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Buffett on Gold: Who Has the Midas Touch?

March 15, 2012

(Reprinted from the April 2012 edition of the Bath Country Journal.)

By  Kevin Kroskey, CFP®, MBA

Over the course of a lengthy and illustrious business career, Warren Buffett has offered thoughtful opinions on a wide variety of investment-related issues—executive compensation, accounting standards, high-yield bonds, derivatives, stock options, and so on.

In regard to gold and its investment merits, however, Buffett has had little to say—at least in the pages of his annual shareholder letter. Wes Wellington of Dimensional Fund Advisors notes, “We searched through 34 years' worth of Berkshire Hathaway annual reports and were hard-pressed to find any mention of the subject whatsoever. The closest we came was a rueful acknowledgement from Buffett in early 1980 that Berkshire's book value, when expressed in gold bullion terms, had shown no increase from year-end 1964 to year-end 1979.”

Buffett appeared vexed that his diligent efforts to grow Berkshire's business value over a fifteen-year period had been matched stride for stride by a lump of shiny metal requiring no business acumen at all. He promised his shareholders he would continue to do his best but warned, "You should understand that external conditions affecting the stability of currency may very well be the most important factor in determining whether there are any real rewards from your investment in Berkshire Hathaway."

As it turned out, the ink was barely dry on this gloomy assessment when gold began a lengthy period of decline that tested the conviction of even its most fervent devotees. Fifteen years later, gold prices were 25% lower, and even after thirty-one years (1980–2010), had failed to keep pace with inflation. By year-end 2011, gold's appreciation over thirty-two years finally exceeded the rate of inflation (205% vs. 195%) but still trailed well behind the total return on one-month Treasury bills (398%).

Gary Brinson, another investing living legend but lesser known than Buffet, remarked that an ounce of gold bought a fine men's suit in the time of Shakespeare, and so it does today.

Perhaps to compensate for his past reticence on the subject, Buffett has devoted a considerable portion of his forthcoming shareholder letter to the merits of gold. With his customary gift for explaining complex issues in the simplest manner, Buffett deftly presents a two-pronged argument. Like a sympathetic talk show host, he quickly acknowledges the darkest fears among gold enthusiasts—the prospect of currency manipulation and persistent inflation. He points out that the US dollar has lost 86% of its value since he took control of Berkshire Hathaway in 1965 and states unequivocally, "I do not like currency-based investments."

But where gold advocates see a safe harbor, Buffett sees just a different set of rocks to crash into. Since gold generates no return, the only source of appreciation for today's anxious purchaser is the buyer of tomorrow who is even more fearful. Call this the greater fool or greater fearful theory depending on your belief. It’s also important to note that only about 10% of the annual gold supply is used in industry, so its commercial use as a commodity is quite limited. The vast majority of it is used for jewelry at about 80% and the balance for financial transactions, the latter of which has been increasing over recent years.

Buffett completes the argument by asking the reader to compare the long-run potential of two portfolios. The first holds all the gold in the world (worth roughly $9.6 trillion) while the second owns all the cropland in America plus the equivalent of sixteen Exxon Mobils plus $1 trillion for "walking around money." Brushing aside the squabbles over monetary theory, Buffett calmly points out that the first portfolio will produce absolutely nothing over the next century while the second will generate a river of corn, cotton, and petroleum products.

When Buffett assumed control of Berkshire Hathaway in 1965, the book value was $19 per share, or roughly half an ounce of gold. Using the cash flow from existing businesses and reinvesting in new ones, Berkshire has grown into a substantial enterprise with a book value at year-end 2010 of $95,453 per share. The half-ounce of gold is still a half-ounce and has never generated a dime that could have been invested in more gold.

Few of us can hope to duplicate Buffett's record of business success, but the underlying principles of reinvestment and compound interest require no special knowledge. Real wealth is easily observable from investment in farms, businesses, or real estate either directly or via stock ownership.

Where are the fortunes created from gold? These are most likely from those selling the gold who advertise on talk radio and cable television and not from speculators buying bullion, coins, or other gold-based investments.

If you insist on owning gold, buy jewelry. While gold pays no dividends, at least by owning jewelry you will receive a synthetic dividend of wearing it and may make your spouse happy as well. Companies that mine gold and other precious metals, including precious metals more heavily used in industry are a different story. These may have merit it a diversified portfolio, but gold itself does not.

(Special thanks for Wes Wellington of Dimensional Fund Advisors for his contributions to this article.)

 

Kevin Kroskey, CFP®, MBA is President of True Wealth Design, an independent investment advisory and financial planning firm that assists individuals and businesses with their overall wealth management, including retirement planning, tax planning and investment management needs. Kevin can be reached via email at kkroskey@truewealthdesign.com or by phone at 330-777-0688.

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