Gold vs. Value Investing: An Historical Perspective

I continue to be intrigued by David Einhorn's recent disclosure that his Greenlight Capital funds are now significantly long gold and gold miners. Read his 2008 letter to investors for his reasoning. I don't disagree with any of it.

But Einhorn is a value investor, one of the best-known and most successful of our day. His skill is in finding and buying undervalued companies (and shorting overvalued ones). His bet on gold is not in that vein (no pun intended), but is rather a macro bet, a bet on the state of the world in the future. It's not a particularly cheap one either.

When I (very timidly) asked Einhorn about his gold bet at the CIMA conference, he stated that it, like all other investments, should be evaluated in terms of its opportunity cost. It seems to be, however, that Einhorn's opportunity cost of holding gold is not the return on cash or treasuries, but rather the expected return from doing what Einhorn does best: value investing.

Consider the following mini-case study. History doesn't repeat itself but it does rhyme: the 1973-1974 bear market in stocks coincided with a bull market in gold.

President Nixon moved off the gold standard and inaugurated the era of paper money, Vietnam-era "guns and butter" spending led to increased inflation, the Yom Kippur war highlighted the vulnerability of the west to commodity shocks, Watergate threatened everyone's faith in government, etc. Gold traded up from its old fixed price of $35 an ounce in the late 1960s to about $150 in late 1974. Stocks of course plummeted, even those held by the great value investors of the time. I don't remember it but others do. It was pretty bad.

What happened then? The rest of the 1970s were outstanding for gold, although you had to wait until the latter part of the decade to start making money. It performed amazingly well, hitting a high of $850/ounce on January 21, 1980 (I read somewhere that Jacqueline Kennedy Onassis bought gold during this period and made a fortune, on the advice of her companion Maurice Tempelsman. If the story is true, he belongs in the Hall of Fame of Investors' Consiglieri. But that's for another post).

If you bought gold at $150 in late 1974 and managed to sell at the top, you more than quintupled your money, a compound annual return of over 41%. The gold bugs, in short, were absolutely right.

But not so fast. How did the top value investors of the day, the David Einhorns of yesteryear, perform in the footrace against gold from 1975-1979? As far as I know, none of them made any significant bet on gold at this time--they were just doing good old-fashioned value investing. Here is the record, taken from the Berkshire Hathaway (BRK.A) annual report and Warren Buffett's famous essay "The Superinvestors of Graham-and-Doddsville":

Berkshire Hathaway 34% (book value growth)
Walter Schloss 43%
Tweedy, Browne 32%
Sequoia 36%
J.P. Guerin 51%

Yes I'm cherry-picking the data here, but on balance I'm giving gold a head start by assuming you sold it at the $850 top, which occurred only briefly. If you only managed to sell at $675, the average price during January 1980, your five-year return went down to 35%.

My conclusion is that old-fashioned value investing, as practiced by its best practitioners, was remarkably competitive with gold during one of the latter's greatest bull markets.

Disclosure: None

Comments

[akenaton:]

I'm amazed that most of people are bearish (if not naked short) Gold. Those are the same that shorted crude oil at $50 thinking it was too expensive. But in the mean time crude spiked up at $147 and believe me they had to cover their short positions. Investing is not being right or wrong (we are all right or wrong at a certain time) but timing. Timing is derived by people's willingness to make a bet or not. In today's world everybody is on the sideline, traders are death, banks are not there anymore and on top of it you'll have paper money that can barely buy anything...with this in mind I have no clue where Gold could go in the short-future but what I know is that if we see a run on Banks as I think of colossal dimensions, no one want paper of any kind and I would rather prefer to own a depreciated house, piece of land, a sh... piece of Gold than a paper like I have in my office of those that were stamped during the 1920's and are just nice to see on a wall....

Feb 22 07:48 AM

[ROLEXDAYTONA:]

The only value I found in this article is mentioning of Warren Buffett, how can you compare some hedge fund hot shot, to W.B.
W.B. never invested in Gold mining stocks or Gold futures ( he had Silver investment in the 1980's that he sold 10 years later at a loss at the worst time ) like your hedge funf hero.
Hedge fund superstars come and go, W.B remains, it is bubbles that make some hot shot famous, not value investing.

Feb 22 09:58 AM

[Mad Hedge F...:]

GOLD! GOLD! GOLD! This is the cry being heard worldwide by investors in the Great Gold rush of 2009, looking for a generic “short America” trade. Where in the past gold seekers used sluices, shovels, and jackhammers to extract the glittery stuff in California’s Sierras, Alaska’s Klondike, and South Africa’s Rand, today the instrument of choice is the mouse. Online traders are unleashing clicks by the millions to buy ETF’s, American Eagles, mining shares, and futures contracts. With stock traders sitting on their haunches, wondering if the Dow will hold 7,000, this is the only thing that is working right now. Gold is no longer just catastrophe insurance. Traders are buying gold more for what it isn’t, than what it is. It isn’t made of paper, made in the US, or held in custody by Bernie Madoff or Stanford Financial. The yellow metal hit a new high for the year of $887 overnight, and the risk of a “melt up” is increasing. The Street Tracks Gold Trust ETF (GLD) is now the seventh largest holder of the barbaric relic in the world. For the newly aggressive, look at the DB Gold Double Long ETF (DGP), which gives you a 200% long exposure to gold, and is up 54% in a month. Who says there is nothing to buy out there?

Feb 22 12:41 PM

[Ricard:]

Good article. It's a great reminder that stocks, like gold, are also an inflationary hedge.

Feb 22 01:48 PM

[silverwood:]

The possibility that precious metals will rise to new all time highs in terms of USD as they have in most other currencies and stay at or near thoses levels will result in predominately precious metal mining companies being a excellent value play.

A number of reasons for this are:
1. Mining costs have dropped dramatically, ie energy costs and other raw materials needed.
2. Base metal miners who often have precious metals a by-product have curtailed activity as base metal prices have plummeted therefore reducing supply of precious metals.
3. In the 70s bull in precious metals many miners paid a handsome dividend and I believe this will be the case again.
4. Large deposits of precious metals have been harder to find and with what has occurred to the junior miner explorers this will curtail supply of precious metals further.
5. I'm sure there are other factors that could be added to this list so comments are encouraged.

Feb 22 02:36 PM

[Jgib:]

Gold, itself as bullion, does not pay dividends or interest, and must be stored and insured. Gold miners pay dividends (most of them) and they only store gold in the form of deposits, and in bullion form awaiting sale or delivery. The dividends are paid after all related costs have been accounted for.

Feb 22 08:44 PM

[bestorinvestor:]

Gold is in fact an essential component of EVERY portfolio and those with the savvy to see opportunity that gold presents tend to be labeled gold bugs. Metanor Resources, MTO.V a canadian producer as of October of this past year is one of those opportunities. They just poured 20,000 oz gold and have huge exploration blue sky and an open pit that they should produce 60,000 oz gold annually from. Their mill and infrastructure is valued at $140M ...presently trading at aprx 40% of that infrastruture value alone ignoring the 1M oz resource etc. Currently trading under .70 cents !!! Opportunity !!! Me thinks so. Good read
miningmarketwatch.net/

Feb 22 09:42 PM

[mr freddo:]

Gold is the safe harbor investment for the rest of the decade. If investors wish to retain value they will park their funds in gold. It is the safest investment available at this time.

Feb 23 01:11 AM

[Pepyn:]

Sir,

in your comparison you're actually giving value investing a bit of a head start, for 2 reasons:

1. your comparison starts in 1974, when gold was at a intermediate high and stocks at their nominal bottom of the 70's bear market. More fair would be to take the 1970s as a whole, and take gold where it was after it crashed. Gold went up from 35$ to appr. 500$ after the crash of '80. A factor 14... Not even Buffet matched this return.

2. You compare against the world's best value investors. None of us small time investors could ever dream of matching their returns. This gives a highly favourable bias to value investing.

The big lesson of the 70s was that for the average investor, somewhat less sophisticated then Warren Buffet, the best thing to do was sit out the decade in gold. It would have taken considerably less time and effort and given far greater returns...

Feb 23 06:46 AM

[Ricard:]

Gold is not an investment - it is a store of value, nothing more. The fact that you hold gold does not enhance productivity in any way. The fact that we dig more out of the ground does not give more prosperity to people.

If you hold a bond, that is an investment. Stocks as well. Even real estate. It's just that for the latter, America has made horrendous choices as to how it allocated its capital.

All of these choices, if properly invested (say, we don't make 50 years of toilet paper in 3 years, i.e., CDS), will enhance our productivity (think capital goods) and raise our level of prosperity in the future. Gold does none of this.



On Feb 23 01:11 AM mr freddo wrote:

> Gold is the safe harbor investment for the rest of the decade. If
> investors wish to retain value they will park their funds in gold.
> It is the safest investment available at this time.

Feb 23 09:01 PM