February 29, 2012
Santiago, ChileIn Warren Buffett’s latest round of gold-bashing last weekend, he described all the gold in the world as a useless cube that would fit snugly within a baseball infield.If you owned such a cube, you would only be able to ‘fondle’ it… but generate no investment return.
The same ‘value’, meanwhile, would allow the owner to purchase all the productive farmland in the United States plus 16 Exxon Mobils, in total yielding over $800 billion annually.Granted, Buffett’s views on gold are perhaps stymied by his poor experience investing in silver some 15-years ago. But still, he fails to see some obvious fallacies in his logic.
Most assets left unmanaged will fail to produce an investment return. The virtuous farmland that Buffett extols in his hypothetical example does not magically spawn corn, nurture it, harvest it, sell it, and deposit the proceeds into its owners’ pockets. Our farmland here in Chile certainly does not.
No, it takes a lot of work, a lot of experienced people, a lot of know-how, and a little bit of luck. All of this has to be managed.
Even the baseball field that Buffett references (when trying to give his investors an idea of the scale of all the gold in the world) is an asset. Simply left sitting there, a baseball field will soon be overtaken by erosion, weeds, and the dilapidation that comes with neglect.
Maintained and well-managed, however, a savvy owner of a baseball field can lease it out to the local little league. Or pull a Kevin Costner and turn it into a tourist attraction. None of this happens without appropriately managing the asset.
Even Exxon Mobil, with all of its royalties and intellectual property, requires tens of thousands of employees to manage the company’s assets, collect the profits, and ensure shareholders get paid.
Likewise, a huge cube of gold left alone in a baseball infield will fail to produce any investment return. When managed, however, gold is like any other asset– it can be leased, traded, loaned out, used as collateral, etc.
More importantly, though, the reason that many gold investors purchase the metal to begin with is because physical gold carries no counterparty risk.
Unlike paper currencies which are issued at will by corrupt central banks, or even Exxon Mobil, whose success depends heavily on the management team’s goodwill and diligence, a one ounce gold coin in your pocket will still be a one ounce gold coin tomorrow. This is the entire premise behind money as a store of value.
As my friend Tim Price told me over drinks in London several months ago, fiat currency is simply an abstraction of the concept of money; paper money conjured out of thin air cannot be real money, it’s merely an idea based on confidence and collusion.
Curiously, only a tiny percentage of worldwide money supply is actually physical paper– most ‘money’ is in digital form, simply entries in a computer… a few bits of code which constitute your net worth. In this way, our currency is actually an abstraction of an abstraction of the concept of money.
To this I would add that the entire financial system is underpinned by a complex network of hypothecated debt and derivative instruments whose notional total exceeds (by many multiples) the entirety of world GDP. In this manner, we are talking about abstractions of abstractions of abstractions.
Gold is real. It exists. And it scarcity dictates that it is a reasonable store of value, particularly in a world of abstract money.
There’s a lot of talk right now, for example, about rising oil prices which have created uncomfortably high gasoline prices. In gold terms, however, gasoline prices are in a deflationary spiral. The chart below shows unleaded gasoline prices in grams of gold since January 1976:
and for the last five years:
Priced in grams of gold, gasoline is near an all-time low. [In fact, there’s a great siterun by my friend Charles V. that shows this trend with a variety of commodities and retail goods.]Buffett (and others) argue strongly that investors should be in stocks… that a company like Coca Cola or productive farmland is a better long-term investment than a useless hunk of metal.He’s probably right. Except that the useless hunk of metal isn’t really an investment. It’s an anti-currency… appropriate for those who want to sit out of the market and be in cash without having to be in cash.
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