Warren Buffett: Stocks Are Better Than Gold

Warren Buffett recently wrote an

, which is adapted from his upcoming Berkshire Hathaway

shareholder letter. In the editorial, the Oracle of Omaha explains why equities are the best long-term bet versus the alternatives such as gold and bonds. While this is hardly the first time that Buffett has shared his negative opinion of gold, his latest missive on the subject is gaining a lot of attention as the yellow metal looks to regain its uptrend. Buffett's arguments, not surprisingly, are cogent and well thought out, but his conclusion is misleading. First, let's summarize Mr. Buffett's argument before examining it in the proper context. He describes gold as belonging to a class of assets which "will never produce anything, but that are purchased in the buyer's hope that someone else - who also knows that the assets will be forever unproductive - will pay more for them in the future." In order to underscore this point, Buffett uses the 17th century tulip mania as an example of this phenomenon. According to Buffett, gold has "two significant shortcomings." He notes that "gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile if you own one ounce of gold for an eternity, you will still own one ounce at its end." According to Buffett, "What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As "bandwagon" investors join any party, they create their own truth -- for a while." He says that this is basically what happened with internet stocks and the housing market and insinuates that the same thing will eventually happen with gold. Buffett then presents a pretty interesting argument: The world's gold stock today is roughly 170,000 metric tons and at today's prices is worth around $9.6 trillion. If all of this gold was melded into one bar, it would form a cube of about 68 feet per side. Buffett notes that this cube would fit comfortably inside a baseball infield and others have said that it could fit into an Olympic-sized swimming pool. He calls this asset (the giant gold bar), "Pile A." He then asks readers to imagine a theoretical "Pile B" which costs an equal amount to "Pile A." Buffett's second pile of assets (being of equal value to all of the gold in the world) would consist of "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)." In addition, investors would have an extra $1 trillion left over for "walking-around money." Buffett concludes his argument by saying, "Can you imagine an investor with $9.6 trillion selecting pile A over pile B?" The Oracle goes on to explain that he is confident that the value of "Pile A" will compound over the next century at a rate far inferior to that achieved by "Pile B". Buffett uses this analogy to explain why he prefers to invest in productive assets such as businesses, farms, or real estate - which will almost always outperform alternatives over the long run. The legendary Berkshire Hathaway CEO makes a unique and compelling argument against owning gold at current levels. While his logic is undoubtedly solid, his conclusions are misleading when put into the proper context. Basically, Warren is saying "instead of buying gold at current prices, why not buy stocks or cash flow producing real-estate, because over the very long haul, these assets will outperform gold." For a number of different reasons, this is not an airtight argument as it relates to most investors. The first problem is that it totally ignores timeframe. Unfortunately, we are all mortal, and as such, our investment timelines can only extend so far - particularly when planning for retirement. For example, if I were planning to make an investment today in anticipation of holding if for 10 years, my timeframe is restricted to those ten years. I want to earn the highest risk adjusted returns during that period of time. Not surprisingly, given Buffett's track record, his argument hinges on the VERY long-term, as he acknowledges that assets such as stocks are prone to big price swings. While productive assets such as stocks and real estate may outperform consistently over long periods of time, they are also notoriously volatile, and as such, are not always best suited for investors with a shorter time horizon. The fact of the matter is that gold has pretty much trounced any alternative under the sun over the last ten years. The S&P 500, on the other hand, has only risen 22.48% over the last decade. Given our finite investing lifespans, which would you have rather owned? Furthermore, Buffett completely ignores that fact that most investors who are investing in gold have substantially more money allocated to stocks and other securities. For the average individual investor the stocks vs. gold argument is totally irrelevant - you should own both. He states very clearly in the article that he thinks cash and bonds are extremely risky right now - recounting the historical ravages of inflation and repeating a famous comment made by Wall Streeter Shelby Cullom Davis who said "bonds promoted as offering risk-free returns are now priced to deliver return-free risk." While Buffett's bashing of gold, cash, and bonds might make perfect sense in a theoretical investment world, it isn't very helpful for most individual investors. After reading his op-ed, wouldn't it be rather imprudent of me to pull all of my money out of these asset classes and re-allocate it exclusively to stocks and real-estate if I was planning on retiring in 5 years? The other major contextual flaw that can be identified in his argument is how he fundamentally views gold. Buffett sees gold as an "unproductive asset." While it is unproductive and does not offer a yield, gold is much, much more than just another asset class. Gold is the closest thing to actual "money" that human civilization has ever known. For whatever reason, Buffett seems unwilling to admit this. Throughout the history of civilization, gold has been money. Currencies of all kinds have come and gone, including innumerable "paper" or fiat currencies, yet gold has held its value and continues to be desired by people across the planet as a store of wealth. This is a fact. Furthermore, unlike most financial assets, gold has no counterparty risk - an incredibly attractive property in times of economic turmoil. If you look at the "long-term," the U.S. Dollar, the Euro, the Japanese Yen, any fiat currency on Earth, cannot hold a candle to gold in terms of its security and track record as a store of wealth. Put another way, it doesn't take a genius to come to the conclusion that it makes sense to trade in some of your paper Dollars printed by a nearly-bankrupt government in return for the only real money civilization has ever known. Given gold's unique properties and history, it isn't even really fair to compare its "investment" merits versus an asset class such as stocks. Since gold is money (and, as such, is far superior to paper currencies) its primary investment purpose should be to retain purchasing power and provide a liquid store of wealth free of counterparties and shielded from the consequences of destructive fiscal and monetary policies. In this context, I think gold has proven to be a pretty valuable asset over the course of time. In fact, it has served its purpose astonishingly well, and was a good investment, for thousands of years before the stock market even existed. Not to be too apocalyptic, but would you have rather had a bag full of Roman coins or one filled with gold bars right around the time that the Roman Empire collapsed? The Romans invented fiat currency and were forever diluting their silver coin, the denarius. Around the time of the Empire's collapse the denarius contained around 0.02% silver - when it was first instituted it was essentially pure silver - and was no longer accepted as a medium of exchange or a store of value. When you are attempting to compare gold versus other alternatives, it is important to get the context correct. The context that Buffett uses in his op-ed is only relevant from a theoretical perspective and is misleading. While there is nothing wrong with his argument that stocks and other productive assets make better long-term investments than gold, it is disingenuous to try to suggest that it is not sensible to own gold as a part of a prudent investment strategy. Stocks are absolutely terrific assets. But for most of us not named Warren Buffett, and who are working on a fixed investment horizon, buying stocks involves a degree of speculation. If we have learned anything from the financial crisis, it should be that stocks can fall dramatically in value and that when we need liquidity the most it may be the most inopportune time to access it in the stock market. Therefore, it would be imprudent to buy only stocks as part of an overall investment portfolio. As investors, we are willing to take the risks of dramatic price swings in the stock market because over time stocks have offset these risks by generating higher returns than many alternatives. We continue to believe that this will happen in the future, despite the fact that the stock market has, from time to time, produced negative returns over the course of multiple decades. Nevertheless, stocks have done a great job of preserving and compounding wealth over long periods of time. Gold has served its function - to be a liquid store of wealth which retains its purchasing power - equally well. It should be viewed as "real money" as opposed to a speculative investment. As such, we only need to be fairly convinced that gold will do a reasonable job of maintaining our purchasing power over a period of time. It has a superlative track record of doing this. It has fulfilled its function just as well as stocks - and for a lot longer time. Buy stocks, they might make you rich, but it probably isn't a bad idea to have some gold around too...throughout human history it has ensured the financial security of those who possess it in adequate amounts. The same cannot be said for the formerly wealthy Roman merchant whose fortune was denominated in the denarius.