Has the Gold Bubble Popped?

We’ve seen gold enter into bear market territory with the metal’s price falling 29% since September, 2011. The decline on April 15th 2013, of almost 10 percent in a single day, is a reminder that even the perceived “safe haven” of gold can be a volatile investment. As with any asset class, we believe some exposure to alternative asset classes may be warranted.  It is a principle of sound portfolio diversification. Yet, we have heard of extreme cases of individuals cashing in IRAs or 401ks to buy gold over the last several years. We can’t seem to get away from the “buy gold” ads and fear mongering among gold distributors. Where will the price of gold go from here? Will it rise again? It likely will. Nonetheless, as we consider what percentage of a portfolio to allocate to alternative investments, we must be wise and put each asset class into historical perspective. We’ve appreciated the perspective of Warren Buffet as shared in his shareholder letter in 2011, near the peak of the price of gold. It appears at this point Mr. Buffet may have been right again…at least for now.

Warren Buffett on Gold:

“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.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

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 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.” p.18 - 19

Berkshire Hathaway INC.—2011 Annual Report


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