Buffett rebuffs gold, but inflation says ‘buy’

Buying gold is now accessible for all, but the sage of Omaha has spoken. Warren Buffett says gold is not an investment — it’s a speculation and does not belong in an investor’s portfolio.

In his annual letter to Berkshire Hathaway shareholders, published Feb. 25, Buffett states:

“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 about $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?”

Anyone for pile A? No, I didn’t think so. It’s as though Buffett, in one fell swoop, reduced the gold investor to a blustery, slightly deranged Yukon Cornelius wandering the financial markets with a metaphorical pickaxe in hand, singing an off-key melody of “Silver and Gold.”

But before you shamefully squirrel away your private gold stash into some spider hole, let’s take a closer look at Buffett’s argument and determine if there is in fact a case for gold as a portfolio tool.

Gold’s problem: it doesn’t produce anything

Buffett is correct that gold is an asset that will never produce anything. In comparison, owning stocks is a direct participation in corporate productivity, whether in the form of sales revenues, rent collections, annual dividends and so on. Not only do corporations produce stuff people want and need, their annual production represents a powerful compounding effect over the years. Corporations produce revenue and therefore have an inherent net present value of returns. This can be calculated, priced and employed in making a reliable investment decision.

Gold, on the other hand, sits there and glistens. It doesn’t produce income, just oohs and aahs. This makes its value hard to price, and according to Buffett, reduces it to a mere speculative vehicle.

Could the sage be wrong?

It’s bold to call Buffett ignorant, but according to the rules of logic and their Latin parlance, in this instance he may be. His argument is ignoratio elenchi — an ignorant conclusion, or put simply, he’s missing the point. According to logic, because X is true, it does not necessarily follow that Y is false.

Buffett suggests that because someone would not exchange pile B (the best of productive, corporate America) for pile A (a massive cube of all the world’s gold), then gold should not be in your portfolio. You don’t have to be an investment sage to know that you shouldn’t take all your cash to buy a pile of metal. (Although, to be slightly playful with this point, if you owned all the gold in the world, you would quickly become the world’s gold market-maker — and market makers generally do quite well in driving up an asset’s value.)

To explore this question, simply exchange gold for cash in this comparison. Would it be wise to own a huge $9.6 trillion pile of cash over $9.6 trillion in diversified corporate value? The answer is the same, no. The wise investor would select the diversification and compounding of corporate productivity every time. What can cash do for you other than sit there, produce nothing and deflate at an historic rate of approximately 3% a year.

Should you then draw a conclusion that cash does not belong in your portfolio? Obviously not. Even Buffett himself would acknowledge that cash, stocks and bonds are fundamental building blocks of a portfolio. Cash is useful on several levels including liquidity, security, fixed value, and simplicity, to name a few. Therefore, although you may not want your entire portfolio to consist of one asset class, you may in fact want some of that asset class represented in a globally diversified account.

Gold is good

Today, investors are faced with a unique and difficult problem. The U.S. and European economies are strapped with unprecedented levels of government and personal debt. The Federal Reserve’s approach to this problem appears to be currency debasement that could take many years to work out. In contrast, gold has provided an accepted and reliable currency across societies and ages.

Should you sell everything and buy the cube of gold? No. Should you consider some exposure to gold in your globally diversified portfolio? At MarketRiders , we think that make sense.

ETFs such as SPDR Gold Shares ETF GLD +0.25% make owning gold practical. Yet if gold isn’t right for you, building an inflation hedge is still crucial. With iShares Silver TrustSLV -0.23% , for example, you can gain low-cost exposure to silver. If you would rather own companies than physical metals, you can consider SPDR Metals and Mining ETFXME -0.10% which will provide metals exposure but with the protection of corporate productivity.

In the end, a modest exposure to gold can help you create a diversified hedge that protects your portfolio from both the U.S. debt burden and the vagaries of the world economy. Pickaxe sold separately.