SMITH BRAIN TRUST – Ancient rulers loved it. Modern investors have, at times, flocked to it. What is it about gold, anyway?
Q3 2019 hedge fund letters, conferences and more
Gold prices have gained more than 15% this year, amid worries about the trade war between the United States and China, uncertainties surrounding Brexit, and signs of weakness across major economies.
In an unfavorable market environment, gold tends to perform well, favored by investors as a so-called safe-haven asset.
David Kass, clinical professor of finance at the University of Maryland’s Robert H. Smith School of Business, has closely followed financial markets for over 50 years and has been watching gold’s recent rise. He offers some insights on why investors like the shiny metal and how famed investor Warren Buffett views it.
Q: Why does gold appear to be performing so well recently?
Kass: Gold has increased in value recently as interest rates have declined or gone negative in Europe and Japan. Investors seeking a positive rate of return are seeking other asset classes such as stocks and gold.
Q: Where do you see gold prices going from here?
Kass: If interest rates remain very low or negative, then gold is likely to maintain its recent price increases.
Q: How do people invest in gold?
Kass: Investors can buy gold coins, gold bars, gold ETFs (exchange-traded funds), and gold mining stocks. A good source for further discussion on this question is Investopedia’s ‘How do you purchase physical gold bars.’ Gold, a non-productive asset, has historically resulted in a rate of return approximating the rate of inflation. It has substantially underperformed stocks as well as underperforming bonds.
People who buy gold do so out of fear that the economy will get worse in the near future. They follow the ‘greater fool theory’ – that a greater fool will subsequently buy their gold at a higher price than they paid.
What Warren Buffett Thinks About Gold
When Warren Buffett, chairman and CEO of Berkshire Hathaway, spoke about gold during the 2018 Berkshire annual shareholders meeting, Kass took notes.
“Buffett mentioned that at age 11 he bought his first shares of stock.” Kass said. It was March 11, 1942, and he bought three shares of Cities Service Preferred at $38 per share.
Buffett noted that had someone invested $10,000 in the S&P 500 Index on that date, it would now be worth $51 million (for a compounded annual return of 12%). “By contrast,” Kass said, “a $10,000 investment in gold would be worth only $400,000 (compounded annual rate of return of 5%).”
Here are Buffett’s other takeaways about gold, from his 2011 letter to Berkshire shareholders:
- “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
- “The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn’t going to do anything for you. … 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 that you expect to produce income for you over time.”
- “Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn’t produce anything.”
- “I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side. …Now, for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States. … For $7 trillion … you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money. … And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally. … Call me crazy, but I’ll take the farmland and the Exxon Mobils.”
- “The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.”
- “What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As ‘bandwagon’ investors join any party, they create their own truth – for a while.”
- “I have no views as to where it will be, but the one thing I can tell you is it won’t do anything between now and then except look at you. Whereas, you know, Coca-Cola (NYSE:KO) will be making money, and I think Wells Fargo (NYSE:WFC) will be making a lot of money and there will be a lot – and it’s a lot – it’s a lot better to have a goose that keeps laying eggs.
Article by Dr. David Kass
