Why Apple Is Better Than Gold

My critique of Apple (Nasdaq: AAPL  ) inspired not one, not two, but three Foolish rebuttals.

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:

Gold.

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.

See a stock in this story you'd like to follow? Add it to My Watchlist, which will find all of our Foolish analysis on it.

Fool contributor Chris Baines hopes to not attract the attention of Mr. Goldfinger. He actively participates in CAPS as cbaines2. Chris owns none of the companies mentioned here. Microsoft is a Motley Fool Inside Value selection. Apple is a Motley Fool Stock Advisor pick. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Apple, Microsoft, and Sprott Physical Gold Trust ETV. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (32)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 23, 2010, at 6:03 PM, sarcastro999 wrote:

    Fail. Just...fail. That's all I can say here.

  • Report this Comment On December 23, 2010, at 6:17 PM, cbaines2 wrote:

    Care to back that up?

  • Report this Comment On December 23, 2010, at 6:20 PM, avikey wrote:

    There are two kinds of money- money for spending (paper money) and money for saving (precious metals). There is a good reason for this- The value of paper money, which is the liability of governments, depends on the whims of politicians and central bankers, which tend to depreciate its value over time. The US dollar has lost 97% or more of its value (purchasing power) in the past 100 years. Gold is not the liability of anyone. Gold is not an investment, it is money. Why do you think central banks keep it in their vaults, just for show? You do not buy gold to get rich. You buy gold if you have wealth that you wish to preserve over time, if you choose to save rather than spend. That's right, it is not a business and does not generate a rate of return. On the other hand, its value is not dependent on the sagacity of management. Gold will never go out of business like ENRON, GM, etc. Why gold rather than some other commodity? We all know- it holds much value in a small volume, it is easily divisible, and virtually indestructible. You can't say that for pork bellies or orange juice. Gold is like Popeye; it says, "I am what I am, and that's all what I am." Some people like to speculate in gold with options and futures contracts. God bless 'em. They provide liquidity and depth to the market; but they are not investing, they are gambling. If all you want to do is preserve your wealth, rather than grow it, choose gold. Like anything else, its "price" is not perfectly stable, but over a sufficient length of time, it will hold its value. OK?

  • Report this Comment On December 23, 2010, at 6:24 PM, DefunctAcct wrote:

    You wrote a personal opinion of Apple, NOT a critique. A meaningful critique would have facts and logical constructs supporting the critique. I will never based my investment decision on a simple personal opinion, not even my own.

    The complete lack of any logical basis to support any meaningful position makes the whole "personal opinion" piece useless. I am surprised it got that many rebuttals.

  • Report this Comment On December 23, 2010, at 6:59 PM, kschnable wrote:

    Buying AAPL does not provide Apple with additional funds if it's not a public offering. Buying AAPL from someone else other than Apple (a public offering) *is* participating in the greater fool's game since Apple does not have a dividend. Until they do, the greater fool's game applies unless it's a public offering. You're buying it only with the hopes of selling it to someone else at a higher price who will then hope to sell it to someone else at an even higher price, etc.

  • Report this Comment On December 23, 2010, at 7:12 PM, cbaines2 wrote:

    "Gold is not the liability of anyone. Gold is not an investment, it is money. Why do you think central banks keep it in their vaults, just for show?"

    The gold standard hasn’t been around for the past 40 years. There is no reason for gold to trade at a certain percentage of the money supply (or for central banks to keep it for that matter). End of story.

    You could argue that inflation should cause the price of gold to increase with the money supply, and there is a shred of truth to this for other commodity investments like the oil ETFs. Gold, however, has not increased over the long-term with inflation (it went from around $850 an ounce in 1980 to $250 an ounce in 1999). This is because there are few real needs for gold in today's society, besides jewelry and some industrial application.

    In any case, I think we can agree that the price of gold today is not justified by jewelry or industrial demand.

  • Report this Comment On December 23, 2010, at 7:29 PM, Davidovich wrote:

    I agree that gold is not an investment, it's a form of money though not a currency. Buying Euros or Canadian dollars isn't an investment, nor is holding cash in US dollars. Does that make it a bad idea? I think it's a form of liquidity that can help offset a falling dollar and makes sense if held for that purpose.

    As as for the dollar losing 97% of its value over the years as someone mentioned, why is that a bad thing? Money does not need to hold its value, unless you want to return to the days of Herbert Hoover and the depression. An expanding economy needs more currency to grow through lending and transactions, and that's why we got off the gold standard, so we could grow the money supply.

    The trick is to continue to make more dollars as the dollar loses value, and not fall behind the rate of inflation, and you do that by owning something that rises in value -- land, commodities, or equities --- even as the currrency is diluted.

    It's not rocket science, it's just important to stay diversified, know that you are using one asset to offset declines in others, and hope the economy grows and creates more wealth overall.

  • Report this Comment On December 23, 2010, at 8:17 PM, geoslv wrote:

    For how many years can Apple use the excuse for not paying dividends that they are not sure their success will continue?

    Gold may be a fool's game, but if your predictions are good you won't be the fool.

    The Gold Standard was eliminated and it led to fools increasing the money supply about 15%, causing inflation ~12% in the 1970s. Congratulations on that.

  • Report this Comment On December 23, 2010, at 8:42 PM, TMFRhino wrote:

    FWIW, was thinking about writing about Apple's efficient R&D/ability to easily "innovate" now that iOS has become a development hub before your article. Was just a good debate to frame the article around. Not to look like everyone's piling on the new guy :).

    Fool on!

    -Eric Bleeker

  • Report this Comment On December 24, 2010, at 12:55 AM, sergal wrote:

    Original Scarlett Galabekian never was engaged and 200 pieces of stolen biological material called Scarlett Johansson was not design for family life

  • Report this Comment On December 26, 2010, at 9:20 PM, cbaines2 wrote:

    Eric,

    I didn't take any offense. :-)

    Thanks,

    Chris Baines

  • Report this Comment On July 16, 2012, at 4:40 PM, sigiam wrote:

    Gold has no inherant value what so ever. Sure gold is worth a lot of money because others are willing to pay for it, and in that regard sure you could call it money (anything can be money)... like tulip bulbs, which used to be valuble under the exact same logic. It's a castle in the air type scenario, and the fact that this specific form of stupidity has been around for thousands of years isn't adequate justification for me to engage in it.

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