This made me realize I should give credit where credit is due. There is one popular "investment" that makes Apple look like Scarlett Johansson in comparison:
Let me be blunt: I would rather you put all your money into Apple stock than ever own gold. Here's why.
Commodities are like Ponzi schemes
Despite protestations otherwise, gold is a commodity. As such, it has all of the problems inherent with one.
To a certain extent, commodities are like Ponzi schemes. They partake in no real business activity. No original cash flows are generated except when producers first dig them out of the ground or turn them into consumable goods. Proponents of the yellow metal, such as our own Andrew Sullivan, brush off this common criticism as mere sophistry taught by b-school professors.
It's not sophistry: Without cash flows, or the prospect for future cash flows, the internal rate of return on the "investment" (I use the term lightly here) can only be 0% inflation-adjusted in a best-case scenario. Since one invests money to earn an internal rate of return in his or her investment above inflation, "investing" in gold or gold ETFs, such as SPDR Gold Shares (NYSE: GLD ) or its popular cousin Sprott Physical Gold Trust (NYSE: PHYS ) , hardly makes any sense from that perspective.
But Chris, I've tripled my money investing in gold! How is that not an internal rate of return?
Yes, you can sell your gold position and pocket the cash (which I hope you do), but no wealth is actually created by your investment. In that sense, whatever you earned above inflation is not real. The unlucky person who sold you the gold lost out on a portion of speculative return, and the person who's willing to purchase it from you at a higher price is betting on gold's continued ascent. It's market demand -- not internal rate of return -- that is the sole source of your gain.
This predatory dynamic is the reason Charlie Munger, Warren Buffett's business partner, thinks owning gold makes you a "jerk." A real investment -- like Apple stock -- generates an internal rate of return on its investors' capital. For Apple's stock, the internal rate of return is around 6% after taking into account the net cash on the balance sheet, and if we assume no growth. Furthermore, Microsoft, the company that I suggested was a better buy than Apple, has an internal rate of return of more than 11% by the same calculation.
But why does it matter if the return comes from speculation or from the internal rate of return of the investment?
Good question. The problem with speculative return is that you are hostage to the "greater fool" theory. For you to "make bank," you must sell your asset to someone who's even more foolish than you were. That person, in turn, must sell it someone else. Eventually -- as the housing bubble showed -- people get smart and stop wanting the asset.
The thing is, you see, you never think you'll be the person with the hot potato when the music stops. Nobody ever expects to be that person, or else no one would choose to play the game.
So how is Apple any better? You yourself don't like Apple. And since Apple doesn't pay a dividend, by your definition how can it have an internal rate of return?
Another great question. Although Apple doesn't pay a dividend (and it should, but that's a topic for another column), the cash still goes somewhere. Apple doesn't just light it on fire. The company reinvests it in the business or leaves it in cash. If Jobs & Co. thought the free cash could be better used as a dividend, they would distribute it as such. Apple's capital appreciation should at least offset any potential dividend.
If Apple's management were misusing its free cash flow, shareholders would punish it with a lower stock price. Since Apple has had hit after hit with the Apple Stores, the iPod, the iPhone, the iPad, and the Macbook Air, no such action has taken place.
The bottom line: If a company is generating free cash flow, that money should eventually find its way into shareholders' hands -- dividend or no dividend.
Any final thoughts about gold you want to get off your chest?
There are few needs for gold in today’s society. Yes, there's jewelry. But industrial demand is not what has dictated the price of gold over the past 50 years. The price of gold has been driven largely by expectations about the overall direction of the economy, leading to booms and busts for individual investors.
It resembles a popularity contest -- one I don't believe Fools should partake in.
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