Gold and The Greater Fool Theory

In times of stock market volatility and government intervention in financial markets, some people are comforted by owning hard assets (e.g., gold). We have never been big proponents of investing more than a few percent of a portfolio in the precious metal and neither is Warren Buffet. Mr. Buffet has clever and memorable ways of explaining things such as this example from a 1998 speech he gave at Harvard:

“It (gold) gets dug out of the ground in Africa, or someplace. Then we meld 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.”

Why I don’t like gold as an investment:

The biggest issue with investing in gold is it pays no interest or dividends. Stocks are valued based on a company’s earnings. Gold has no earnings, so its value is based on the theory that there will be a greater fool who will pay more for it in the future. Forecasting future price increases on gold is pure speculation. This is not an investment strategy we recommend.

In 2011, Warren Buffet wrote in his annual shareholder letter:

“If all of the gold in the world were melded together, it would form a cube 68 feet by 68 feet. At $1,750 per ounce—gold’s price as I write this, its value would be about $9.6 trillion. Call this cube pile A. (Note: gold’s price has fallen to $1,246 since 2011.)

“Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we 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?” Yet, some investors do pick gold over productive assets that produce income.

Gold as protection against future inflation:

The main reason given for investing in gold is the concern about future inflation. A segment of the population believes the world is going to fall apart and paper money is going to be worthless. If that is the case, you could hedge your inflation risk by investing in other physical assets that rise with inflation, yet also have productive uses and pay consistent dividends (e.g., stocks, real estate, oil, etc.). In case you need one more reason to avoid investing in precious metals…if you do make money, Uncle Sam will tax any gains at 28% (the rate charged on collectibles) instead of the lower capital gains rate charged on almost every other capital asset (15% for most taxpayers).

Final thought: My unofficial polling data suggests that most women prefer gold over stock certificates as anniversary gifts. Have a great week.