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Warren Buffett’s Choice of Investing: Case Against Gold

  • Investing is often described as the process of laying out money now in the expectation of receiving more money in the future
  • At Berkshire, we define investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power in the future
    • More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date
  • The riskiness of an investment is not measured by beta but rather by the probability of that investment causing its owner a loss of purchasing-power over his contemplated holding period
  • Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period

Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

  • Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time, such policies spin out of control
  • Even in the US, USD has fallen a staggering 86% in value since 1965
    • It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power
    • For tax paying investors, during the same 47-year period, continuous rolling of US Treasury bills produced 5.7% annually. That sounds satisfactory but if an individual paid personal income tax rates of 25%, this 5.7% return would have been 4.3% – and the invisible inflation tax would have devoured the remaining 4.3%
  • High interest rates can compensate purchasers for the inflation risk they face with currency-based investments – rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing power risk that investors assume
  • Berkshire needs ample liquidity, however inadequate rates may be – we primarily hold US Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions
  • Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain – either because a particular credit is mispriced or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall

Gold: asset that will never produce anything but is purchased in the buyer’s hope that someone else will pay more for them in the future.

  • 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 but rather by the belief that others will desire it even more avidly in the future
  • Gold has two significant shortcomings, being neither of much use nor procreative
  • 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
  • What motivates most purchasers is their belief that the ranks of the fearful will grow. 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
  • Over the past 20 years, both internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop
  • World’s gold stock is about 170,000 metric tons – if all of this gold were melded together, it would form a cube of about 68 feet per side
    • At $1,750 per ounce, it’s value would be $9.6 trillion (call this cube pile A)
  • Now create a pile B costing an equal amount: for that, we could buy all US cropland (400 million acres with output of about $200Bn annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40Bn annually). After these purchases, would have about $1 trillion left over for walking-around money
    • Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
  • A century from now, the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions
    • The 170,000 tons of gold will be unchanged in size and still incapable of producing anything
  • When people a century from now are fearful, it’s likely many will still rush to gold
    • Confident that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B

Warren Buffett’s preference: investment in productive assets, whether businesses, farms, or real estate

  • Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing power value while requiring a minimum of new capital investment
  • In the future, the US population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce
  • Our country’s businesses will continue to efficiently deliver goods and services wanted by our citizens
  • Metaphorically, these commercial “cows” will live for centuries and give ever greater quantities of “milk” to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends)
  • Berkshire’s goal will be to increase its ownership of first-class businesses
    • I believe that over any extended period of time this category of investing will prove to be the runaway winner. More important, it will be by far the safest

The Basic Choices for Investors and the One We Strongly Prefer, Berkshire Hathaway Shareholder Letter 2011

Source: CSInvesting
Image Source: Commodity Trade Mantra

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