Warren Buffett has written an article appearing in Fortune that explains why he prefers productive assets rather than gold, both for investments and as inflation hedges. The argument boils down to the fact that gold is an inert metal that just sits there, while farmland, businesses and real estate are assets that produce something of value to society. I forwarded the article to a few very astute portfolio managers in my "cabal," and a lively discussion ensued. Here are the highlights.
"Special K" is a retired value manager whose fund compounded at 27% annually between 1997 and 2007. "The Eskimo" is a Minneapolis-based hedge-fund manager who's been racking up great returns for years. "The Tobacco Kid" is another retired value manager who understands the value of compounding machines (we started our careers together as interns at Fidelity back in the day).
Special K: Since Jan. 1, 1965, the S&P 500, excluding dividends, has increased about 6% compounded annually, to 1340 from 87.56. For argument's sake, let's assume a 2.5% annual dividend return, compounded annually, over this time. An 8.5% compounded annual return means that $1,000 invested at the beginning of 1965 would be worth $46,259 today. Gold, meanwhile, has increased from $35 per ounce to $1,720 per ounce, or more than 49 times. A thousand dollars worth of gold at the beginning of 1965 is now worth $49,143. Bottom-line: Buffett is once again talking his book.
Tobacco Kid: Consider the beginning and endpoints. Gold is up approximately sevenfold in the past 10 years, going from $250 to $1750 for a 21%-plus compound annual growth rate after doing nothing for a long time. Meanwhile, stocks were essentially flat for the past 10 years. Looking back from the early 2000s, gold doesn't look so good. Looking forward, I'd put my money on stocks for the next 10 years despite the poor macro and dollar situation. At least there will be some dividends to spend.
Special K: The major difference between stocks and gold is that during the period under study, stocks produced much steadier returns than gold. But also note that during the period under study, GDP growth was mostly fueled by debt growth to the point that the incremental growth in GDP that now results from an incremental dollar of debt is de minimis, because debt levels are no longer, in aggregate, supportable by productive capacity.
Eskimo: If you look at the Dow in gold ounces, you see how each has outperformed the other over large periods, and that cycle is closer to the end than beginning. But, like Special K, I wonder what happens to gold and stocks if the next decade is about de-leveraging?
Special K: Tobacco Kid's logic is MUCH better than Buffett's, but I still think gold will outperform stocks this decade, too. It confounds me that Buffett does not understand the value of stable money for the efficient AND fair allocation of resources in an economy -- especially when you consider his father's views. Gold is a lot more useful than See's Candies and Coca-Cola, that's for sure.
Gary "The Count" Dvorchak: On this one, I generally agree with Buffett in that during a period of high inflation, I want to own productive assets with pricing power. People will always need to eat. I do see the value in gold as a substitute currency, and that is how I use it now -- as a safer form of cash. I have about 15% of my portfolio in SPDR Gold Trust (GLD), a cash equivalent that will hold its purchasing power during times of inflation. Most of my portfolio is in high-income stocks, with a smattering of venture-like small growth names.
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Editor's Links
More on gold and the Dow:
- Gold Bulls Still Have a Technical Edge
- GLD Coming Into Support (Real Money Pro)
- Golden Crosses and Beating the Dow (Options Profits)
