Tuesday, February 14, 2012

Buffett: Why Stocks Beat Gold

Some thoughts from Warren Buffett on gold from his recent Fortune Magazine column.

Warren Buffett: Why stocks beat gold and bonds

In the column, Buffett talks about what he describes as the three major categories of investments. The first category he covered was currency-based investments. That category includes money-market funds, bonds, mortgages, and bank deposits among other things.

In a nutshell, his view of currency-based investments pretty much came down to this:

They are anything but safe over the long haul.

Here's the next major category.

Category II: Nonproductive Assets Like Gold

Buffett points out that all the gold in the world forms a cube of 68 feet per side and is worth roughly $ 9.6 trillion.

"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..."

In a century, the 400 million acres farmland will produce lots of corn and other crops and still be capable of doing so. In a century, Exxon Mobil (XOM) will have delivered trillions of dollars to owners and still have valuable assets. Over that time frame, in contrast, all that gold will be no bigger and still unproductive. 

In fact, it costs real money to protect.

In a typical year, the 16 Exxon Mobils and U.S. cropland shouldn't have much trouble putting $ 500-700 billion of earnings in the owners pocket.

That's year after year.

So these productive assets will likely earn every 12-15 years the entire current value of a gold. During that time and thereafter, the gold will produce nothing. In contrast, whatever the oil and crop bounty happens to be during the first 12-15 years, the productive assets will continue to benefit owner and society thereafter.

With technological advancements and mostly self-funded further investments, there'll likely be quite a bounty of crops and energy resources for a very long time coming from these assets.

Gold will produce nothing and is only worth what the next buyer will pay (if you couldn't find a buyer for Exxon Mobil or the U.S. cropland you'd still collect the income stream). In fact, gold costs an owner money to store, protect, and insure (negative carry). A good business has the capacity to fund those costs from operations and still generate income for owners.

Now, the stream of income produced by productive assets has more than decent odds of growing over time. Year in and year out, the additional income could be wisely invested by the owner into more productive assets.

Let the compounding effects begin.

The growing earnings stream from the Exxon Mobils and the U.S. cropland, even as the inevitable degradation in currency value proceeds, has a very good chance of compensating the owner at least enough to maintain purchasing power. There's also a high probability that the earnings stream, as the value of it is reinvested and allowed to compound, will actually increase purchasing power.

The only problem with commodity businesses is, as a currency is debased, knowing how the price of each individual commodity will change over time to compensate for the debasement isn't always predictable. In a commodity business the owner frequently has little control over price in the long run (there are some obvious exceptions, of course).

That's where pricing power comes in.

Now, imagine owning a business with actual pricing power. As a currency is debased, the management of a good business with pricing power has little trouble adjusting the price to compensate.

I'd still rather own a productive asset like an oil company or cropland than a nonproductive one like gold but it's just that better alternatives exist.

Finally, don't forget about that other $ 1 trillion of walking-around money Buffett mentions above. Those dollars can also be put to productive use.

Still want the gold?

Check out the full Fortune Magazine column for Buffett's thoughts on the other two major investment categories.

Adam

Related posts:
-Buffett on Productive Assets
-Buffett: Why Stocks Beat Bonds
-Buffett on Gold, Farms, and Businesses
-Beta, Risk, & the Inconvenient Real World Special Case
-Howard Marks: The Two Main Risks in the Investment World
-Black-Scholes and the Flat Earth Society
-Edison on Gold: Fictitious Value & Superstition
-Munger on Buying Gold
-Thomas Edison on Gold
-Grantham on Gold: The "Faith-based Metal"
-Buffett: Forget Gold, Buy Stocks
-Gold vs Productive Assets
-Buffett: Indebted to Academics
-Grantham on "The Greatest-Ever Failure of Economic Theory"
-Grantham: Gold is "Last Refuge of the Desperate"
-Friends & Romans
-Why Buffett's Not a Big Fan of Gold
-Superinvestors: Galileo vs The Flat Earth
-Max Planck: Resistance of the Human Mind

Related article:
CNBC - Warren Buffett: Stocks Will Outperform Gold and Bonds..and They're Safer 'By Far'

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