From time to time we are asked to
offer our opinion as to whether or not gold should be a part of one’s
portfolio. While interest in gold seems
to ebb and flow as economic reports and political events unfold, general
interest seems to persist. As such, we
thought Dimensional Funds VP Weston Wellington’s recent article exploring the
merits of holding gold as an investment is instructive. Throughout the article Weston cites the
thoughtful opinions of Warren Buffett.
His comment that “where gold advocates see a safe harbor, Buffet sees
just a different set of rocks to crash into” offers insight into his question
of Who
has the Midas Touch? Find this
month’s article below.
Who Has the Midas Touch?
Weston Wellington
Down to the Wire
Vice President, Dimensional Funds
Over the course of a lengthy and
illustrious business career, Warren Buffett has offered thoughtful opinions on
a wide variety of investment-related issues—executive compensation, accounting
standards, high-yield bonds, derivatives, stock options, and so on.
In regard to gold and its investment
merits, however, Buffett has had little to say—at least in the pages of his
annual shareholder letter. We searched through 34 years' worth of Berkshire
Hathaway annual reports and were hard-pressed to find any mention of the
subject whatsoever. The closest we came was a rueful acknowledgement from
Buffett in early 1980 that Berkshire's book value, when expressed in gold
bullion terms, had shown no increase from year-end 1964 to year-end 1979.
Buffett appeared vexed that his diligent
efforts to grow Berkshire's business value over a fifteen-year period had been
matched stride for stride by a lump of shiny metal requiring no business acumen
at all. He promised his shareholders he would continue to do his best but
warned, "You should understand that external conditions affecting the
stability of currency may very well be the most important factor in determining
whether there are any real rewards from your investment in Berkshire
Hathaway."
As it turned out, the ink was barely dry on
this gloomy assessment when gold began a lengthy period of decline that tested
the conviction of even its most fervent devotees. Fifteen years later, gold
prices were 25% lower, and even after thirty-one years (1980–2010), had failed
to keep pace with rising consumer prices. By year-end 2011, gold's appreciation
over thirty-two years finally exceeded the rate of inflation (205% vs. 195%)
but still trailed well behind the total return on one-month Treasury bills
(398%).
Perhaps to compensate for his past
reticence on the subject, Buffett has devoted a considerable portion of his
forthcoming shareholder letter (usually released in mid-March) to the merits of
gold.
With his customary gift for explaining
complex issues in the simplest manner, Buffett deftly presents a two-pronged
argument. Like a sympathetic talk show host, he quickly acknowledges the
darkest fears among gold enthusiasts—the prospect of currency manipulation and
persistent inflation. He points out that the US dollar has lost 86% of its
value since he took control of Berkshire Hathaway in 1965 and states
unequivocally, "I do not like currency-based investments."
But where gold advocates see a safe harbor,
Buffett sees just a different set of rocks to crash into. Since gold generates
no return, the only source of appreciation for today's anxious purchaser is the
buyer of tomorrow who is even more fearful.
Buffett completes the argument by asking
the reader to compare the long-run potential of two portfolios. The first holds
all the gold in the world (worth roughly $9.6 trillion) while the second owns
all the cropland in America plus the equivalent of sixteen ExxonMobils plus $1
trillion for "walking around money." Brushing aside the squabbles
over monetary theory, Buffett calmly points out that the first portfolio will
produce absolutely nothing over the next century while the second will generate
a river of corn, cotton, and petroleum products. People will exchange their
labor for these goods regardless of whether the currency is "gold,
seashells, or shark's teeth." (Nobel laureate Milton Friedman has pointed
out that Yap Islanders got along very well with a currency consisting of
enormous stone wheels that were rarely moved.)
When Buffett assumed control of Berkshire
Hathaway in 1965, the book value was $19 per share, or roughly half an ounce of
gold. Using the cash flow from existing businesses and reinvesting in new ones,
Berkshire has grown into a substantial enterprise with a book value at year-end
2010 of $95,453 per share. The half-ounce of gold is still a half-ounce and has
never generated a dime that could have been invested in more gold.
Few of us can hope to duplicate Buffett's
record of business success, but the underlying principles of reinvestment and
compound interest require no special knowledge. Every financial professional
can point to individuals who have accumulated substantial real wealth from
investment in farms, businesses, or real estate, and sometimes the success
stories turn up in unlikely places. (See "The Millionaire Next Door.")
Where are the fortunes created from gold?
