Friday, October 8, 2010

Gold vs Productive Assets

I understand that all the gold that's ever been mined fills something like just a couple olympic-sized swimming pools* and, after the recent run up in prices, its combined value stands at around $ 7 trillion.

So let's say we happen to have $ 7 trillion laying around to invest.

We could 1) use those dollars to buy a couple of pools of yellow metal (and presumably a very expensive and large army to guard it) or, 2) instead, use those dollars to acquire 100% ownership of all the following businesses:

Company/Market Cap
Apple/$ 264 billion
Microsoft/$ 212 billion
IBM/$ 175 billion
Google/$ 169 billion
Oracle/$ 139 billion
Cisco/$ 127 billion
Hewlett Packard/$ 93 billion
Exxon/$ 325 billion
Chevron/$ 168 billion
Berkshire Hathaway/$ 205 billion
Walmart/$ 197 billion
Coca-Cola/$ 137 billion
Pepsi/$ 105 billion
All 3 Major U.S Railroads/$ 85 billion combined
Johnson & Johnson/$ 174 billion
Procter & Gamble/$ 172 billion
Philip Morris International/$ 103 billion
Kraft/$ 54 billion
McDonalds $ 80 billion
General Electric/$ 182 billion
Verizon and AT&T/$ 260 billion combined
Petrochina/$ 223 billion
BHP Billiton/$ 222 billion
Boeing/$ 50 billion
Every team in the MLB, NBA, NHL and NFL
Combined value: ~ $ 4.1 trillion**

If we still wanted some gold exposure, could easily still afford 3 of the biggest gold mining companies. Hey, and just for the heck of it, with some of our pocket change we could purchase all the cars that Ferrari, Porsche, Lotus and Aston Martin produce this year. No big deal.

So we'd own 27 of among the largest companies in the world, 120 or so major sports teams, 3 gold mining companies, and a full year's production of some great cars.

After that buying spree, we'd still have over $ 2.7 trillion of cash left in the bank. Plenty of dry powder.

Two swimming pools of metal or all of the above productive assets plus remaining cash? Take your pick.

Now, there may be some slight anti-trust issues but it shouldn't matter...we can afford great lawyers (and politicians of course).

The above companies have productive assets that generate collectively $ 300 billion of free cash flow (FCF) in a bad year. Now that we own them outright, those annual cash flows are ours to spend/invest however we choose. Gold is, in contrast, a non-productive asset that generates negative FCF since you've gotta guard it, store it, insure it etc.

It is not a stretch to expect the cash flows from our businesses to grow over time especially if that $ 300 billion of fresh annual cash is invested wisely. So the intrinsic value is very real and growing. This becomes even more true if the dreaded inflation kicks in that those two pools of metal are supposed to provide protection against. Over the long run, in almost all cases, the value of those businesses will adjust upward with inflation.

"I remember the $0.05 hamburger and a $0.40-per-hour minimum wage, so I've seen a tremendous amount of inflation in my lifetime. Did it ruin the investment climate? I think not." - Charlie Munger

Gotta go with the two pools of yellow metal, right?

I understand the arguments in favor of gold over fiat currencies. If you don't trust paper money, and cannot find a productive asset to invest in, gold can theoretically function as a temporary store of wealth***. I just consider it incorrect to think of gold or have it sold as a true alternative to investments in productive assets.

Gold will probably hold its own simply as a reflection of the real wealth and value creation that goes on everyday. In other words, as we become richer from the value-creating activities, some of us will use that wealth to buy the yellow stuff. Yet, that begs the following question:

What would the value of gold be if the useful wealth creation that goes on everyday (some of it found among the companies listed above) ceased to occur?

The answer to that question reveals that gold's value is derived...not intrinsic.

Adam

Related posts:
-Grantham: Gold is "Last Refuge of the Desperate"
-Why Buffett's Not a Big Fan of Gold

* I have no opinion on gold prices (even if it happened to fill three swimming pools). I figure once buyers are willing to pay $ 7 trillion for two or three swimming pools of the yellow metal the price can become just about anything.

** Assuming ~ $ 1 billion per sports team.

*** Though hardly a slam-dunk. It has functioned poorly as a store of wealth for extended periods of time with the early 1980s to 2000 being a recent example. Even when it "works" what you own doesn't do anything useful besides stare back at you. If things go badly in the world would you rather own some gold bars or fertile farmland?
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