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Does Gold Have a Place In Your Portfolio? Warren Buffett and I Say No

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There is perhaps no other asset more closely associated with wealth, opulence, and success as gold. It's shiny. It's beautiful. If you dropped it on your toe, it would hurt (a lot, because it's heavy). It's also an inflation hedge, a commodity that behaves somewhat like a currency, and a staple of the diversified investment portfolio. Right?  


Fools, its time we banish gold from the lexicon of value investments. 

Why buy gold in the first place?
I've written about this before, taking a deeper dive into what actually drives the demand for gold. Click here for the background. Here is the short version.

  • Reason 1: Intrinsic Value -- Gold does have use in our economy. Jewelry is the most visible example, but gold also has a place in dentistry, technological components, and other industrial applications.
  • Reason 2: To Hedge Inflation -- Perhaps the most widely accepted function of an investment in gold is to protect your hard-earned wealth from the ravages of inflation. Unfortunately, history doesn't really bear this out. Adjusting for inflation, gold has traded recently at half its value from 1980. If your investment is going to lose 50% of your principal, then I think it's safe to say that the hedge failed, no matter what happened in the currency markets.
  • Reason 3: As a Liquid Alternative to Cash -- Gold is a unique asset, in that in many ways it behaves very similarly to a currency. Many successful currency traders have made a career out of arbitrage trades between gold and various other currencies (for example, buying gold in Japanese Yen and the selling it in in U.S. dollars. If conditions are right, this style of trading can be very, very lucrative).

For many investors, its a combination of reasons Nos. 2 and 3 that attracts them to gold. The metal's liquidity is advantageous to that of equities because gold is a real physical asset -- recollect the pain it would cause your toe. A stock certificate? Not so much. So gold is an asset that is kind of like a currency, can't be destroyed by a weekend bankruptcy filing, and can be converted back to cash essentially instantly. I get the appeal. I really do. 

But I'm not buying gold. Not happening. Bull, bear, or apocalypse, there won't be any bullion in my safe or any units of the SPDR Gold Shares  (NYSEMKT: GLD) ETF in my portfolio. 

The Oracle of Omaha Speaketh
In Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  )  2011 letter to shareholders, Warren Buffett spoke directly about gold. Buffett is not a fan. In his own words, Buffett explained his thinking:

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 ExxonMobils (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?

The entire point of investing is to spend dollars today to buy something that will create more wealth in the future. It can be through cash flow and net income that lead to dividends and retained earnings. It can be through price appreciation in the markets --value driven or speculative. 

I'm firmly in the value-driven boat, and gold simply does not create value. It historically has been a store of value, but will be in the future only so much as the collective psychology of the markets continues to view gold as a near-cash, psuedocurrency, inflation hedge.

Why not hedge inflation with value creation?
Berkshire Hathaway's per-share book value has increased 19.7% annually from 1965 to 2012. Over that same time period, average inflation maxed at 13.5% in 1980. Inflation averaged more than 10% just four times -- 1974, 1979, 1980, and 1981.

And just like in Buffett's example in 2011, Berkshire Hathaway is clearly a "pile 2" type of investment choice. Gold is still just gold, while Berkshire is now a moneymaking machine reporting a total gain for shareholders of $24.1 billion in 2012. And it should be noted that Buffett considered this $24.1 billion as "subpar." Gold zero, Berkshire $24.1 billion.

Buffett is not alone among the very smart market followers. Federal Reserve Chairman Ben Bernanke told the Senate Banking Committee in July that "nobody really understands gold prices and I don't pretend to really understand them either."

All that glitters is not gold, and I don't even want the gold
People will always need goods and services. They need food, shelter, clothing, and services. Businesses will always arise to meet those needs. And businesses will always arise to meet the needs of other businesses. Gold, however, will always just be gold.

And that's why I'll never invest in gold. 

Read/Post Comments (4) | Recommend This Article (2)

Comments from our Foolish Readers

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  • Report this Comment On October 08, 2013, at 1:48 AM, Ericsarmy wrote:

    First, you could fill that baseball infield with what Ben doesn’t understand. Ben and the FED claim not to understand gold, and what that really means is "let’s not talk about gold because it’s the anti-dollar, a store of value, a hedge against inflation, and therefore the enemy to any private organization who is actively trying to debase the dollar by printing it to infinity.”

    And by the way, if gold isn't a good investment then please explain why from 2000 through 2011 Gold was the best-performing asset, up more than 15% a year. Those are pretty good returns which, btw, beat the S&P 500's returns over the same period of time. I don’t know about you but if I invest $250 dollars in 2000 and that investment was worth approx. $1900 in 2011 I’d be happy.

    All this combined with the fact that the stock market is currently overvalued with average P/E ratios above 19 means that the better, safer investment now-a-days is gold because the current world wide currency wars and the race to debase our money will eventually cause this QE inflated stock market to crash or massive inflation or the bond markets to crash, etc.

    Oh, and it’s one thing to listen to top investors and helicopter Ben but actions speak louder than words so you might want to stop drinking the fed cool aid and take a look around at what people and governments are doing instead of what they are saying. Why are China and Russia buying insane amounts of gold? China is mining gold in Australia, having the Perth Mint mint it, and then shipping it directly to Shanghai instead of buying it through London. This keeps the price of gold down while allowing China to gobble up as much gold as they can get their hands on. Germany just asked for all their gold back from the US and the US told them it would take 7 years. Why so long? There are a 100 more examples of rich people, banks, and government positioning themselves to acquire gold and silver because they obviously know what you don’t, QE will never end, we can never pay back our debt let alone the interest on our debt, and eventually the world will shun the dollar as the world reserve currency due to our irresponsible monetary policies.

    There is credible evidence that the next attack on this country will be a fiscal attack by either China, Russia, or all the BRICS countries because they are tired of the US exporting their inflation and imposing the petrodollar on them. That said, if you believe the powers that be and think unemployment numbers are really at 7% (a joke) and that the economy is recovering then buy a few shares of Coca-Cola. If not I’d advise you to protect your wealth in something that can’t be printing endlessly. Oh, and Silver is actually a better investment then gold right now.

  • Report this Comment On October 08, 2013, at 9:12 AM, Icutchacokov wrote:

    This article is dated Oct 7,2013. On what planet, as he mentions in the article, is gold at 1750 an ounce at this time? Try 1323 butthead.

  • Report this Comment On October 09, 2013, at 7:24 AM, Ericsarmy wrote:

    I never made mention to gold being 1750. The only time I mentioend price was when I said, "if I invest $250 dollars in 2000 and that investment was worth approx. $1900 in 2011 I’d be happy." What crack are you smoking?

  • Report this Comment On October 28, 2013, at 12:00 AM, neocolonialist wrote:

    Hey great article. Might as well talk about what a disaster of a stock that KOH is, I mean it just had a huge run to the bottom like Gold has had, so it must be a really bad investment too right?

    How about we look at Gold related to inflation from 1980 to three years ago? Oh, because that doesn't fit your premise at all.

    So, now that gold has likely bottomed and you should be telling people to buy, you are letting your biases fly and diverting people from a very likely place where their money could do quite well now.

    I am no gold bug, but commodities are going to do well in the next couple of years, ESPECIALLY gold. It's already been beaten into the ground while physical demand has steadily been increasing. Virtually every major economy in the world (except Russia) is doing their dead level best to inflate their monetary supply and thus devalue their currencies. Yep, all in all a terrible time to buy gold. Great advice!!

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