On Warren Buffet’s view on gold

Summary

Warren Buffet prefers to invest in income producing assets rather than non-producing assets such as gold.  He claims that just about the only reason people buy gold is because of fear.  But beneath Buffet’s case against gold might lie a motive to support the US dollar.  By discouraging investment in gold, Buffet supports the US dollar. 

Detailed response

I respond here in detail to Warren Buffet’s views on gold expressed in the “Berkshire Hathaway Inc. 2011 Annual report”.  [1]

Buffet’s statement is correct that gold will never produce an income stream or anything.  It just sits there, lifeless, as he puts it.  (See footnote #1.)  He claims that assets which never produce anything are bought in the buyer’s hope that someone else will pay more for that asset in the future, and gold is such an asset.  Those claims are all reasonable.

Buffet appears to avoid investing in gold for fear of investing in a bubble.  He argues that an investment in gold would be based on the expectation of an expanding pool of buyers who are enticed to buy by a belief that the buying pool will expand even further. 

Buffet’s reference to tulips in the same section implicitly suggests that investment in gold has parallels with “investments” in the great Dutch tulip bubble.  I believe that analogy is invalid for two reasons.  Firstly, the supply of tulips was not strictly limited.  The tulip bubble burst when alternative supplies became available, reducing their scarcity.  Gold cannot be grown, bred, multiplied or printed.  The steady supply of approximately 2400 tons per annum of newly mined gold cannot easily be increased.  Only 160,000 tons has ever been mined from this planet, in all history.  Much is unavailable to the market, stored eternally in central bank vaults, temples, or in sunken treasure ships. 

Secondly, I disagree with the inference that gold is in a bubble.  I define a bubble as existing when everyday acquaintances and strangers, at dinners or the local pub, enthuse strongly about buying a particular asset, so spreading demand wildly across the broader masses of population.  Those circumstances prevailing in Holland which fuelled wide public demand for tulip bulbs do not exist for gold today.  Therefore, in my opinion, there is currently no gold bubble, and therefore I believe that if any gold bubble were to burst in the near future, the fall in the gold price would not be as severe as it was for tulips.  Eventually, there may well be a gold bubble which will burst, but that is not relevant to the current discussion.  When drunks in bars enthusiastically tell you that you should buy gold, then it will be time to sell gold because the bubble’s burst would be imminent.  Therefore I perceive today less risk associated with gold investment than with tulip investments at the time, and that Buffet’s analogy with tulips is a little misleading.  

Buffet also suggests that gold demand is driven by a fear of almost all other assets, especially paper money.  There is currently great fear about the future value of the US dollar and the euro, both of which are being inflated by massive quantitative easing money printing programs which are devaluing those currencies.  I believe devaluation will continue over the long term.   (See [2].)

Buffet claims that what motivates most gold purchasers is their belief that the ranks of the fearful will grow.  It is difficult to know what motivates most gold purchasers, but I believe there are many gold purchasers, especially in Asian, “BRIC” (Brazilian,  Russian, Indian and Chinese), and other central banks, whose motivations are not driven by fear.  Some buy gold to diversify away from the US dollar to preserve the value of their foreign exchange holdings, some for economic and financial security, and others to strengthen their domestic currencies:  to provide a loose form of “gold backing” which the west has abandoned.  It is in China’s strategic interest to offer a strong and trustworthy yuan as an alternative to the US dollar for international trade.  It is possible that most gold purchased is not purchased, as Buffet suggests, because of a belief that the ranks of the fearful will grow.

Buffet claims that gold is not a good investment because it is neither of much use, nor procreative.  I argue that gold has uses as a refuge from debased fiat currencies, as a shelter against inflation, as a convenient and trustworthy store of wealth, and as a valuable backing for paper currencies.  Underlying my view is my assumption that quantitative easing will fuel increasing inflation.  

Buffet’s statement that “if you own one ounce of gold for an eternity, you will still own one ounce at its end”  is entirely correct, and indeed that is why the Chinese accumulate gold.  Ownership of gold is not for ownership’s sake per se, rather it is for reliably storing wealth.  Gold can be bartered or sold for paper money in the future, and Buffet agrees that currency based investments are amongst the most dangerous.  As currencies lose value, gold will buy more currency.  At the end of eternity, gold will buy more money.  Therefore investments in gold are preferable to currency based investments.

I believe that Buffet has held his negative views about gold for at least the period shown on the chart below.

Courtesy OptionVue Systems

The gold price, 2008-2012

Buffet’s focus on fear in his report betrays his apprehension of the relationship which the gold price has with collective fear.  In concentrating attention onto fear Buffet invites the reader to ponder further the relevance of fear.  It is possible that Buffet’s negative views about gold are influenced by a patriotic and financial incentive to protect and to support the US dollar currency.  It is in US economic interests to maintain global market confidence in the US dollar.  The gold price is sometimes an indicator of confidence in the US dollar.  A high gold price can indicate loss of confidence in the dollar.  The value of the US dollar generally rises and falls inversely to the price of gold.  When the gold price falls, the dollar rises.  

In discouraging investment in gold, Buffet helps depress the gold price, which supports the US dollar.  Furthermore, if Buffet were known to buy gold, collective market sentiment could be signalled that Buffet has less than full confidence in the US dollar, and the US dollar’s decline would accelerate.  Buffet cannot afford to support investment in gold because to do so could be misinterpreted by global market “groupthink” and possibly erode confidence in the US dollar and in the global financial system, and possibly even foster fear.

Conclusion

I believe that Buffet’s primary motivation to claim that gold is a poor investment is to delay and to slow down the loss of confidence in the US dollar, and so to stabilise the US currency.  Buffet argues that it is unwise to invest in bubbles, and therefore it is unwise to invest in gold.  Buffet rests his argument on the premises that gold is currently in a bubble, and that any rise in the gold price would primarily be driven by collective fear, creating a temporary bubble.  Buffet provides no evidence for those premises claimed.  I have argued that those premises are insufficient to support his argument that gold is an unwise investment, and that there might exist other reasons which would increase the global demand for gold.  But I do agree that the fearful turn to gold.

Footnote
#1.  Actually gold can produce an income stream when leased out.  Gold is often leased out to be short sold into the market, to suppress the gold price to support and stabilise fiat currencies such as the US dollar.  But no investor would knowingly lease out their asset to drive down the price, even though your fund manager and your broker probably do so with your stock investments.  So leasing does not refute the essence of Buffet’s claim, which I endorse. 

References

[1]  pp17-19 of the “Berkshire Hathaway Inc. 2011 Annual report”, found at http://www.berkshirehathaway.com/2011ar/2011ar.pdf.

[2]  My presentation to Thomson Reuters: “Gold price fundamentals from a currency perspective”, found at http://options21.com/2011/04/gold-price-fundamentals/.