Tuesday, August 4, 2015

What's Gold Intrinsically Worth?

For roughly a decade, starting in 2001, gold prices performed extremely well.

So fans of the yellow stuff will rightly point to that fact.

I'll say upfront that I have just about zero interest in owning gold or any other nonproductive asset. Yet I'm certainly familiar with some of the arguments that are made for owning gold. As is often the case, Jim Grant is thoughtful on the subject of gold (and many other things related to finance and financial history) and worth paying attention to whether or not you happen to agree with him.

Grant points out that the dollar -- and this clearly applies to other paper currencies -- has "no intrinsic value" and is "faith-based."

Can't really argue with that but I think Jeremy Grantham makes a fair point when he says:

"...just as Jim Grant tells us (correctly) that we all have faith-based paper currencies backed by nothing, it is equally fair to say that gold is a faith-based metal. It pays no dividend, cannot be eaten, and is mostly used for nothing more useful than jewelry."

Grant does, in fact, think it makes sense to own gold recently calling it "an investment in financial and monetary disorder."

He also makes his case for a return to the gold standard.

"...the existing monetary arrangements are so precarious, so ill-founded and so destructive of the economic activity they are supposed to support and nurture, that they will be replaced by something better."

For Grant, that'd be a monetary system directly linked to the quantity of gold that can be dug up over time.

Those who share these views (and similar ones) may even prove to be right.

I certainly agree that a paper currency, even under the very best of circumstances, is likely -- if not certain -- to diminish in value over the longer haul. Inflation of some kind or another should erode the purchasing power of just about any currency over time whether or not there is a full-blown currency crisis.

The question is what to do about it.

I think that Grantham has it essentially just about right:

"I believe that resources in the ground, forestry, agriculture, common stocks, and even real estate are more certain to resist any inflation or paper currency crisis than is gold."

For me, the problem has been and remains estimating what gold is intrinsically worth.

Unlike a high quality business it doesn't produce any cash.

Gold's value is perceived, or maybe relative, but it's not intrinsic.

Jason Zweig explains it this way:

"...you will put lightning in a bottle before you figure out what gold is really worth."

WSJ: Let's Be Honest About Gold: It's a Pet Rock

Without a stream of free cash flow how can what something is intrinsically worth, if anything, be known within a narrow enough range?

Warren Buffett, much like Grantham, also suggests that productive assets* are the way to go: "Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor" to buy something like their favorite soda or candy.

Investing in a productive asset is very different than attempting to guess what someone else will be willing to pay for a lump of metal down the road. Here's what Buffett once said on CNBC:

"...it is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something you expect to produce income for you over time."

Some may know (or think they know) where the price of gold is headed.

I have no idea and never will.

In fact, I'll never spend a moment trying to guess such a thing.

Zweig writes the following about those who are the truest believers -- the so-called "gold bugs" -- in the wisdom of gold ownership.

"Recognize...that gold bugs...often resemble the subjects of a laboratory experiment on the psychology of cognitive dissonance.

When you are in the grip of cognitive dissonance, anything that could be regarded as evidence that you might be wrong becomes proof that you must be right."

He then added this line:

"You don't want to be one of these people, spending years telling reality that it is wrong."

Zweig's article shows that for the past forty years or so the faith-based yellow metal has not generated much in terms or relative or absolute returns:

Avg Annual Return Since 1975 (after inflation)
- Gold: 0.8%
- Bonds: 5.0% ,
- Stocks: 8.3%
- Cash: 1.1%

Maybe the future will prove very different.

Personally, I'd be surprised if stocks or bonds do nearly as well going forward considering current valuations especially if (when?) interest rates normalize.


No idea.

Few asset categories, broadly speaking, are plainly inexpensive though there's almost always some individual investment that's selling at a discount for situation specific reasons.
(The tough part being to find one you understand well enough to invest.)

Charlie Munger is, to say the least, usually rather forthright and has a unique way of getting to the point. Well, here's how he looks at gold:

"I don't have the slightest interest in gold. I like understanding what works and what doesn't in human systems. To me that's not optional; that's a moral obligation. If you're capable of understanding the world, you have a moral obligation to become rational. And I don't see how you become rational hoarding gold. Even if it works, you're a jerk."

And one final thought on gold from Jeremy Grantham...

"I hate gold. It does not pay a dividend, it has no value, and you can't work out what it should or shouldn't be worth...It is the last refuge of the desperate."

Of course, for all I know, gold will do very well in the future.

This is irrelevant for me since I have no way of valuing it.

For me it's simple:

If I don't know how to value something, I shouldn't own it.


Related posts:
-Buffett & Munger on Gold
-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

* Examples of what Buffett calls productive assets:
    - Businesses (incl. partial ownership of businesses via marketable stocks)
    - Farms
    - Real Estate

This site does not provide investing recommendations as that comes down to individual circumstances. Instead, it is for generalized informational, educational, and entertainment purposes. Visitors should always do their own research and consult, as needed, with a financial adviser that's familiar with the individual circumstances before making any investment decisions. Bottom line: The opinions found here should never be considered specific individualized investment advice and never a recommendation to buy or sell anything.