extraction. The mine supply curve in Chart 3 shifts rightward.
Note that this response is not a short-run market phenomenon but a genuine Hotelling arbitrage. Mine owners aren't reacting to current prices, instead they're reacting to expected future prices, and moving their production schedule forward accordingly.
Channel 2: Hoarders Dishoard — “Mining at Zero Cost”
The second channel is where the gold story departs from the oil story, and it's the one I find most instructive. When I discussed this scenario in a recent podcast, I described what happens to gold hoarders as “mining at zero cost,” and a listener told me afterward that insight was worth the admission price of the whole episode.
Here’s the logic. At the moment of the announcement, the expected future price of gold is now lower than before. This means the expected capital gain from holding gold — which was equal to the 5% real interest rate in the old equilibrium — is now lower. At the old price of 100, a holder of gold is no longer earning the market rate of return. She has two options: keep holding and accept a below-market return, or sell and put the proceeds elsewhere.
Rational hoarders sell. They liquidate their gold holdings onto the market — at zero extraction cost, since the gold is already above ground sitting in vaults and jewelry boxes. This is economically identical to what mine owners are doing (bringing forward supply to get ahead of the price decline), but without any extraction cost at all. The hoarders are, in effect, mining their own stockpiles.
Furthermore, the announcement also reduces the monetary credibility of gold — its appeal as “hard money” — because the asteroid news implies that gold will no longer be as scarce relative to global wealth as it once was. This is captured in our model by a reduction in the parameter β. As a result, the entire hoard demand curve rotates, as shown in Chart 2: at every price level, people want to hold less gold than before, not just because they expect less price appreciation (π is still 5% in the new equilibrium, once the dust settles) but because gold’s role as a monetary safe haven has been partially undermined.
At the initial equilibrium, the price index is 100, and mine output of 5 units per year splits roughly 75/25: namely, about 3.75 units flow into industrial uses (jewelry, electronics, dentistry) and 1.25 units flow into hoards. The choke price — the price at which industrial quantity demanded goes to zero, because substitutes become viable — is 200, or double the current price. The mine shutdown price, below which high-cost extraction becomes uneconomical, is 50.
What ties this all together is the Hotelling principle: in equilibrium, mine owners must be indifferent between extracting an extra ounce today versus leaving it in the ground for next year, which requires that the real price of gold rises at the real interest rate (5% per year in our model). As the price gradually rises along this path over time, industrial quantity demanded slowly falls and hoard accumulation slowly rises, until the price eventually reaches 200 and both flows go to zero simultaneously. The in-ground gold reserves are completely exhausted at that point (about 14 years from now in the initial equilibrium).
Hoard Demand and the Monetary Premium
Before getting to the asteroid shock, it's worth elaborating on hoard demand, since this is what distinguishes our gold model from the pure Hotelling story I used for oil in Part 2.
The demand to hold gold in a hoard depends on two things: the expected rate of price appreciation (π), and the current price level itself. The π-dependence is standard: if gold is expected to rise faster, people want to hold more of it, just like they'd hold more of any appreciating asset. The price-level dependence captures something subtler: at $10 per ounce, nobody treats gold as "hard money." But at $3,000 per ounce, central banks hold it as a reserve asset and ordinary people buy coins as an inflation hedge. Gold's monetary credibility is itself a function of its value, which is why Chart 1's orange hoard accumulation curve slopes upward rather than downward.
We have calibrated the parameters in this model so that 25% of annual mine output flows into hoards in our baseline case. This is consistent with real-world data showing that investment demand (bars, coins, ETFs) has historically absorbed around 20-30% of annual mine output.
The Asteroid Announcement
Now the news breaks. What happens? Two things hit the market simultaneously, and they both push the gold price down.
Channel 1: Mine Owners Accelerate Extraction
Under the Hotelling rule, mine owners hold gold in the ground because they expect it to appreciate at the real interest rate. The asteroid announcement changes this calculation. With a massive new supply arriving in 10 years, the expected future price of gold is now lower than before. That means leaving gold in the ground is less attractive; the capital gain from waiting is smaller. So mine owners rush to extract now, before the price falls further.
This is the same logic as the oil example from Part 2. The announcement of future abundance makes current in-ground reserves relatively more valuable than they will be once the asteroid gold arrives, so the rational response is to accelerate extraction. The mine supply curve in Chart 3 shifts rightward.
Note that this response is not a short-run market phenomenon but a genuine Hotelling arbitrage. Mine owners aren't reacting to current prices, instead they're reacting to expected future prices, and moving their production schedule forward accordingly.
Channel 2: Hoarders Dishoard — “Mining at Zero Cost”
The second channel is where the gold story departs from the oil story, and it's the one I find most instructive. When I discussed this scenario in a recent podcast, I described what happens to gold hoarders as “mining at zero cost,” and a listener told me afterward that insight was worth the admission price of the whole episode.
Here’s the logic. At the moment of the announcement, the expected future price of gold is now lower than before. This means the expected capital gain from holding gold — which was equal to the 5% real interest rate in the old equilibrium — is now lower. At the old price of 100, a holder of gold is no longer earning the market rate of return. She has two options: keep holding and accept a below-market return, or sell and put the proceeds elsewhere.
Rational hoarders sell. They liquidate their gold holdings onto the market — at zero extraction cost, since the gold is already above ground sitting in vaults and jewelry boxes. This is economically identical to what mine owners are doing (bringing forward supply to get ahead of the price decline), but without any extraction cost at all. The hoarders are, in effect, mining their own stockpiles.
Furthermore, the announcement also reduces the monetary credibility of gold — its appeal as “hard money” — because the asteroid news implies that gold will no longer be as scarce relative to global wealth as it once was. This is captured in our model by a reduction in the parameter β. As a result, the entire hoard demand curve rotates, as shown in Chart 2: at every price level, people want to hold less gold than before, not just because they expect less price appreciation (π is still 5% in the new equilibrium, once the dust settles) but because gold’s role as a monetary safe haven has been partially undermined.
Three things shift simultaneously: mine supply accelerates (the green curve moves right), the one-time hoard dump adds a pulse of supply shown by the shaded coral rectangle, and the total demand curve rotates slightly inward as hoard accumulation demand falls. The combined effect drives the equilibrium price from 100 down to 60 (a 40% drop), occurring immediately upon announcement, before a single ounce of asteroid gold has been extracted. The new equilibrium also has higher flow quantity of 5.85 units per year, up from 5, as industrial users absorb gold at the lower price.
One important asymmetry is worth highlighting. The accelerated mine supply is an ongoing flow shift; mine owners permanently move more gold to market each year going forward. The dishoarding, by contrast, is a one-time stock event. After the initial dump, hoarders don’t keep selling indefinitely. In fact, since the gold price continues rising at 5% per year along the new Hotelling path, desired hoards are growing again almost immediately after the announcement, as gold begins to recover its status as a store of wealth. The gold hoards just grow from a lower base, and more slowly than before.
The Price Path Over Time
Chart 4 shows the full dynamic picture.
The dashed gray line is the old Hotelling path: the gold price rising at 5% per year, heading toward the choke price of 200 around t=14. The solid green line is the new path after the announcement. At t=0 (the moment of announcement), the price drops immediately from 100 to 60. It then resumes rising at 5% per year, just from the new, lower starting point.
Two features of this chart deserve emphasis.
First, there is no price discontinuity at t=10 when the asteroid actually arrives. This may surprise casual readers, but those who have been following this series should expect this result by now. Rational markets price in anticipated events immediately. By t=10, everything the asteroid implies for the gold market has already been incorporated into the price at t=0. The asteroid’s arrival at t=10 is a complete non-event from a pricing standpoint, because people in the market have known about it for a decade.
This is the central lesson of the entire three-part series. Whether it’s dollars, oil, or gold, forward-looking markets respond to information, not to the physical arrival of the goods in question. The moment a credible announcement is made, equilibrium prices jump to their new values and stay there.
The second feature worth emphasizing is that the announcement extends the life of terrestrial gold mining. At the old equilibrium, in-ground reserves would be exhausted around t=14. At the new equilibrium, they last until around t=24, a decade longer. This might seem to contradict the earlier finding that mine owners accelerate extraction after the announcement. But the resolution is straightforward: the asteroid roughly triples the in-ground reserve base, and a tripled stock takes longer to exhaust even with faster extraction rates and higher industrial consumption at the lower price.
The Silver (and Bitcoin) Lining
There is one more implication of the asteroid scenario worth drawing out, particularly for readers who think about gold as a monetary asset.
If the asteroid news made gold less attractive as “hard money,” where would the displaced monetary demand go? In the real world, the obvious candidates are silver (a close monetary substitute with similar historical pedigree) and Bitcoin (the digital-age contender for the “scarce monetary asset” role). Both would likely appreciate at the moment of the asteroid announcement, as investors switch from a newly-abundant gold to alternatives whose scarcity is unaffected by the news.
This is a nice illustration of how substitution effects work in monetary assets. Gold’s value as a store of wealth derives partly from its scarcity relative to global wealth. Double the supply of gold and you haven’t changed the supply of silver or Bitcoin. So investors seeking scarcity-based monetary protection would rationally rotate out of gold and into the alternatives. (In the model, we capture this effect by reducing the hoard demand for gold.)
Conclusion: What Gold, Oil, and Dollars Have in Common
Across all three posts in this series, the same basic insight keeps appearing in different disguises: Markets respond to expectations, not to physical deliveries. When people learn that more dollars will be printed next year, the price level adjusts today. When people learn that a new oil field will come online next year, oil prices fall today and pumping accelerates today. And when people learn that a massive new supply of gold will be available in 10 years, the gold price falls today, mines accelerate today, and hoarders dishoard today — all before a single ounce of asteroid gold has touched the Earth’s surface.
The mechanism differs slightly in each case. For dollars, it’s a pure money-demand story: people reduce their desired cash balances when they expect inflation, which itself causes inflation today. For oil, it’s a pure Hotelling story: producers bring forward extraction to get ahead of an expected price decline. For gold, it’s both simultaneously: the Hotelling logic applies to mines, and a monetary logic applies to hoarders, who can “mine” their own vaults at zero cost.
What unifies all three is the market’s forward-looking nature. In a world where people can trade today based on what they expect tomorrow, it’s not only financial asset prices that move, but even physical supplies can seemingly become more abundant.
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together the dependability of Whole Life insurance policies with the benefits of blockchain-based finance.
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