Warren Buffett (Trades, Portfolio) and Ray Dalio (Trades, Portfolio) had contrasting opinions on holding cash at the beginning of this year, prompting many investors to acknowledge the differences in the investment strategies of the two gurus.
The two highly regarded investors, however, seem to have found a common interest in gold. The second quarter 13-F filing of Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) revealed a new investment of $564 million in Barrick Gold Corporation (GOLD, Financial), much to the surprise of many investors. Barrick stock is up a staggering 58% this year, which makes this recent investment even more of a shock to close followers of Buffett.
The guru has never been fond of the precious metal
Buffett's latest move has already baffled many investors who have been following the guru for a long time. In his annual letter to Berkshire shareholders in 2011, the Oracle of Omaha famously criticized investing in gold by attacking the very pillars the thesis of investing in the commodity is built on:
"The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer's hope that someone else β who also knows that the asset will be forever unproductive β will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century. This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce β it will remain lifeless forever β but rather by the belief that others will desire it even more avidly in the future." He continued, "The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money. Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end."
Investing in Barrick Gold is a bet on higher gold prices, which, according to the guru's previous comments, is an investment in a nonproductive asset that would fail to add meaningful value in the long term.
Shelving for now the possibility that the positon was established by one of Buffett's portfolio managers or taken as a hedge of some sort for lack of better alternatives, I will attempt to evaluate the reasons behind the change in Buffett's stance. Note, this is entirely my own opinion; we may not receive word from Buffett himself on the trade until his next letter to shareholders, or ever.
The possible reasons behind the surprise move
There could be several reasons for Berkshire to have invested in gold, and many investors believe that Buffett might not be the originator of this move. However, I believe there are quantifiable explanations as to why the conglomerate has become fond of the precious metal.
First, gold is widely considered as one of the most effective inflation hedges in the world. In a macro-economic environment in which real interest rates lag the increase in prices of goods and services, investors lose money as long as the underlying asset is not beating or keeping up pace with inflation. Gold, historically, has provided shelter against this phenomenon as the price of the metal tends to increase as a result of a decline in the purchasing power of the U.S. dollar. Data from the World Gold Council reveals that there were only eight years of high inflation (over 5%) in the U.S. between 1974 and 2018, and in those years, gold prices have surged by an average of 14.9% per annum in contrast to a meager average gain of less than 4% in low-inflation years.
The trillion-dollar stimulus packages introduced by the Federal government and near-zero interest rates is a recipe for a significant uptick in the general price level in the future. The below is an abstract from a research paper prepared by the World Gold Council in 2010 discussing the effects of "money printing" on inflation.
"An increasing number of investors are becoming wary about the outlook for price stability. What if central banks leave interest rates too low for too long or pump too much money into the economy? If they do, they risk making today's solution into tomorrow's problem: a sharp rise in inflation."
Commenting on the recent fiscal and monetary policy initiatives, RBC Capital Markets economists Tom Porcelli and Jacob Oubina wrote in a research note:
"It is not a stretch to think we could experience persistent and elevated goods inflation in the coming years. Keeping in mind, this is not something we have witnessed here in the U.S. in decades. We think the trade war has set this very real possibility in motion, and Covid-19 is likely pushing it further upfield. We are talking about supply chains."
If history repeats and inflation kicks in, gold could turn out to be one of the very few asset classes that provide attractive risk-adjusted returns. Buffett's shift in stance toward the metal, therefore, could be a contrarian move to secure market-beating returns in the coming years.
Second, it's important to note that Berkshire is investing in a gold miner, not physical gold. Barrick Gold is the second-largest miner in the world and has a reputation for delivering outsized gains to shareholders when macro-economic conditions are favorable. The quality of the asset base managed by the company can be seen from the second-quarter financial results. Barrick reported a 20% increase in free cash flow in comparison to the first quarter and brought down net debt by almost 25% on a quarter-over-quarter basis according to company filings. Below is a snapshot of company earnings for the three months ended on June 30.
Source: Company presentation
The improving fundamentals enabled the management to hike the quarterly dividend by 14% to 8 cents per share while more than 180 U.S.-listed companies have cut their dividends and another 150 have suspended distributions temporarily as a result of the economic downturn. Berkshire's continued search for steady income might have been one of the reasons to invest in Barrick amid the positive outlook for gold.
Third, the billions of dollars sitting idle and the lack of attractive investments in the market might have been a reason behind the surprise move. As illustrated in the below chart, cash reserves at Berkshire have continued to grow in the last couple of years due to the overvalued nature of the market.
Source: GuruFocus
Investing in an asset that has the potential to appreciate substantially in the coming years seems to be a better decision than sitting on cash, and this could have played a role in changing the guru's view of gold.
Takeaway
I think it is likely that Buffett's decision to invest in Barrick Gold is a clear indication of his expectations for an inflation shock in the coming years. A closer look at how Buffett dumped banking and financial sector stocks gives reason to believe that he projects ultra-low interest rates to persist in the foreseeable future, which creates a strong platform for gold to head higher, resulting in higher earnings for miners.
Value investors might want to err on the side of caution when investing in stocks in the coming months as Buffett's decision to get behind gold is an indication of troubles ahead for global stock markets. A small position in gold, on the other hand, could help with portfolio diversification.
Disclosure: I do not own any stocks mentioned in this article.
Read more here:
- Buffett's Stance on Stock Splits Will Be Tested by Apple
- 2 Gurus Have Contrasting Views on the Economy and Market
- Skyworks Solutions Has More Gains Ahead
Not a Premium Member of GuruFocus? Sign up for afree 7-day trial here.
