Wednesday, February 8, 2012

"Gold Is the Courtesan of the Investment World"

From Fortune Magazine dated October 19,2010:

"Look," {Warren Buffett} says, with his usual confident laugh. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"

Okay, so gold is not a screaming buy to Buffett. What should a typical upper-middle-class person in the U.S. buy to prepare for retirement?

"Equities," Buffett answers without a moment's hesitation.

Yesterday the Boston Security Analysts Society held a luncheon presentation on investing in gold.

The title of the talk was "Bull vs. Bear - Gold".  Eric Biegelesisen from Windhaven Investment Management presented the bull case for gold investing, while Edward Chancellor from institutional investment manager GMO presented the bear case.

It was a very informative session, with both Eric and Ed presenting very coherent and thoughtful remarks on their particular point of view.  What I thought I would share today are some of the highlights of the hour-long presentation.

Before the talks started, the moderator posed a question to the room:

"How many of you believe that gold should play a role in client portfolios?"

To my surprise, nearly every hand in the room went up. 

Boston has never been known as "gold bug" haven but clearly the events of the last few years have chastened investors who previously stuck to more conventional bonds and stocks.

Eric's case for gold should be a familiar one to anyone who reads the financial press. 

Gold historically has been a store of value in inflationary times, or in times of political uncertainty. While inflation is not an issue today, many believe the hyper-expansive monetary policies of central banks around the world will inevitably lead to upward pressures on prices.

Gold is also fairly limited in supply. If  you took all the gold in the world that has ever been mined it will fill up one Olympic-sized swimming pool, as Warren Buffett noted.  Gold  also is only one of five elements on the Periodic Table that will not change its physical characteristics over long periods of time.

Gold, of course, is used by many central banks as a vehicle for storing wealth.

Finally, gold is highly desired by Asian investors, who have been large buyers of the metal.  With the rapid creation of wealth in countries like China, demand for gold will be constant, if not increasing, meaning that any weakness in gold prices will be met by strong demand from the Far East.

Ed did not necessarily disagree with any of Eric's thoughts, but rather felt that gold prices had gotten ahead of reality.

There is a time, Ed noted, that gold should be bought - but that time is when it is fairly valued, which it is not today.  In his opinion, gold should be priced around $450 an ounce, not $1,700, based on simply regressing the price of gold back through time to the present.

The problem, Ed said, is that the value of gold is essentially unknowable, since it does not offer any sort of income stream that can be discounted back to the present.

Gold has no industrial uses, nor can it be used as a medium of exchange.  Instead, gold is mined from the ground, polished, placed in vaults and guarded in  the hope that someday it will be worth more than its purchase price.

Gold's recent meteoric price rise has been driven by the historically low level of interest rates, in Ed's opinion.  With yields on cash so low, the opportunity cost of holding gold is minimal.

Ed said, look, if you're concerned about inflationary pressures, why not simply buy inflation-protected Treasury notes?  Or even high quality dividend-paying stocks, that at least can raise payouts if inflation rises.

Ed - who is the author of several books, and writes a regular column for the Financial Times - had a line that I thought was great:

"Gold is the courtesan of the financial markets - it is all things to all people. Concerned about central banks and the fallibility of paper currencies? Gold is the answer. Worried about holding value? Gold to the rescue.  Inflation? Gold again. Think the stock market is vulnerable?  Gold can help.  But can it honestly be all of this to all people?"

Finally, Ed cited a study by Goldman Sachs that studied the price of gold going back to 1265 using the U.K. pound sterling.  In this work, on a inflation-adjusted basis, gold has been at this level only twice in the last 800 years.  Buying gold today - at the wrong price, in Ed's opinion - means you might have to wait several hundred years to achieve a satisfactory return.

The audience was largely unmoved by Ed's remarks. The tone of the questions ranged from skeptical to almost hostile, mostly directed at Ed.  The group yesterday takes their gold views seriously, and don't want to be told that they are being swept up in an unsustainable bubble.

But I must confess that I was more convinced by Ed's comments than Eric's.  Gold might be an interesting trade, but the widespread enthusiasm for the metal makes me nervous.

I was also struck by Ed's aside that most people today are buying gold through the Gold ETF.  If one is truly concerned about government interference in the private markets, suggested Ed, what makes one think that the convertability of a gold ETF into the bullion would be allowed by governments if there truly was a moment of crisis?