Monday, May 7, 2012

Buffett & Munger on Gold

This morning on CNBC, Warren Buffett offered his views on gold.

According to him, productive assets (and maybe even caves) have an advantage over the yellow metal.

As he has said on earlier occasions, Buffett believes since gold is not a productive asset that, over the long haul, it will not do as well as productive assets like farmland and stocks.*

Buffett added that gold buyers have it right to be concerned about the future value of paper money, but he thinks the strategy of buying gold to protect against that decline is the wrong one. From this CNBC article:

They have a "correct basic premise" that paper money will be worth less in coming years.

He disagrees with them on the strategy of buying gold to avoid that decline in value. 

Buffett later added...

"They want everybody to be so scared they run to a cave with gold. Caves might be a better investment than gold. At least they're not producing new caves all the time."

Charlie Munger believes civilized people don't buy the yellow metal. In this separate interview on CNBC, he added:

"...I think civilized people don't buy gold, they invest in productive businesses."

It's certainly not at all wrong to expect that paper money will go down in value. In fact, paper money almost certainly will go down in value over time, much as it has been doing this past century or so.
(and, well, pretty much throughout financial history.)

It's just that the right productive assets (durable competitive advantages, capable management, conservatively financed) bought at the right price (comfortable margin of safety), at least in the long run, offer a fine way to protect against that seemingly inevitable decline in paper money, Well, at least for the investor with discipline, who can judge value well, and control emotions during market highs and lows.

Now, let's say gold does in the long run, in fact, perform better than the paper currencies (as it very well may).

To me, that's equivalent to voluntarily choosing to be the passenger of one of two sinking ships when there's a more seaworthy long-term alternative.

Best case, the satisfaction comes from having chosen the sinking ship that, under certain conditions, seems to be remaining afloat but may actually also taking on water, albeit more slowly.

The more seaworthy alternative, that being well-chosen productive assets (especially the more durable ones), not only can remain afloat but the better ones benefit from a rising tide that to some extent is their own making.
(By producing something useful and through reinvestment of the proceeds generated.)

A farm (especially one with some built in advantages, better yielding, well-located etc.) will still be a farm in a hundred years (assuming no development of it for other purposes) but its owner(s), and the world for that matter, will have benefited from everything it has produced over that time, plus what it's capable of producing from that point forward.

The value of what the farm produces each year will be sold at inflation-adjusted prices, of course, in whatever currency exists at that future time. So some inflation protection is built in. Also, technology has a good chance of continuing to enhance what that farm can yield per acre (better seeds, fertilizer, machinery etc.).  Compounded over a long period of time, the growth in value of this activity is far from inconsequential. This works with partial ownership via marketable securities of the right businesses (as, of course, does outright ownership).**

In contrast, an ounce of gold will also just still be an ounce of gold in a hundred years, but will have produced nothing of use or value in all those intervening years for the owner(s), and will continue to produce nothing of value. Since gold is a nonproductive asset, its faith-based price depends on how the changing attitudes of buyers/sellers impact demand for it, and whether lots of the yellow stuff happens to be discovered over time.

To me, that seems a pretty daunting thing to effectively judge.

I can certainly see why many would want to bet that gold, over the long run, will be worth more than all the paper money that is being printed.

It just seems that there are more weaknesses and limits to this approach than some admit.

Adam

Related posts:
-Buffett on Productive Assets
-Buffett: Why Stocks Beat Gold
-Buffett: Why Stocks Beat Bonds
-Buffett on Gold, Farms, and Businesses
-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
-Grantham: Gold is "Last Refuge of the Desperate"
-Why Buffett's Not a Big Fan of Gold

* Whether it comes in the form of non-controlled ownership or controlled ownership. From partial, non-controlling ownership via marketable securities to total ownership (owned and operated outright) can work if the business is sound, reasonably well run, and bought with a margin of safety.
** Of course, in the real world the operator of a farm or any business may get caught up during speculative periods, overleverage their assets, and pay too much for expansion opportunities. So none of this works in a vacuum. 
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