Like many gold investors, I've grown increasingly tired of listening to what Warren Buffett has to say about the yellow metal in recent years, but his latest comments do offer something valuable. It is another timely reminder that conventional wisdom here in the U.S. is decidedly "anti-gold," and that many investors will never, ever understand (or care) why gold has been one of the very best performing asset classes for more than a decade (many of them never even bother to try).
In many ways, this is a classic case of cognitive dissonance, a condition that I normally summarize as "rejecting out of hand or going to great lengths to construct weak/invalid arguments against beliefs that are inconsistent with other strongly held views".
In short, for many to believe that there is a valid investment case to be made for gold, they must grapple with other uncomfortable possibilities, such as the idea that the world's monetary system is unsustainable over the long run and that, perhaps, many assets have been mispriced for decades now due to actions taken by central banks and other policymakers, and that this was a major cause of the ongoing financial crisis.
Despite their poor track record over the last decade, Buffett remains fixated on stocks like most other U.S. investors, and that's not likely to change anytime soon, though there will surely be slowly increasing asset allocations for gold in U.S. investment portfolios, while most activity in the ongoing gold bull market takes place in other parts of the world, namely, China and India.
In many ways, it just amazing...
As smart as Buffett is and as successful as he's been, for some reason, he just can't seem to come to grips with the idea that the price of gold is not really about the metal, but a reaction to the rapidly deteriorating quality of paper money around the world. It is due to the quickening loss of confidence in government and central bank policymakers, and growing questions on the sustainability of the current monetary system that, in the broad sweep of time, is still relatively new and untested.
That view is clear in this Forbes story that contains excerpts from his shareholder meeting speech, my comments interspersed:
Buffett: The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer's hope that someone else -- who also knows that the assets will be forever unproductive -- will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.
This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce -- it will remain lifeless forever -- but rather by the belief that others will desire it even more avidly in the future.
There is a lot to like about Warren Buffett, but his insistence that the only type of asset worth owning is one that offers a yield, a dividend, or is in some other way "productive" is not one of them. Moreover, likening the rise in the gold price to a Ponzi scheme is just lazy analysis, particularly when considering the recent gold buying surge from central banks around the world, a group not typically known for participating in such activities.
The first two sentences below are quite curious. Buffett mistakenly thinks that gold investors invest in gold almost exclusively (not a bad approach over the last decade, by the way), then admits that they're right to "fear" paper money. He finally returns to the "gold is unproductive" argument, as if he confused himself over the comment about fearing paper money.
The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.
What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth -- for a while.
The idea that gold buyers are motivated by the "belief that the ranks of the fearful will grow" takes on an almost comical context when thinking about rapidly increasing central bank gold purchases. Like many individual investors, they are diversifying away from paper assets in favor of a metal that has functioned as money for millennia.
It's Not Just Gold Bugs Anymore
Sure, there are lots of wild-eyed gold bugs in the world today who have been stockpiling gold and silver coins along with ammo and canned goods, but they're not the ones that have driven the gold price towards $2,000 an ounce. It has been institutional investors, central banks and individual investors who simply look around and see what's happening in the world and figure they should trade in some of their paper money for what has served as money for thousands of years.
Next, comparisons are drawn between the internet stock bubble, the housing bubble, and, while not stated explicitly, the developing gold bubble. But, what's interesting about the paragraph below is the implication that the rise in gold prices had an "initially sensible thesis" - quite the contradiction.
Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the "proof " delivered by the market, and the pool of buyers -- for a time -- expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: "What the wise man does in the beginning, the fool does in the end.
Yes, someday U.S. fools will rush into the gold market when it's reached its final bubble stage and it will end in tears for many, but we're still a long way from that point. The gold price hasn't yet reached its inflation adjusted 1980 high in a world with far fewer available policy options, and today's gold buyers are not foolish in the least, though that's the clear implication.
Now, back to the "unproductive" argument...
Bonds Gold Stocks Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be about $9.6 trillion. Call this cube pile A.
Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today's annual production of gold command about $160 billion. Buyers -- whether jewelry and industrial users, frightened individuals, or speculators -- must continually absorb this additional supply to merely maintain an equilibrium at present prices.
By "staggering valuation," it is presumed that "overvalued" was really meant, and it must be maddening to someone like Buffett to not know how to value this asset - no one really does, despite many attempts.
Given his background, it's easy to understand how this could be a major impediment to actually buying the metal as an investment and, while that's almost forgivable, the idea that $160 billion in annual gold production is too much to absorb is certainly not.
Just look at the current central bank gold holdings in Asia, and you'll see a trillion dollar hole, that is, if these groups simply adopt the European conventional wisdom of 10 to 15 percent of reserves held as gold. Western central bankers aren't exactly sure why they hold this much gold - Fed Chief Ben Bernanke says it's tradition - but, the important point is that, in the West, central banks have stopped selling their gold while, in the East, they've accelerated their purchases.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, many will still rush to gold. I'm confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.
Yes, silly gold investors can fondle the metal, but it won't respond, and Buffett may be right about what happens a hundred years from now, but is anyone really concerned with the world in 2112? It is the period ahead that is most important and people like Buffett denigrating the idea of investing in gold is not likely to keep the price from rising.
It's not about gold - it truly does just sit there, unresponsive - it's about what policy makers are doing to paper money.
As Herbert Hoover once said, "We have gold because we cannot trust Governments" and that has never been more true than today.
Disclosure: I am long (GLD), (SLV).
Additional disclosure: I also own gold and silver coins and bars
