I recently discussed a Bloomberg interview with hedge fund manager Paul Tudor Jones (Trades, Portfolio), in which he said he believes gold will prove to be a superior investment in the near- to mid-term future due to the rollback of globalization and attack on free trade. I have also written about the usefulness of gold as a hedge against volatility and inflation.
While I am not a goldbug, I do think it is useful to hold an asset that can maintain its value in extremely uncertain circumstances. At the same time, it is undeniable that gold is not intrinsically valuable (apart from its use in electronics, which far undershoots its market capitalization) and that it is not a productive asset. This is why Warren Buffett (Trades, Portfolio) does not hold the precious metal and why he thinks it is fundamentally speculative to do so.
Gold does not produce, but also does not lose
In a 2015 interview, Buffett explained the difference between buying an asset that is valued speculatively and one that is valued based on productivity:
“There are some assets that don’t produce anything, but you count on them becoming more attractive to people next year or the year after. You’re looking at the price change, rather than a change in the output of the investment. That’s a whole different game. If you pay $20 million dollars for some painting, you don’t look for the painting to produce anything as an investment, you just hope somebody else likes that painting even more a year from now or two years from now. You’re betting on the price of the asset rather than the productivity of the asset. I like things where I look at the productivity of the asset,”.
Not to be pedantic, but every asset is ultimately valued speculatively - the future dollar cash flow of a business is only valuable as long as there is demand for those dollars. Of course, it would take a pretty significant event for there to be a big loss of confidence in the dollar - but that is why gold is considered to be a good hedge against such events. That said, the commodity is certainly a non-productive asset in the sense that it does not produce more gold. This is Buffett’s point:
“If you take all of the gold in the world that’s ever been produced, it comes to about 165,000 metric tonnes. If you put all of that together in a cube, you would have a cube that’s about 67 feet on a side...That gold, at present prices, is selling for $7 trillion, so that cube is a $7 trillion asset. Now, all of the stock market in the United States might be $20 trillion. Would you rather have a third of all of the businesses that exist in the United States, or would you rather have that cube to look at?
If you take all of the farmland in the United States, there’s about a billion acres of farmland. That’s a little over a million and a half square miles, about half of the continental United States. You take all of the farmland in the United States, that billion acres, you add in seven Exxon Mobils and leave yourself a trillion dollars for walking-around incidentals, that would be the value of that cube. Now, would I rather have that cube, or would I rather have all the farmland in the United States, plus seven Exxon Mobils, plus a trillion dollars to stick in my pocket? I think that’s kind of an easy decision.”
While this is an amusing analogy, I think it’s somewhat intentionally obtuse in that it misses a key reason why gold is so attractive to bearish investors. For the average investor, the choice does not lie between owning a gargantuan cube of gold or seven Exxon Mobils (XOM). Rather, the choice is between owning a small amount of gold or a handful of companies (or cash, but we are talking about people who are actively invested in the market).
It doesn’t matter which specific lump of gold you own, but it does matter what specific companies are in your portfolio - and you could miss on those picks. Even buying an index only exposes you to a certain section of the market, and the risk of capital loss in a bear market is much greater with an index than with gold. Incidentally, Buffett does not buy the S&P 500. And by his own admission, he made much of his fortune by avoiding losers. Sometimes in order to not lose, you need safe assets.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Paul Tudor Jones: Gold Is Going Up Because of the Trade War
- Carvana: Game-Changer or Expensive Mistake?
- Warren Buffett Explains the Difference Between Good and Bad Businesses
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