Economic Conditions And Buffett's Views On Gold

Includes: GLD
by: Alexander J Poulos

Warren Buffett granted an interview to CNBC talking about gold and his preference for farmland and Exxon Mobil (NYSE:XOM). The focus of this article will be the two economic conditions necessary for Buffett's disdainful ideas to come true.

Chart courtesy of Wikipedia.

Historical Debt Outstanding - Annual 2000 - 2010























Figures provided by Treasury Direct.

The primary condition necessary for gold to depreciate would be the US government abandoning the weak dollar policy. Starting in 2001 the US government has run up excessive debts due to wars and the creation of a new entitlement program namely Medicare part D. If we notice from the charts above the rampant spending by both political parties has caused the US debt to increase by over 150% in the last decade.

The excessive spending has weakened the perceived value of the US dollar as evidenced by its greater than 50% depreciation versus the euro. I am using the euro as a reference point based on its status as the world's second-largest currency. The EU government has hardly been the model of fiscal restraint, as evidenced by the ongoing turmoil there. This fact alone makes the US dollar's drop even more troubling. If the US dollar is compared with smaller currencies, such as those of Australia, Canada and New Zealand, the depreciation is even starker.

Chart courtesy of Wikipedia.

Chart courtesy of Wikipedia.

A drastic step such as balancing the US budget (in my opinion, the best path) would not even be necessary to see a decline in the price of gold. If we look at the above charts the GDP growth rate accelerated rapidly coming out of the recession in 1982 and stayed above 3% throughout the Regan years. The US was still running a budget deficit primarily due to military buildup; however we had rapid economic growth that compensated for it.

Chart courtesy of Wikipedia.

As evidenced by the above chart GDP growth form 1996-2000 was above 4%, which led to a slowing of the federal budget. The price of gold was subdued for most of the 1980s through 2001. I am of the view that gold and most commodity prices were subdued for the time frame due to strong US GDP growth which leads to a strong dollar. The charts referenced above have shown a direct correlation between a strong dollar and commodity prices (specifically gold). Unfortunately, a strong dollar is not in vogue with the current administration.

The second condition needed to precipitate a fall in the price of gold is for the Federal Reserve to stop intervening in the bond market. Under Ben Bernanke's watch the Fed has intervened via QE 1&2 and Operation Twist. The Fed has successfully driven interest rates artificially lower. When combined with high debt levels the US dollar becomes a very unattractive currency and has remained weak for an extended period of time.


2012 is an election year in the US, and I am of the opinion that there will be no major shift in current Fed policy. The US Congress along with the President played a political game of chicken this summer threatening to default on the US debt however no real reform as accomplished. As the deadline approached, both sides blinked by agreeing to raise the debt limits, and to basically pit off any tough decisions until after the election of 2012.

I fully expect the status quo of easy money and excessive government spending to continue well into the election. Even if a reform candidate is chosen, as seen in the Regan years, reform will take time to work its way into the system. From an investment perspective, I consider gold to be an attractive investment. I prefer the S&P 500 Gold Trust (NYSEARCA:GLD) due to its high liquidity and sheer size, and am long the ETF.

Disclosure: I am long GLD.

Disclaimer: The above article is for informational purposes only, and not actual investment advice.