||Vedant "VK" Mimani|
By Vedant “VK” Mimani
Yet again, Warren Buffett has explained why he favors equities over bonds and gold, and yet again I will point out where the old man goes wrong. I take issue not because I like gold at $1775 per oz (current market price), because I don’t and you can read why in my article “Gold at $1800 is a fool’s bet,” but because I think market gurus ought to be called out when preaching false doctrine.
Mr. Buffett’s problem with what he calls currency-based investments (money-market funds, bonds, mortgages, bank deposits) is the long term erosion in the purchasing power of currency (a.k.a. “inflation” tax). Yes, a million dollars just ain’t what it used to be. In spite of its demerits, Buffett readily admits the necessity to hold such investments because “at Berkshire the need for liquidity occupies center stage and will never be slighted, however inadequate rates may be.”
After trashing bonds, but then accepting their role on Berkshire’s balance sheet, Buffett moves on to investment category two, which he all but labels “greater fool” investments; those assets that remain forever “unproductive” and purchased in hope a buyer will pay higher in the future. It is here where Buffett, in his mind, categorizes gold; as he says, “if you own one ounce of gold for an eternity, you will still own one ounce at its end.” Mr. Buffett, this is the precise value and function of gold.
Other assets have no steady state; they bloom with care and deteriorate with neglect. Farmland must be tilled, hogs and cattle fed, fine art maintained and corporations managed. Without due care and maintenance (which requires money, skill, knowledge, and effort), value is destroyed. Not so with gold; an ounce is an ounce is an ounce, for eternity. Gold’s utility on the balance sheet is to do nothing but hold value and hedge regress.
I know Buffett and his followers are fond of thought exercises, so let me give one to highlight the role of gold. Let’s say you will be using your one-use time machine to travel 500 years into the future. You want to give yourself a head start for when you arrive to 2512 and so you bring as much of your accumulated capital as you can. In what form should you bring your savings?
The title deed to some farmland? Are you willing to bet that the ruling government in 2512, including its rules and regulations (such as water rights), fertility of land, and relative efficiency will be the same or better? Somewhere somehow humans will be growing crops, but that doesn’t mean it must be on your particular plot of land. Diamonds? Sorry ladies, they may be your best friend now, but until 1938 and De Beers' master marketing campaign, this was not the case (read this story about the fascinating invention of diamonds as rare and valuable). Do you really want to speculate on the fashions, tastes and social mores of the 26th century? How about art? Yes, high art will likely remain priceless in 2512 as it represents the epitome of high culture, but speculating on pieces that are affordable now is incredibly risky and finding affordable masterpieces is not something the majority of retail investors will ever accomplish. Unless you’re already a multimillionaire or billionaire, the Mona Lisa ain’t coming with you. Buffett will claim stocks are best for the long term, but there is close to zero chance that shares of Egyptian Papyrus Ltd., Horse and Buggy Corp. or Apple, Inc. will have any value in 2512. Want to buy a piece of the Dutch East India Company? It was a good bet in 1602, but went bankrupt a mere 196 years later.
There is one and only one asset we can be certain will keep its value in 2512 and that asset is gold. Human civilizations from the earliest four, Mesopotamian, Egyptian, Indian and Chinese (c. 3100 BC to c. 1500 BC) all held gold in esteem and we humans have done so continuously to the present day. Odds favor gold remaining valuable from tomorrow until 2512. Of course, nothing is preventing you from bringing a diversified portfolio of assets. The point is you would be a fool to leave gold out of the mix.
Gold is humankind’s way of transmitting its accumulated surplus non-intellectual capital to future generations. We transfer our knowhow and skills (intellectual capital), our productive capacity and infrastructure (physical stock) and our surplus/savings. Surplus bears fruit if invested wisely, but is destroyed if misallocated. It is gold that insures availability of surplus capital for future use.
All major asset classes play an important role in economics and finance and to dismiss an entire category as useless because it’s said to be “unproductive” is not cold, hard logic, but rather reflective of a flawed model of the way the world works. But Mr. Buffet is no ignoramus and understands the world quite well.
Mr. Buffet knows he was a beneficiary of a great credit boom and the associated inflation in asset prices and without continued credit growth, asset prices will fall victim to deflation. Owning productive capacity well in excess of needs, controlling the free cash flow (for the majority owned enterprises), being a master capital allocator and having access to credit markets all ensure Buffet’s financial well being. Such is not the case for the average investor whose return on assets may not cover expenses, who has zero influence over what management chooses to do with the excess cash, who is not fluent in capital stewardship and is shut off from credit. For most investors, gold is not useless, but rather guarantees some financial wherewithal come what may.
By attacking bonds and gold, and emphasizing the merits of stocks, Buffet attempts to make the case for why everyone should buy shares of such corporations as Berkshire Hathaway. Unsaid is that, in the absence of meaningful dividends or a favorable dividend tax policy, the earnings of the corporation do not really flow to the investor. Shareholders too must hope a buyer will pay a higher price in the future for the share of equity they hold today. In addition, stock investors must also hope the suits don’t mismanage the company, squander cash in the treasury, issue too many stock options, or commit outright fraud. In our world of Enron, Worldcom, Tyco, Fannie Mae, AIG, Lehman Brothers, General Motors, MF Global, Greek Sovereign Debt and future unknowns, it is not particularly hard to fathom why investors seek in gold the type of protection that it alone can provide.
Vedant “VK” Mimani is the lead portfolio manager for the Atyant Capital Global Opportunities Fund, a macro hedge fund in Boca Raton, Fla., focused on precious metals.