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Is Warren Buffett Right About Gold?

Many investors, Warren Buffett among them, believe that gold is an inferior investment to equities.

Buffett made the following famous statement in May 2011:

I will say this about gold -- if you took all the gold in the world, it would roughly make a cube 67 feet on a side. Now for that same cube of gold, it would be worth at today's market prices about $7 trillion dollars – that's probably about a third of the value of all the stocks in the United States. For $7 trillion dollars, you could have all the farmland in the United States, you could have about seven ExxonMobils, and you could have a trillion dollars of walking-around money. And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally Call me crazy, but I'll take the farmland and the ExxonMobils. 

Since May 2011, SPDR Gold Trust (NYSEMKT: GLD  )  is down 14% while the SPDR S&P 500 ETF  is up 38%. Owning gold has not been a rewarding investment over this period as the U.S.10 year yield has risen and the U.S. economy has improved. 

Source: Ycharts

Despite the pessimism, many investors still believe in gold's prospects over the coming years. Here's why. 

Federal Reserve's trillions
First, the Federal Reserve has a $4.1 trillion balance sheet. That number is simply gigantic versus historical norms. Currently, the Fed is getting away with it because the U.S. is in a Goldilocks zone, where inflation and interest rates are low while growth is pretty steady.

This type of macro situation has not been historically sustainable. Eventually the U.S. will run into inflation when the economy reaches full employment. When that time comes, it remains to be seen whether the Federal Reserve can withdraw enough liquidity to avoid further inflation. If inflation becomes a big problem, demand for hard assets like gold will increase greatly. 

China and India demand for gold will only increase over the next 10 years
Second, as they get wealthier, China and India will consume larger quantities of gold. Even though their economies are not doing well at the moment, on a ten year time-frame, China and India's wealth will only increase. Since gold is a luxury good, as Chinese and Indian wealth increases, gold demand should likewise increase.

Data over the past decade backs this up. According to the China Gold Association, China became the largest consumer of physical gold in the world last year. Chinese gold jewelry consumption grew 43% to 716.50 tonnes in 2013.   

That number absolutely blows away Greater China's 2003 gold jewelry consumption of 232.2 tonnes. 

Similarly, India's total gold jewelry consumption last year was 612.7 tonnes versus 2003's 565 tonnes. 

The dollar and twin deficits
Third, the dollar is pretty strong right now because the U.S. economy is the best house on a bad block. On a ten year timeline, however, the dollar still has questions. The U.S. still has twin deficits: a large fiscal deficit and a large trade deficit. The dollar has not depreciated because the Chinese have been buying treasuries en masse, but as China becomes more of a consumer nation, it will buy less treasuries and the dollar may fall. Other major economies may also improve their competitiveness versus the United States, which would further weaken the dollar. If the dollar weakens, gold's value versus the dollar will strengthen.

The bottom line
I believe the principle reason to invest in gold is the growing Chinese and Indian demand over the next decade. Gold's protection against inflation is kind of like a free call option in this case.

Buying low-cost producers with disciplined management is probably the best way to go. Low-cost producers will still be around if gold prices fall below the $1,200 per ounce level and companies with disciplined management will contain costs better than companies with average management.

Some names to consider are Goldcorp  (NYSE: GG  ) and Barrick Gold (NYSE: ABX  ) . Goldcorp has a 2014 all-in sustaining cost of between $950 and $1,000 per ounce. The company forecasts production increases of 50% and a reduction in all-in sustaining costs of between 5% and 20% over the next two years. 

For 2014, Barrick Gold has an all-in sustaining cost forecast of between $920 to $980 per ounce. Soros Fund Management also recently added 6.3 million shares of Barrick Gold to its portfolio. 

Despite the recent rally, gold is still a pretty controversial investment. Warren Buffett may be right on gold over the next ten years. Equities may continue to outperform gold. There are, however, some good reasons to take the opposite side. 

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Read/Post Comments (5) | Recommend This Article (1)

Comments from our Foolish Readers

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  • Report this Comment On March 12, 2014, at 4:39 PM, MrRand wrote:

    Buffet is terrified confidence will be lost in paper assets, including the dollar. A gold/silver backed currency does not allow central banks to print with impunity. Central banks hate any metal standard. So do governments because they can't print at will. You are living in a dream world if you think this massive printing will not have a y negative ramifications to our dollar and economy.

  • Report this Comment On March 12, 2014, at 9:27 PM, dlwatib wrote:

    Warren Buffett began his career in 1951. Stocks were just in the second year of a 20 year long bull market that lasted until about 1970. From 1970 until 1980 stocks were in a 10 year long bear market relative to gold. The S&P500 lost all every bit of gain it had earned since Mr Buffett had begun investing and then some. Mr Buffett somehow managed to not see the utility of being in gold and not in stocks during that timeframe. Stocks had another 20 year long bull market between 1980 and 2000. Again Mr Buffett prospered because he happened to be in stocks. But in the year 2000 the stock market began another long slide relative to gold where Mr Buffett would have prospered more had he seen the utility of switching into gold and out of stocks. The markets switched once again in 2011 and stocks again outperformed gold until 2014. Now Mr Buffett should once again switch from stocks to gold, but he's too blinded by his own prejudices to do it.

    Mr Buffett may be good at sniffing out bargains among value stocks, but he's very weak in judging growth stocks or commodities, especially gold. He's also not very good at putting together a balanced and diversified portfolio. Berkshire Hathaway is unnecessarily volatile without earning extra returns for that volatility.

  • Report this Comment On March 12, 2014, at 11:16 PM, sammy2 wrote:

    How about an on-going 10% of assets in precious metals? What my grandfather taught me; worked for him; he died rich. (I would never put 100% of anything into anything.)

  • Report this Comment On March 13, 2014, at 6:32 AM, TempusFugit wrote:

    Buffet is wrong. Comparing bubble for bubble, the world equities market capitalization peaked in October 2007 at $62.8T; by November 2013 it had peaked again at $63.4T (in nominal terms). In October 2007 gold was priced roughly at $790; today it's priced at roughly $1350. This data suggests a broad preservation of purchasing power through gold ownership worldwide.

    Buffet is guilty of the same crime of omission as other financial pundits, negating the $USD role as the world reserve currency backed by militarism and rampant inflation. The inflationary effects are acutely felt by local (sub-dollar) currencies. By not handicapping the dollar (and its stock exchanges by extension), distorted conclusions are drawn.

  • Report this Comment On August 26, 2014, at 11:29 PM, Markbisselle wrote:

    I have never agreed with Warren Buffett on everything and while I am not a billionaire as he is... I have done ok for myself. In 2002 I invested a major portion of my 401 in gold.. it paid off in spades. Gold is true, actual wealth. He speaks of farmland and Exxon as being better investments because you cannot eat gold. How does one eat a gas station or a piece of real estate... ?

    I have invested in gold coins and sold them .. I have invested in gold by the ounce and sold it .. both for nice change, both for profit. I did well in my 401 and today I would do the same thing. Gold is true, actual wealth and has been before Buffett and will be long after. The big investors won't always tell you what they themselves invest in...... many have 5-20% of their personal port. in solid gold (at least). The only thing is use a good firm. There is a club in which I always used their ratings for metals.. ... If you are going to invest, go by people who are doing it all the time.

    Anyway gold is indeed a wise choice and it will CONTINUE to go up over time and Buffett never comes out and says that. Just use a solid firm that chooses a flat rate. Check the clubs ratings on their website (its free club and they list them) before choosing one and you will be good as ... gold lol

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Jay Yao

Jay is an energy and materials writer. He reports on oil and gas fundamentals and macro trends in the industry.

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