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After Warren Buffett came down hard on Gold (GLD) in his 2011 Berkshire Hathaway (BRK.B) shareholders' letter, this prompted a huge reaction from the gold bugs. Basically each and every one of them said "Warren Buffett is wrong", much like what can be seen in CommodityHQ's recent article "Why Buffett Is Dead Wrong On Gold".

What's the problem with this reaction? Well, it's simple. The problem is that Warren Buffet isn't wrong. The problem is also that when defending gold, the gold bugs usually attack not Warren Buffett's thesis, but a straw man they have erected, instead.

The straw man

I say this because Warren Buffett's thesis is not whether gold is better or worse than the dollar. He flat out says that he doesn't like currency (and thus, the dollar):

High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments - and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Under today's conditions, therefore, I do not like currency-based investments.

Why Warren Buffett can only be right

What Warren Buffett does do, is compare all of the World's gold to a portfolio of assets including all of the U.S.'s cropland and 16 Exxon Mobils plus $1 trillion in cash. He compares these two hypothetical investments over the course of a century - that's one hundred years.

There is NO way for Warren Buffett to be wrong when doing this comparison. The best you can expect from gold is for it to purchase about the same goods now as it would purchase in one hundred years' time, keeping its purchasing power stable. Now, all of those Exxon Mobils and cropland would be producing goods every year and even discounting the costs of doing so, those companies and cropland would be earning their worth several times over. After all, if you bought the portfolio at 10 times earnings, then in 100 years it will produce at least (100/10=10) ten times its cost in earnings. What this means, is that over the course of one hundred years, just the earnings from the investment would be enough to purchase goods in excess of its cost several times over, which is obviously better than just buying the stuff once.

Besides, cropland and equities benefit both from the increase in productivity and the increase in population, as well as inflation. Gold does not - it only benefits from inflation. So not only can we expect the pile of cropland and Exxon Mobils to keep our purchasing power and deliver purchasing power several times its cost over one hundred years, but we can actually expect the investment to show increased purchasing power over time (over and beyond what results from accumulating many years of earnings), due to a larger population and increased productivity.

Conclusion

Warren Buffett is not wrong if gold outperforms cash, for Warren Buffett also warns against cash and is not comparing gold to it. And Warren Buffett is certainly right that cropland plus equity would beat gold over a century, simply because such a portfolio would earn its cost many times over, while also reflecting inflation, population growth and productivity increases.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Why Buffett Is Not Wrong Regarding Gold