As detailed many times in my writing, it’s been the objective of Bernanke and crew to force money into two areas: Assets and wages. From the “printing presses” to the balance sheets, and from the balance sheets to employees, and then from employees to the stock market and real estate. Anything to stave off the destructive powers of a deflationary vortex. So when analyzing where an investor or money manager would put his dollars to work, you have to look at several areas. Please allow me here the opportunity to detail why I favor real estate to stocks and stocks to hard assets. In three parts, I’ll reason why gold is a bad investment, why real estate and stocks are good ones and why real estate is the best.

Now, before I go any further, I have to first express something indirectly related to this post. As I started to venture into economics, and teaching myself some basics in order to better equip myself as a stock trader, I admit, I initially fell for the theories of Austrian economics; a heterodox school of thought that more or less is a polar opposite to the more mainstream Keynsesian and Monetarist views. And, as such, I was a huge proponent of gold and other hard commodities, screaming and hollering about debt, fiat currencies, etc and how the very complex financial space will assure gold higher prices into the future. So please do not be surprised if by rummaging through some of my more ancient posts you find me touting the blessings of the yellow metal and other hard assets, as since then I’ve become more educated in the realm of economics and have had a change of heart. And last for this interruptive paragraph, I wanted to say that I’ve had the majority of this written for a few weeks now, but have been entirely too lazy in putting the finishing touches. But in light of Warren Buffett’s investor letter and gold’s performance on this very day, I decided to finish it up as best (quickly) as I can. Back to the issue at hand…

As previously mentioned, Warren Buffett released his 2011 Berkshire shareholder’s letter and a large portion of it was devoted to his analysis of the precious metal. He not only expanded on some issues I was pondering, but wrote them in a far more eloquent manner than I could. For that reason, I’m going to cite some of his reasoning and concentrate rather on part II and, if required, part III, as part I will analyze only why gold is a bad investment, which is entirely in conjunction with WB’s.

The reason why gold bulls favor the asset is quite simple: the deterioration of fiat currencies. Multiple causes can be cited for why a fiat currency loses its value over time, such as debt, central bankers, inflation, the world ending, etc. When you look at the four properties of money, you find as one “Store of Value.” Gold, as a hard asset whose quantity can’t be increased out of thin air, thus acts as a much better “money” than a fiat currency such as the dollar, thanks to its inability to be devalued. And as gold is an asset that’s free to own, those who are in fear of rampant inflation and devaluation damaging their wealth can buy and hoard all they want of it. It’s true, the pitfalls of overbearing debt loads are very harmful to a currency. It’s also true that central bankers have certainly not helped the value of fiat currencies in the past. And, it’s true too that inflation is omnipresent. But have any of any of these causes been the real rise in the price of gold over the last decade? It certainly has not been overbearing debt loads, as nominal interest rates are incredibly cheap and still near all-time lows, showing the ease for the US government to borrow. Nor can it be the value of the USD, which is more or less flat since ‘05, when gold really started to take off, despite investors right to be fearful of long-term declines in value of the USD. And while inflation is omnipresent, real-rates will show right now that it is not effective at all, not even a cause for worry. Essentially, gold has been rising, especially since ‘09, on the basis of a “fear trade.” That is, the world is going to crumble and all you will be left with is your gold, guns, rice and water. Well, consider me jaded on this argument since it hasn’t happened and the economy has climbed out of its seat on death row. As Warren Buffett put it so well, “Owners [of gold] are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.” That is to say that the shmuck who buys gold is buying it in anticipation of another shmuck buying it at a higher price. And only for that reason, since “… if you own one ounce of gold for an eternity, you will still own one ounce at its end.” But, but, but, the proof is in the pudding! Just look at the gold market confirm the wonderful investment thesis over this last decade! Well, let me point you in the direction of the same two examples Mr. Buffett used in his letter: internet stocks and housing. In my opinion, as this decade long bull run comes to an end, the holders of gold will soon not have a seat left for them as the music stops.

To understand why I believe the market is soon to come to an end, the reasoning must include price. At today’s prices, the yearly production of gold is worth about $160B; with a B for billion. Therefore, gold bugs and investors must invest 160B NEW dollars each year, just to maintain its price. While its non-monetary uses, such as that for jewelry, can soak up some of that demand, it’s widely noted by even the most ardent of gold bugs that this demand cannot equal the supply of new production of gold each year. Collectively, then, all those interested in gold must deposit 160B new dollars each year just to maintain its current price. Should the price of gold climb a bit higher, to, say, $2000/oz, then that is another $40B that investors must come up with. For now, let’s assume that this group of people can come up with the required new investment dollars each year.

Opportunity cost is an economic concept that defines the cost of not doing something, or the cost of choosing one option over another. For example, if you had $100 to invest, the opportunity cost of buying gold is the benefits of whatever you didn’t buy. WB kills it here, by creating this example…

“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. At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A. [note: gold has sinced declined to ~$1,650 per ounce, a negligible difference for this example]

Let’s now create a pile B costing an equal amount. For that, we could buyall 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 feelings trapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

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.”

And that is why, in my opinion, this train has come to its last stop and is due to reverse course. At this price per ounce of gold, it is completely nonsensical to purchase gold, knowing full and well the opportunity costs. To the group of investors responsible for coming up with the $160B each year to invest in gold, I say to you, “I’ll sell you all the gold you want. $9.6T actually — and I’ll take my Exxons and my farms and even in the case that the entire world comes to an end as we know it, I’ll survive better than you will.”

Tweet