Gold investors typically have an iron will and a discipline that would be the envy of most Warren Buffett (Trades, Portfolio) disciples. Despite the disdain that many have for the yellow metal and those that own it, those that participate in stock market actually could learn some important lessons from gold investors.
Now when I say gold investors, I am talking about people who have established and dedicated long-term positions either through physical or paper holdings if not both. I am not focusing on those that trade gold or silver over short-term periods of time, as this is an actively managed investment strategy that requires a separate focus and skill set. I am also not talking about those speculators that were drawn to the precious metals space over the last few years by the allure of steady price increases only to suffer disappointment and move on in the time since the onset of the gold and silver bear market in 2011. Instead, those that I am focusing on as gold investors for the purpose of this article are individuals that have owned the metal for years if not decades with steadfast but not dogmatic conviction. It should be noted that many of these investors also own silver (SLV) as well as gold (GLD).
Before going any further, it is worthwhile to note that I am not what some might describe as a "gold bug". My initial foundation in investments is based on fundamental value investing and equity research inspired by the principles of Graham & Dodd's Security Analysis and other related texts. This is because of these very principles and those related to it that I own names such as Exxon Mobil (XOM), International Business Machines (IBM), General Electric (GE), McDonald's (MCD), Emerson Electric (EMR), Oracle (ORCL), Qualcomm (QCOM) and Cisco Systems (CSCO) among others.
It was only after arriving in economic research and investment analysis nearly two decades ago that I began exploring the principles behind a variety of other strategies. This included technical analysis and various specialized fixed income categories. It was also during this same time over the last two decades that I came to know and understand the principles and beliefs behind gold investing. And understanding these principles has helped strengthen my overall investment philosophy including how it relates to stocks and other asset classes.
Stock and gold investors strike a vast contrast when it comes to their intrinsic behavior.
Boiling it down to its core, the typical stock investor can best be described as an optimist. They are disposed to believe that things are going to grow and conditions are going to improve, for these underlying forces as they relate to the broader economy, revenues and earnings are all essential for stock prices to go up. Thus, the focus is almost always tilted heavily toward the positive over the negative including why the economy is going to strengthen and why the fortunes of the companies in which they are invested stand to improve even further from where they are now.
But while the resolute faith of the optimist is most admirable, they are often left greatly exposed to sudden and unexpected shocks. This is due to the fact that by the fundamental nature of being an optimist, one is almost always looking on the bright side and expecting the best possible outcomes. And when one is not only focused on but also expecting the positive, they tend to completely overlook the negative. So when things end up disappointing or turning out much worse than expected, stock investors are often blindside in the process. "How could this have happened?" and "nobody could have seen this coming" are common refrains among stock investors when trouble arrives, which it inevitably does over time. And this is why in the current environment we hear so many analysts make the highly questionable statement "I can't envision a scenario where stock prices could possibly go down."
The typical gold investor is cut from an entirely different cloth. Now the temptation by many is to paint the typical gold investor as nothing more than a cave dwelling doomsday prepper that thinks they need gold to bribe the border guards when the time comes. First of all, such broad sweeping depictions are not only narrow minded but also obtuse. Sure, there are a few that own gold that may fit this characteristic, but there are probably just as many if not more that are equally fanatical about stocks as well as unicorns and rainbows on the other end of the investment spectrum. In general, this description does not describe at all the typical gold investor.
Most gold investors can best be described as realists. They are not necessarily pessimists who expect the worst. Instead, they are mostly individuals that view things for what they actually are and are pragmatic in their thinking. They usually disregard any reliance on hope or blind faith and instead view things with a healthy degree of skepticism and the need for proof. And it is this more balance thinking that drives them to own gold. It's not that they don't also own stocks, bonds and other asset classes, as many certainly do. But they view gold as a major insurance policy on their investments and purchasing power. And just as one does not hold auto insurance with plans on getting into a car crash or health insurance with the intent of getting sick, one does not necessarily own gold because they are expecting the worst. But if the worst does come to pass, they are prepared for such an outcome by holding gold as an insurance policy for their wealth. Thus, most gold investors are not being paranoid. Instead, they are being pragmatic.
A more scrutinizing look at global currencies provides a good example to understand the thinking of the typical gold investor. The current global fiat currency system that we operate under today has not been around forever. In fact, it has only been in place for around 40 years. For it was only starting in 1971 when the Bretton Woods system of international currency exchange and the direct convertibility of U.S. dollars into gold was ended. Thus, the current system that we have today with fiat currencies backed by nothing other than the full faith and credit of their issuing governments has been in place for only a very short time. To put it into perspective, the Super Bowl,Sesame Street and the soap opera Days Of Our Lives are all more established institutions from a longevity standpoint than the current global fiat currency system. As for the euro currency in particular, it is younger than teen pop star Justin Beiber. And returning from pop culture to an investment market vantage point, the current global currency regime has existed for less than three full secular market cycles.
It is with this current fiat currency system where the gold investor may have justifiable concerns. First, many of these investors were born when their U.S. dollars were backed by gold instead of faith, so they see a currency today that is potentially not as sound as it was before. Second, they look back over the past four decades and see that the fiat currency system has been prone to extended periods of instability. For example, the U.S. dollar has spent more years mired in turbulence during the 1970s and into the early 1980s as well as since the turn of the millennium than the time it has spent in relative stability during the late 1980s and 1990s. Lastly, they look at how global central banks are aggressively printing these currencies backed by nothing more than faith with grave concern. For example, the U.S. Federal Reserve has nearly quadrupled the amount of U.S. dollars since the outbreak of the financial crisis several years ago, and the Bank of Japan just announced that they are going to double the amount of yen in the coming year.
One has to look no further than the principles of supply and demand to understand the gold investors' argument that currencies backed by nothing more than faith have the potential to be worth a lot less in the future than they were in the past. And while this realization may not be shown in current gold prices or reflected in today's exchange rates, since nearly all major central banks are engaging in the same behavior at the same time, the gold investor recognizes that the potential for a major accident in the global fiat currency system is rising with each new bank note printed. Such an accident may not happen today, a year from now or ever for that matter. But they recognize that potential is definitely there and are not willing to simply concede to blind faith that the system will just work itself out. Thus, gold and silver are the insurance policies they can own to protect themselves if such an accident were to occur. Once again, this is not paranoia, but it is reasonable prudence to protect oneself against the risks associated with a global currency regime that is still fairly new and is being managed most aggressively at present.
This is just one of many examples that highlights the thought process of many gold investors.
Overall, gold investors through their realistic perspective bring a discipline to their investment decisions that should be the admiration of stock investors, not the derision.
First, gold investors often have a deeply ingrained long-term discipline that helps them overlook any short-term volatility along the way. Many have been accumulating gold and silver for years in a variety of forms that may include investment portfolio exposures through closed end funds like the Central Fund of America (CEF) and the Central GoldTrust (GTU) as well as the purchase of physical coins, ingots, bars and exonumia. Some also have been taking delivery to put in their safe or stuff in the Christmas stockings of their children and grandchildren consistently each year for decades in what essentially amounts to the classic dollar cost averaging strategy. And they did so during the stagflationary 1970s, the secular bear market in gold during the 1980s and 1990s and in the years since the turn of the millennium. Thus, they view the recent volatility in gold as nothing more than the latest short-term swing in the long-term price trend that has more than maintained their purchasing power over time with cumulative returns that remain well in excess of the inflation rate.
Also, gold investors by their nature of typically being realists instead of optimists are generally not surprised when market conditions turn sharply against them at any point in time. This is due to the fact that they have often already anticipated the worst-case scenario playing out, which is one of the reasons that they own gold in the first place. This preparedness enables the gold investor to better weather periods of extreme market turbulence without losing their heads and making panic moves. This, of course, stands in stark contrast to the optimistic disposition of many stock investors that are often stunned by any sudden short-term price moves and become more inclined to panic and sell the greater the downside pain becomes.
Lastly, gold investors often respond to major downside shocks in precious metals prices very differently than the typical stock investor does to sharp market corrections. Something that has been most notable during the recent sell-off in gold and silver is the perspective coming from many precious metal investors. Many are not only unruffled by the recent decline, they are welcoming it. In fact, some are even cheering for the price of gold to drop to $1,000 per ounce or less. Why? Because they are effectively collectors as investors, and the price of the item that they wish to own and accumulate is increasingly on sale with each drop in price. As a result, the more the price drops, the more they are eager to buy, exhibiting the classic buy low, sell high discipline. This perspective stands in sharp contrast to the typical stock investor, which often do not see a price decline as the item they covet going on sale. Instead, they frequently see it as a painful refute to their expectations and are often driven to sell as a result. Unfortunately, this often leads to the undesirable buy high, sell low phenomenon that so many stock investors would like to avoid.
Thus, the typical gold investor often exhibits the following characteristics - a long-term discipline with the ideal holding period for many gold investors being as long as forever, preparedness during times of market panic, and the sagacity to capitalize on the opportunity in being greedy when others are fearful. These are all attributes that would make any Buffett influenced stock investor proud. So while Mr. Buffett understandably may not like the precious metals, he at least has good reason to give deference to many of those that invest in the asset class.