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Buffett, Goodwood Inc and I All Agree About the Intrinsic Value of Gold - We Don't Understand It

December 01, 2010 | About:

I’ve got a little black book of value investors that I follow. I’m sure most of you do. One that is in mine that you likely haven’t heard of is the Canadian value investing firm Goodwood Inc. Following the smaller concentrated value firms like Goodwood can be particularly lucrative as they are often fishing in the micro cap waters where some real bargains can be found.

In this month’s report they discussed why they aren’t invested in gold related equities or the commodity itself and how that has hurt them. I found their thinking to be pretty much along the lines of where mine is, although they likely articulate it quite a bit better. They also provide a couple of stock ideas.

I thought this quote from Buffett was pretty spot on about gold when interviewed by Ben Stein:

Ben Stein : My first question, as I sit there on the couch in his office, is: "What about gold? Is this a classic bubble or what?"

Warren: "Look," he says, with his usual confident laugh. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to

Of course Buffett, Goodwood and yours truly would have done very well to invest in nothing but gold for the past decade.

Here is the piece from Goodwood:

As we enter the final month of 2010 we find the Goodwood Funds’ net asset values continuing to bounce along down from our spring highs and basically flat for the year-to-date. And, of course, still below our high water marks. Very frustrating.

It turns out that all we had to do was to go long (in a big way) gold and silver bullion and junior gold/silver stocks (NB: we do have some long junior gold miner and small short gold ETF exposure). Alas, we struggle to understand gold’s intrinsic value as it is never consumed. According to GFMS Limited’s “Gold Survey 2010”, there are an estimated 165,500 tonnes of gold (approximately 5.3 billion ounces) above-ground at the end of 2009. And, estimated total supply of new gold in 2009 was 4,033 tonnes as against 3,451 tonnes of “total identifiable demand” (the estimated 582 tonnes of excess supply may have been at least partially absorbed by unreported buyers of gold such as institutional buying channeled outside the well-known gold ETF’s). And, the gold bugs’ justification for its importance seems to boil down to “Gold occupies the role it does because it always has.” In the absence of any meaningful consumption, there is no real justification for gold’s safe haven status … just perception. But, perception can be fickle.

Interestingly, if an environment of massive paper currency debasement/hyper-inflation comes about, history argues that stock investors, not just gold investors, will do well (witness the rise in the German stock market in early 1920’s Weimar Germany - a notable period of modern hyper-inflation). And, if disinflation/deflation predominates, businesses with strong free cash flow will stand out as they will have a continuing ability to pay dividends, buy back stock, buy competitors or otherwise reward their shareholders. The foregoing, when combined with our skepticism of any true intrinsic value for gold, makes us wonder if the better hedge after all isn’t simply good businesses bought at attractive prices.

Or, all we had to do was buy long term bonds. Again, not exactly a match with our clearly stated investment strategy.

No, we have stuck to our oft-stated goal of buying assets and/or earnings/cash flow streams at very inexpensive prices. We expect at some point to be rewarded handsomely for doing so. Currently, approximately 61% of the Funds’ equity is invested in our top ten long positions and approximately 46% in the top five. In our opinion, nine of our top ten positions have the potential to double or triple over the next year or two and there are identifiable catalysts in each case. And, we have a wide collection of very cheap long positions below the top ten that also offer significant upside potential. Two examples in the latter category would include our small positions in Xinergy Ltd. (a U.S. coal miner trading at an estimated 2.9X 2011 forecast EBITDA) and Cowen Group Inc. (a combination hedge fund manager and institutional brokerage boutique trading for less than the value of its own cash and securities).

Finally, note that the management teams of our long holdings, by and large, continue to execute well. So, we look forward to the possibility of “golden” performance in 2011.

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