Stocks Vs. Gold And Bonds

by: David Merkel, CFA

I have great admiration for Warren Buffett, even though I am critical of him at a number of points. When I read the piece in Fortune where he talks about asset allocation issues, I agree with him 75%. Where should money be invested? Stocks. And as for me, 75% of my net worth is there. Nonetheless, I see value in bonds, gold, and cash, even though I don’t own any gold, aside from my wedding ring.

Gold is valuable because of its scarcity, and that it is beloved by most cultures in the world. Gold is beautiful. Compare it with other metals, gold stands out because it has little economic usefulness. But that is a feature, not a bug, because it makes gold immune to economic cycles.

Review the gold medal gold model. The price of gold reacts to real interest rates. When they are low, the price of gold flies because the cost of carrying gold is negative. If I could say one thing to Buffett on the topic, I would say read this article, and you will learn why the price of gold is rational and correct in this environment. Negative real interest rates means the government does not care about the value of its currency, and thus scarce things (think of truly scarce collectibles in the 70s) appreciate in value dramatically versus the depreciating dollar.

Gold is valuable, very valuable when governments and central banks are profligate. But what of bonds? Those are the opposite. They are valuable when governments get more serious about their finances, or when people are scared about the future, and buy long bonds because they want certainty of cash flows in the future.

Also, be for real, Warren. The dominant asset class inside BRK is bonds. You hold a lot of them in your insurance companies.

Do I believe in stocks? Yes, if they are my stocks — the value premium of buying beaten-down companies is dependable. It doesn’t work every year, but it works most years.

My main point is this: stocks are great, but they are not a panacea. Gold and things like it are needed for inflation. Bonds are needed for deflation. Cash offers flexibility. These are all useful to investors at the right times.

And, Warren, you have done better than most. Your stock portfolio has beaten others over the last 40 years. Most stock portfolios have not beaten bond portfolios, though admittedly by a smidge.

So, is this the time to buy stocks? I am more bullish than bearish, so yes, but edge in, and be ready to adjust.