I side with Warren Buffett's views on gold. His 2011 shareholder letter (pdf) talks about his views on it, which he has touched on many times before. Gold will forever be an unproductive asset whose owner must hope that someone will pay even more for the privilege of holding the unproductive asset in the future. In addition to the current price of gold, the annual production of approximately 160 billion must continually be absorbed by buyers simply to maintain an equilibrium in the price. Buffett likens the rise in the last decade or so in gold to bandwagon jumping synonymous to those who hopped on both the dot com and housing bubble.
Would you rather own the entirety of the world's gold stock, or would you rather have its equivalent value in companies like Exxon Mobil (NYSE:XOM)? Over time the Exxon Mobils of the world will pay trillions in dividends and produce billions each year in earnings. All of the gold, however, will have produced nothing in one hundred years and also payed out nothing.
A study by Credit Suisse goes into great detail looking over the last last 112 years and finds the the real return of various classes of assets, both in the U.S. and outside. Both equities and bonds have offered superior results over gold, despite gold's exponential growth over the last decade. Beyond that, its price has fluctuated wildly, making even shorter-term holding of it unattractive to many. Decreasing sharply during periods of relatively substantial inflation, and for relatively long periods of time is in stark contrast to claims from some that it is a viable hedge against inflation. It lost over 4/5 of its real U.S. dollar value from 1980 to 2001.
However, what about the mining stocks that dig it out of the Earth, compiled in the Market Vectors Etf Trust (NYSEARCA:GDX), which seeks to replicate the NYSE Arca Gold Miners Index? There are in fact some advantages I can see to owning them over physical gold:
- Dividends. Typically rather small for these companies, but at least it is above what physical will always pay, which is nothing. In fact there are fees associated with the storage of physical as well, which have to be contended with, unless an ETF like the SPDR Gold Trust (NYSEARCA:GLD) is the method of investment
- Easier to value. Physical precious metal has no balance sheet or other financial statements to pour through. Although attempts at valuations can be done, they are in my opinion with inherently less quantifiable metrics.
Despite those advantages, they go by the wayside when viewed next to other companies available to invest in. The gold mining stocks are full of poor management, and are also prone to labor disputes, which causes disruptions, such as what affected AngloGold Ashanti (NYSE:AU). The companies are extremely cyclical. The industry as a whole has been a terrible place for investors to park their money, catching a few good years of growth, only to slash dividends and get itself into serious trouble whenever the economy stalls, finding themselves frequently in need of financing. Even during a remarkable bull market for gold prices, mining stocks can lag terribly behind and not translate those high prices into shareholder value or even profitability many times. Kinross Gold Corporation (NYSE:KGC) has barely budged in 10 years. It is not alone.
It operates in a highly capital-intensive business, and costs for it to operate the mines are absolutely exploding. Recently the World Gold Council, which comprises the leading gold mining companies of the world, had its chief executive Aram Shishmanian claim that in five years time, gold needs to reach $3,000 an ounce just for the gold mining industry to remain profitable. Currently it is in need of a $1,300 price.
Peak gold prices have never even touched $2,000 an ounce, and inflation adjusted prices have also come nowhere close to $3,000 an ounce. The gold mining company's future is far too dependent on the price of an extremely volatile metal reaching highs nearing 100% more than the current price, and doing that in only five years time. All this just to remain profitable. Looking at certain common metrics set up by popular stock screeners might lead investors to believe these gold mining companies are attractive, but they have the potential to be an immense value trap.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.