Whether Gold Prices Are Up or Down, You Should Stay Away

Along with China and the potential implications of rising interest rates, many stories have come out this week heralding the fall of gold and the new world we now live in as a result. It seems only a few years ago, we were simply deluged by articles about the merits of gold, the frailties of fiat currencies, and how the shiny metal needed to be an essential component of any serious investor’s portfolio. This was especially true after a very healthy run from 2002 to 2011. We did not subscribe to this back then and we don’t now. While it’s easier to make our case now with the low price of gold, our reasoning remains the same.

We do not invest in gold (and by extension commodities) because we do not feel they are an investable asset class that creates value. Our view is that gold is an input used by companies. It does not generate anything. The companies in our various asset classes create value (i.e., earnings).

In a 2011 annual letter to shareholders Warren Buffet expressed his disdain for gold in a manner that is both understandable and accurate. Enjoy:

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 $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.

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 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, it’s likely 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.

Please remember the above when gold bounces back in a few years and the media, once again, is heralding the virtues of gold as an investment to hedge against doom.

 

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