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Buffett on gold

Warren Buffett, the Oracle of Omaha, sets out his theory on gold and explains why he is not enamoured by its charms. And why there is no treasure to be found in Treasuries.
When one of the richest investors in the world - if not the richest - with a four-decade record of picking the right companies, talks about asset classes, investors should sit up and listen.

And so when Warren Buffett, the legendary CEO of Berkshire Hathaway, muses about gold, it's important to pay attention.

Indeed, anybody who has followed Mr. Buffett's career knows he is not a fan of the yellow metal.

In a commentary, the Oracle of Omaha sets out his theory on gold and explains why he is not enamoured by its charms.

For a start, gold has no intrinsic use, nor can it 'procreate', says the CEO and chairman of Berkshire Hathaway. "True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production," writes Mr. Buffett. "Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end."

Gold is bought by investors who can make no use of the metal but hopes that others who will find gold unproductive will be willing to pay a higher price for it, says Mr. Buffett, likening gold to 'tulips' mania of the 17^th century.

The tulip mania in The Netherlands of 1667 is one of the earliest examples of a speulative bubble when the price of a tulip bulb exceeded the price of a workers' annual wage. But the euphoria was short-lived and led to the ruin of many Dutch financiers.

Clearly Mr. Buffett is hinting at a bubble in gold prices, which have risen 19% on averge for the past ten years.

Gold investors, he says, have been preying on the fears of an imminent collapse in the global financial crisis.

"What motivates most gold purchasers is their belief that the ranks of the fearful will grow," says Mr. Buffett. "During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth -- for a while."

To be fair to those 'bandwagon' investors, they haven't done badly. A USD100 invested in gold would yield USD4,455 today, which is comparable to USD6,072 invested in S&P 500. Meanwhile, a USD100 in U.S. Treasuries has yielded USD1,336 during the same period.

$9.6 TRILLION GOLD CUBE

But Mr. Buffett can not be convinced.

The total amount of physical gold in the world amounts to 170,000 metric tonnes, which if melded together would make a cube 68 feet wide per side. At USD1,750, that cube is worth USD9.6 trillion in today's price, says the Oracle, calling it Pile A.

Now imagine if an investor was to invest $9.6 trillion in Pile B in the asset classes Mr. Buffett feels passionately about: real companies, real estate and agriculture.

For USD9.6-trillion, "we could buy all U.S. cropland (400 million acres with output of about USD200-billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than USD40 billion annually). After these purchases, we would have about USD1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with USD9.6 trillion selecting pile A over pile B?," asks Mr. Buffett.

The argument is that Pile B is a gift that keeps on giving, with farmers continuing to harvest rich crops, real estate yielding rental returns and 16 ExxonMobils continuing to find new fields to drill, innovating and finding new energy solutions.

Meanwhile, "you can fondle the [gold] cube, but it will not respond," says Mr. Buffett.

NO TREASURE IN TREASURIES
Fear of a detoriating investment climate has not only forced investors to run not only towards gold, but also cash-based assets such as U.S. Treasuries.

"We heard 'cash is king' in late 2008, just when cash should have been deployed rather than held. Similarly, we heard 'cash is trash' in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort," notes Buffett.

The notion that gold and cash are safer than equities have been proven false time and time again. Indeed, equities will continue to outperform these 'safe assets' purely because equities are commercial 'cows' that will live longer and continue to give greater quantities of 'milk'.

"I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we've examined," concludes Mr. Buffett. "More important, it will be by far the safest."

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