Note: This article was originally published September 19, 2015 and updated January 13, 2016.
There is an air about gold and silver that just exudes wealth. Because of that, many believe that if they invest in gold or silver, it will create wealth for them over time. And while it's true that the price of gold or silver can increase in time, it does not necessarily mean that any wealth is being created. This is due to the fact that while gold and silver are assets that hold value, they don't produce more of it. This is why investing legend Warren Buffett has warned against investing in precious metals if creating wealth is the goal.
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A store of value and not much more
Because of their unique properties of strength, rarity, resistance to corrosion, distinct color, and ease of minting gold and silver have become highly sought-after metals. While that desirability makes gold and silver both precious metals, it's the physical properties of both that drive their ability to hold wealth. The fact that they are resistant to corrosion as well as the fact that they can resist the attack of most acids means that both can withstand the test of time. Because of that, there is a confidence that their intrinsic value won't be corrupted over time.
Having said that, the ability to hold value isn't the same as an ability to compound or create value. In other words, while gold and silver can protect against a drop in the value of currencies, or hedge against inflation or deflation, neither can make one truly wealthy outside of the shear collapse of the global economic system.
Warren's warning
This is why in 2012 Warren Buffett railed against gold and other non-equity investments like silver and bonds in an article in Fortune as well as his annual shareholder letter that year. He summed up gold's shortcomings as an investment suggesting its "being neither of much use nor procreative." Instead, he argued that what motivates gold buyers is the belief that gold will rise in value because more people will want it as a store of value due to fears of currency weaknesses or hyperinflation. He warned, however, that this isn't a long-term investment thesis but more of a bet on fear. He then painted a picture of gold against the productive assets he prefers. Buffett wrote:
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 about $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 (NYSE: XOM) (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?
Now, a little bit has changed since he wrote that article with the price of gold now down to around $1,100 an ounce while ExxonMobil's stock has fallen along with the oil price. That being said, it would actually seem like Buffett called the top in gold when he penned those words:
Gold Price in US Dollars data by YCharts.
Further, ExxonMobil is no longer the world's most profitable company after its profits and therefore its value have been hit by the drop in the price of oil. That being said, what Buffett is suggesting is that the pile of gold is just that, while the crop lands and ExxonMobils are productive assets that are generating cash flow each year. In other words, he isn't implying that one should just buy Exxon's stock, but to buy a strongly profitable company. It's why Buffett would then point out that:
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. ExxonMobil 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.
In other words, the price of gold, or silver for that matter, likely will increase over time and that increase could be substantial during a time of fear. However, that rise will pale in comparison to the value created by productive assets held for the long term. It's why those seeking to create wealth should steer clear of assets that are intended to preserve it, which is the role of gold and silver and instead buy productive assets that generate income.
