Gold

“It 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”. – Warren Buffett

Gold deserves its own post because it’s such a unique asset. It’s nice and shiny. We all want more of it. I happened to be in the vault of the Federal Reserve of New York once (the one that gets robbed in the movie Die Hard III) where they stash gold bars from governments from all over the world (my idea of fun in NY). I can’t explain the powerful feeling of having one of these 27.5-lb bars in your hand, but it’s really nice. But no, I’m not writing to reminisce about my past gold exploration. When it comes to investing, gold is a different story. There are many ways to think about gold. 

There’s gold, the physical shiny metal. It makes nice jewelry. Everybody likes gold. It’s beautiful. It’s timeless. It’s universal. It’s inert. It doesn’t chemically react. That natural perpetuity is what gives it permanence. If I could take a time machine and go back two thousand years, my gold would buy me some nice things. It’s safe to say that the lust for gold will be there in the future too. People have pursued gold for centuries. Medieval alchemists tried to turn metals such as lead into gold. People have killed each other for it. Scrooge McDuck has a money vault full of gold where he dives in. It makes people dream. And it makes spouses happy.

There’s gold, the industrial input. Because of its inherent properties, some gold is used in certain industrial processes. Gold conducts electricity and does not tarnish. There’s a little bit of gold inside the iPhone. Gold is used for cosmetic purposes, like in teeth (it doesn’t rust and I’ve seen it in music videos).

There’s gold, the lingos that central banks stash in their vaults. Central banks use gold to diversify their reserves. Central banks hold a lot of the gold ever mined. Gold can back a currency that is subject to swings in value. Gold carries no credit or counterparty risks, it serves as a source of trust in a country.

There’s gold, the money. Money can take many forms. Monetary systems evolve. In ancient times we used cowry shells. In a more recent time paper currency was backed by a reserve of gold and silver. Maybe in the future, we will use some blockchain cryptocurrency thing where you can program money.

There’s gold, the obsession. Some people are nuts about gold. They are called “gold bugs”. They are die-hard believers in gold. They advocate buying gold against an anticipated collapse in the currency or the world. They are all gloom and doom. They have cult-like behavior and none of it is grounded in rational behavior. They have a distorted view of the world and they believe it. That strong belief is what makes them very convincing. Gold bugs say that you should hold gold in case the “world goes to hell”. The parameters of what that means are quite large, but if it’s related to surviving, I lean towards guns, gas, food, and water. With that gold will come your way.

And there’s gold, the investment. Gold is often touted as a “safe haven”. A safe haven is where investors stash their assets when share prices crash, economies collapse, or when inflation wipes out a currency. A safe haven is supposed to preserve its owner’s capital. Safe havens are supposed to hold their value when nothing else is. Other safe-haven assets could be physical things like land, real estate, art, or other precious metals. You can print money, but not gold, or land.

Gold has been prized as a store of value for millennia. But can it be trusted? At the time of writing, the year is 2023, and saying we live in a period of uncertainty is a bit of an understatement. It’s the gold bug dream environment. The one where you park your assets in gold. The ingredients are there. We have a war in Europe. We have nuclear threats from Russia. Iran is getting nukes. China is challenging the world order. The Middle East is blowing up. The economy might fall off a cliff. We have massive environmental problems. We have energy issues. Governments are running massive deficits financed by printing way too much money which leads to inflation and higher national debt which needs to be financed with more borrowed money. I could go on.

I might be overdramatic for effect but according to the gold bug’s doomsday checklist, it sounds like there’s never been a better time to buy gold. If I were a betting man, everything is lining up for gold to skyrocket in price and the dollar to crash. But nope. It’s that easy. Despite the apocalyptic atmosphere gold price is down 22% in 2022 and is barely flat for 2023 so far. And the dollar is up. What else do you need for gold to perform? That’s what I mean by “can it be trusted?”

Yes, gold makes nice jewelry and looks impressive in a vault. But it has its inconveniences. It doesn’t have an income stream. It doesn’t pay interest. It’s hard to value. It’s hard to use for everyday spending (it’s heavy and unsafe to carry around). You need a couple of guards if you are a baller. You need a safe to store it. You need insurance. Gold doesn’t always perform when it’s supposed to (like in moments of high inflation and crisis). Over long periods, gold has been a poor asset to own.

Gold at Work

I’m not dismissing gold, or other precious metals by extension. I have seen gold at work. When I was abroad in emerging countries like Cambodia and Vietnam, many locals kept their assets in gold, other precious metals, or US dollars. There’s also the increased use of crypto-currencies, a gold proxy for some. 

There a several reasons for this. First, the last thing you want is to stash your capital in local currency that is eaten away by high inflation. Or worse, at the risk of being confiscated by the government. That’s fast-tracking yourself to poverty. Second, you risk having your emerging market currency not being recognized. As in nobody wants it. Try showing up at your local bank branch with a bag full of Cambodian Riel notes, you will be welcome with a recycle bin. Or try using rubles outside of Russia. You might say it’s not fair, but turn the table around, do you want somebody to hand you a bag of Cambodian paper or US bills? Do you want to take the counter-party risk? I didn’t think. But gold is universal. You don’t have to explain what it is. Nobody turns down gold. And last, some countries have capital control in place, making it harder to move your money internationally. 

That’s gold at work. I don’t blame them. I would have done the same thing as them if I was in their shoes.

Fiat and the US Dollar

The subject of fiat currencies comes up when you talk about gold. Fiat currencies have major flaws. High inflation can erase a fortune very quickly. Inflation is brutal on purchasing power. We all heard the story of what grandpa could buy with $1 in his youth. Governments constantly renege on their paper promises. Economies are mismanaged. Some default. Some redefaults. Some are invaded. But there’s one currency that’s king: that’s the US dollar. Why?

Because the US dollar is the world’s reserve currency. The US possesses unique strengths. It has the strongest economy and the greatest capital markets giving the US an edge on global capital flow. Everybody loves the greenback. For those who are saying that the US dollar is worthless, I don’t see any of them throwing it in the trash.

Sustaining the achievement of world reserve currency status will be a challenge. One day the dollar’s position as the world’s reserve currency could be lost. It happened to other currencies in the past. I don’t know what form of payment we will use one hundred years from now. But today the US dollar is what makes the world go round. Despite the massive deficits and the money printing, the world relies on the full faith and credit of America’s Treasury Department (so far they pay their debt). Sure, we can trash the US and their “worthless” paper, but I don’t see anybody turning down a US$20 bill.

Inflation is a major issue if you are holding cash. That dollar loses value over time. But despite what you read, stashing all your cash in gold is not a sound strategy. A better solution to inflation is to buy assets that grow and produce income, like companies with pricing power. Companies with pricing power have the competitive advantage of protecting their margins and passing on increased costs to customers. Maybe the company has a great brand, lacks competition, or simply has inelastic demand like gas and cigarettes.

Here’s a story to make my point. You probably never heard of  Ronald Wayne. He’s the little-known third co-founder of Apple, with Steve Wozniak and Steve Jobs. The Steves were kids in their 20s when Apple was founded in 1976 and Ronald, almost twice their age, acted as the “adult” in the room. After twelve days he bailed and sold his 10% stake for $800 and used it to buy gold. In a 2014 Bloomberg article, Wayne said that his savings have been in gold for 40 years and live off of his Social Security checks. At the time of writing, Apple is a $2.4 trillion company. A 10% stake would have made him one of the richest men in the world. As for his gold stake, I’m going to be generous and estimate he doubled his money.

I can see the pushback. Obviously, I cherry-picked the example just to prove my point and hindsight is 20/20. It’s never that easy. I could easily have gone the other where his $800 equity position became a zero. Gold does have shiny moments, like in the 1970s. In 1971 gold traded at US$35. By the end of that decade, gold touched US$850. That’s a 2,300 percent gain in the 1970s.

Gold in your Portfolio

Part of gold’s attraction comes down to personal preference. Some have strong feelings about it, others less so. For some, the gold investment shows up in jewelry, others in mining stocks or royalty companies.

The elevator pitch on gold is “If the financial system collapses, well you still have your physical gold.” First, that’s a crappy elevator ride. Second, if the financial system collapses, we might have larger problems than the price of stocks. But I get the point. You want assets that are not correlated or linked to the financial systems.

Gold has drawbacks:

• No matter what price you forecast, it’s going to be wrong.
• Gold is volatile. You are betting that the price will go up. Gold is shiny and beautiful but it doesn’t guarantee high returns.
• But what’s the intrinsic value of gold? Nobody knows. How do you know it’s not $500/oz or $3000/oz? 
• Part of what drives the price of gold is fear. It tries to play the role of a ‘safe-haven’.
• If you are seeking income from your investments you might find gold less attractive since it doesn’t generate income. 
• Investing in gold means allocating funds away from other potentially lucrative investment opportunities. 
• And gold doesn’t always shine when it’s supposed to.

Gold does have a spot in your portfolio. Gold has been considered a reliable store of value for thousands of years. Gold is intended to serve as a potential hedge against adverse markets. It has a low correlation to the business cycle and other asset classes. It should play a stabilizer role. If you have some gold you can put it to work in very distressed environments and convert it to the ownership of enterprises on very advantageous terms. Gold has survived the test of time. And there’s one gold.

On that, I will you this Charlie Munger quote:

“I don’t have the slightest interest in gold. I like understanding what works and what doesn’t in human systems. To me that’s not optional; that’s a moral obligation. If you’re capable of understanding the world, you have a moral obligation to become rational. And I don’t see how you become rational hoarding gold. Even if it works you’re a jerk.”