“Gold gets dug out of the ground in Africa, or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
-Warren Buffet
Like my boy Buffet, I still can’t get over why people put so much stock in gold when the stock market hits a recession or when international markets in general hit turbulence. It makes little sense to me that this is what people do in order to feel more secure. At the end of the day, when you truly examine gold as a substance, what gives it such a high intrinsic value that it makes people feel safe? I can understand how owning a house or owning land could give someone a false sense of safety, and why someone might choose those as a relatively “safe” store of value. They have obvious uses and while the price may fluctuate, I can understand the rationale behind the idea that those investments might be more secure (they aren’t, but at least I can understand the thought process). Gold on the other hand is just a fairly useless precious metal. It isn’t very strong, and its only real use is decorative. Gold hoarders out there will talk in reverent tones about how fiat money is simple paper whose value is only derived from the meaning we give to it. It is intrinsically worthless. There is very little that separates paper from gold if that is your only argument.
A Special Kind of Crazy
Now I understand that gold has been a store of currency for thousands of years and all that jazz, but the truth of the matter is that just like any other commodity, it is an extremely volatile investment. That volatility is because gold doesn’t really have an agreed upon valuation model, and consequently it doesn’t really have to obey any “investing rules”. The price of gold is not truly subject to its relative merits or any quantifiable metrics. People determine the value of companies by examining basic economic fundamentals such as how much money a company makes, how much debt it holds, and what its market share is. Gold’s price is determined almost exclusively by irrational investor sentiment that is not tied to anything quantifiable. If that is what you are basing your “run to safety” investments on, then I guess we are very different individuals.
What REALLY Has Value Anyway?
There are so many solid companies on the stock market today that are trading for 12x and 13x earnings that it really begs the question: Why are these companies considered any less “safe” than a precious metal whose colour we really like? In my opinion, even if you are an ultra-conservative investor, stock in a company like McDonalds, or Johnson and Johnson makes much more sense than gold. One could even argue that they should actually be safer than the bonds sold by many supposedly stable countries out there. Take a look at Spain’s balance sheet and what its long-term prospects are with its youth unemployment rate, versus an international conglomerate that sells a product and/or services that have proven to be in demand for decades. Are people going to stop liking cheap burgers and fries any time soon? Are they going to stop brushing their teeth and needing diapers? Things would have to get pretty bad before these consumer staples and mega brand names would be considered in any sort of risky position. I feel much safer investing in a company like McDonalds which has branding that likely 60%+ of the world can easily identify on site, has several products that are proven winners as well as a history of innovating new ones, and finally, has one of the most valuable urban real estate portfolios on the planet. Now THAT is diversity and true security, not hoping that people continue to panic and rush to gold while listening to the talking heads (that are getting paid by the gold companies by the way) telling you it has always been that way.
If Warren Buffet and your friendly neighbourhood personal finance blogger aren’t proof enough for you… then maybe I should just buy gold as a hedge against the collective stupidity of investors everywhere.
Another fact to consider is that the idea of gold being negatively correlated with equities is more myth than fact. Talk-radio ads for gold sellers during times of market correction are just looking for suckers to take the bait.
This is definitely a solid point Dave. I’ve been reading a lot of stuff recently that says that these hedge fund guys, when combined with high frequency trading actually pull all asset classes down when one goes down (because they need to offset their losses). This starts to make a lot of sense when you look at the higher and higher correlations we are seeing.
I think that quote by Buffet either demonstrates a complete misunderstanding of gold or he is spouting misinformation. Gold has no utility? Really? Besides its industrial value for various electronic applications and its desirability for use in jewelry it happens to be the best form of money that has ever been discovered. It is far superior to fiat paper money, which can be created at a whim by counterfeiting governments.
And that leads me to the explanation for why people are now buying gold. Stocks may go up in nominal terms but in an inflationary environment you will actually be losing value. If your stock goes up 5% in a year but the rate of inflation was 7% you have actually lost money despite the nominal rise in the stock price.
The reason people are buying gold (the smart ones anyway) is because there is unprecedented money printing happening all around the world, with the U.S. government in conjunction with the Federal Reserve leading the way. They are looking to preserve purchasing power as the value of the dollar continues to decline. And the dollar will be losing a lot of value when the fiscal crisis in the U.S. comes to a head and turns into a monetary crisis. So gold really is not an investment – it is a hedge against monetary inflation. And you’ll want to own it when fiat currencies plunge in value in the coming years and societies start using real money again.
As for stocks, I think you would have to be crazy to want to own anything that has heavy exposure to U.S. consumers, as their purchasing power is going decline sharply as reality hits as it has in Europe. Our situation is much worse than what is happening over there.
I have to disagree with completely Stephen. It’s also nice having the greatest investing mind ever back me up.
To answer your points:
1) Gold is rarely used in electronics, and its use for jewellery could be argued to be merely taste-driven and subject to dramatic volatility. Also, those uses do not reflect its valuation in any way.
2) The best form of money ever invented? That’s a loaded statement. It is until the next thing comes along. It’s actually a terrible method of money for the modern economy because you would have a ton of liquidity problems if they tried to bring back the gold standard. Really, isn’t it just a form of fiat money? If the world went into chaos tomorrow wouldn’t a pound of a gold and a bunch of hundred dollar bills have the same utility – which is to say almost none.
3) Your inflationary example makes little sense. You could say the same thing about gold returns, or any returns on any investment for that matter.
4) You have obviously bought into the hype surrounding gold and read your share of their pamphlets. No matter how much money is printed oil companies still have value, Wal-Mart still has value, gold only has hypothetical value.
5) Sure US consumers will see their purchasing power decrease, I don’t think there is any doubt. HOWEVER that is 350,000 in a world of 7 billion+. The vast majority of the emerging world has a consumer class just waiting to step into McDonald’s and Wal-Marts and drive their first car. You gotta invest when there is blood in the streets my friend.
6) Our situation is not worse than was is happening in Europe for a variety of reasons that would take a while book to describe. The USA is still the financial juggernaut of the world, and their currency is still the world’s reserve currency. The bond market says they will be just fine.
“1) Gold is rarely used in electronics, and its use for jewellery could be argued to be merely taste-driven and subject to dramatic volatility. Also, those uses do not reflect its valuation in any way.”
Demand and value is imputed for gold as they are for every other commodity. So of course this demand is reflected in its valuation. How much is debatable.
“2) The best form of money ever invented? That’s a loaded statement. It is until the next thing comes along. It’s actually a terrible method of money for the modern economy because you would have a ton of liquidity problems if they tried to bring back the gold standard. Really, isn’t it just a form of fiat money? If the world went into chaos tomorrow wouldn’t a pound of a gold and a bunch of hundred dollar bills have the same utility – which is to say almost none.”
If you’re going to refute 6000 years of monetary history, be my guest. But if you’d like a good overview of monetary history of the world and the U.S. in particular I recommend reading The Case For Gold by Ron Paul . And please look up the definitions of fiat money and commodity money. And no, if the dollar is hyper-inflated it will not have the same utility as gold. Gold will of course be in high demand while no one will want dollars for obvious reasons. And I’m curious, just what liquidity problems would there be with a gold standard?
“3) Your inflationary example makes little sense. You could say the same thing about gold returns, or any returns on any investment for that matter.”
It makes no sense only if you do not understand the relationship of gold to fiat currencies. The price of gold reflects how much value a currency has.
“4) You have obviously bought into the hype surrounding gold and read your share of their pamphlets. No matter how much money is printed oil companies still have value, Wal-Mart still has value, gold only has hypothetical value.”
No, I read and understand basic economics and that is why I buy gold. Here’s a good resource to get you started: http://mises.org Yes companies have value no matter how much money is printed. But what you are saying means that oil or other commodities only have hypothetical value because they are not a company, which of course is nonsense. Gold and oil are both goods which are in demand and are produced by companies.
“5) Sure US consumers will see their purchasing power decrease, I don’t think there is any doubt. HOWEVER that is 350,000 in a world of 7 billion+. The vast majority of the emerging world has a consumer class just waiting to step into McDonald’s and Wal-Marts and drive their first car. You gotta invest when there is blood in the streets my friend.”
I completely agree. That is why I am bullish on other economies and bearish on the U.S. economy. But I personally think that investing in companies that are engaged in higher order stages of production vs lower stages will yield better returns. Think mining and manufacturing rather than Mcdonalds.
“6) Our situation is not worse than was is happening in Europe for a variety of reasons that would take a while book to describe. The USA is still the financial juggernaut of the world, and their currency is still the world’s reserve currency. The bond market says they will be just fine.”
Much of the wealth in the U.S. is an illusion because it is just consumer goods financed with debt. We don’t produce a whole lot, we just buy things with paper that other countries like China produce. That will come to an end when our creditors wake up to what a fiscal trainwreck we are. The U.S. won’t be able to finance the debt at current low interest rates indefinitely. What happens if interest rates go up to 7 percent as in Spain and just the interest on the debt alone cannot be serviced? Sooner or later interest rates will go up and we’ll be faced with a choice. Make massive spending cuts, default on the debt, or hyper-inflate the dollar to meet our obligations. And have you ever entertained the idea that the bond market might just be in a bubble? Just what do think will happen to it when interest rates spike? I think bonds are probably one of the riskiest assets you can hold right now.
1) Demand and value for other commodities is completely tied to their utility. The dollar value of gold is completely unhinged from its utility as jewellery, it is based purely on market emotion and fear
2) I am familiar with Ron Paul’s stance and talking points on gold. I’m actually a mild fan of some of his other policies. There are too many problems with the gold standard to get into even. Suffice to say more books have been written against it than in support of it. The liquidity issues comes into play because governments don’t have nearly the levers to use to moderate market swings when money is tied to a gold standard. All it does is increase volatility.
3) So then when the price of gold inevitable collapses, what does this say about its value relative to inflation or deflation?
4) Now your confusing the argument. Oil is much different from gold. The price of oil is directly controlled by supply and demand and it has a huge amount of utility. In fact most other important commodities such as copper, aluminium, natural gas, and corn are obviously tied to basic supply and demand principles. I would argue it is much easier to guage and predict what a company’s direction will be relative to commodities, but at least commodities such as oil follow a logical pattern that is not disrupted by irrational investor “run to safety” shouts. Gold is not “in demand” it is a bet made by fearful people. It serves no purpose.
5) Regardless of where the growth comes from, owning shares in companies will remain more profitable than owning gold, just as it always has. Companies produce things people need. Gold does nothing other than a niche market in jewellery. Think about the fact that jewellery costs more or less the same now as it did in 2000 (give or take 10%) yet the price of gold has skyrocketed. This is an obvious indication that the “value” of gold is purely based on fear an irrationality. It is the definition of a bubble right now. Tulips held value to at one point.
6) I’m the first guy to admit the USA has problems, but so did Canada 15 years ago, and so have a lot of other countries. The USA has so many massive advantages. I suggest reading “That Used To Be Us” for further explanation. If the USA merely cut military spending my 20%, and raised taxes slightly at all levels (admittedly the biggest problem the USA has is its political paralysis) the debt would be wiped out very quickly. That’s relatively painless if you actually think about it. The USA still has the best infrastructure in the world, the leading innovative structure buoyed by strong intellectual and property rights laws, a post-secondary system that is the envy of everyone, and the greatest venture capital system ever produced. I’ll stick with my boy Warren Buffett on this one. How will rates rise to 7%, where are people going to GO?! You bears keep saying that and yet the 10yr is at an all-time low! It makes no sense. The USD is the reserve currency of the world, and where else are you going to park money? Japan? Even more debt. You already commented on the Eurozone. You want to bet on Germany’s exposure to Euro banks? How about China which is seeing its own bubble begin to pop? Russia and its budding social unrest? The USA is still the king of the mountain for many years to come my friend. I agree interest rates will inevitably rise, but it won’t cause the massive panic you’re thinking of.
7) If Glenn Beck is pushing your product, changes are it’s a fools game. That is about as persuasive an argument I have as any!
It’s a worthy debate, but I’ve read the material on gold and it just doesn’t make any sense at all to me to trust in a shiny metal as opposed to companies that are haemorrhaging profits. Buffett vs Beck? I’ll take the Oracle every time.