“What motivates most gold purchasers is their belief that the ranks of the fearful will grow.”
-Warren Buffett
Mr. Buffett’s skepticism toward gold reflects a broader truth about non-productive assets such as gold, crypto, or other collectibles… fear is often the main driver of returns, not innovation or hard work. While popular across a wide swath of the investing public, there are compelling reasons why it makes sense to exclude non-productive assets from your investment portfolio.
No cash flows
Unlike companies that generate earnings and pay dividends, real estate that earns rents or produces crops, or bonds that provide regular coupon payments, a bar of gold or that bottle of wine sits quietly doing nothing. No cash flows, no production, no innovation. You’re essentially betting that someone will pay more for your gold/wine tomorrow, than you paid today.
What’s more, how does one even go about valuing gold or crypto? I readily admit that valuation is not an exact science. But without cash flows, it’s difficult to get a sense of an asset is cheap or expensive. For example, if the US stock market has a price-to-earnings (PE) ratio of 100, we would likely say it’s expensive and future returns could be subpar. However, at a PE of 5 or 10, then the US stock market is likely a great buy! However, we can’t really make that call when it comes to gold or other non-productive assets.
Inflation protection underwhelming
Gold’s reputation as an inflation hedge doesn’t hold up to scrutiny. Over the past 50 years, gold has actually underperformed inflation in many periods. During the 1980s and 1990s, while inflation persisted, gold prices stagnated or declined. Some collectibles have done better over time (ahem, Bitcoin), and some worse (many niche collectibles). But by and large, a low cost stock index fund has historically provided better long-term protection against inflation while generating substantial “real” returns (or returns after you subtract inflation) when compared to non-productive assets. All told, it’s likely that the best way to protect against inflation is to hold stocks for a long time.
There are opportunity costs
Every dollar invested in gold is a dollar not invested in productive assets. While gold languished for decades, stock markets delivered compound growth, real estate appreciated, and businesses created value. The opportunity cost of holding gold instead of diversified equity investments has been substantial for long-term investors.
It matters how you buy/sell and store it
There are multiple ways to gain exposure to gold within an investment portfolio. The easiest way is to buy a gold ETF such as GLD (or it’s cheaper alternative GLDM). This method offers the least hassle and lowest costs. All you pay is a bid/ask spread and ongoing management fee and you’re all set.
But if fear is a motivating factor, then perhaps having someone else hold your gold doesn’t suit. In that case, you could buy physical gold (bars, coins, jewelry, etc.). But who will you buy and sell from? Historically, many retail gold traders tended to charge crazy fees or markups. These days you can buy physical gold at a reasonable price from Costco. Liquidity is still a concern for many collectibles and the market can often dry up for years at a time, or forever. Who remembers Beanie Babies? They had their moment in the sun, but are all pretty much worthless at this point. Until recently, you basically needed a PhD in Computer Science to comfortably trade Bitcoin and other crypto assets.
And how will you keep your hoard secure? Unless you’re a pirate with an uncharted island, you’ll need a safe deposit box or home safe for any physical assets. What about that wine collection? Likely you’ll need a wine cellar with the proper climate control. Don’t forget insurance! These additional costs can eat into your future returns.
And Bitcoin is notoriously sensitive to theft or loss. Many exchanges have been hacked with massive losses for investors. One person lost their hard drive containing 8000 Bitcoin in a landfill. There has also been a recent uptick in attacks on people with large amounts of Bitcoin in an effort to coerce passwords from the victim and enable a quick transfer of the assets.
Volatility without growth
Another concern is excessive volatility. Government actions and economic conditions in the 1970s and 80s caused dramatic swings in the price of gold, and crypto assets seem to go crazy all the time. Unlike stocks, this volatility doesn’t come with the potential for long-term wealth creation through business growth and innovation. You are just hoping that future buyers are more scared.
What’s more, certain markets are subject to manipulation by large players. Just ask Mr. Buffett about the silver market or imagine what goes on behind the scenes in some of the niche crypto currencies. I’ll admit that individual stocks can be open to manipulation, but the broader stock market has generally weathered manipulation attempts without concern.
Better alternatives
Those seeking portfolio diversification or inflation protection may also consider Treasury Inflation-Protected Securities (TIPS) or real estate investment trusts (REITs). These alternatives could offer better long-term growth prospects while still providing some hedge against economic uncertainty.
A final thought from Mr. Buffett
Here is one more interesting thought illustration from Warren Buffett (from the 2011 Berkshire Shareholder Letter, page 19) regarding the inferiority of gold to other investment options:
“Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.
Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.
A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.“
