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Education Article – Investing in Gold

Gold is a favourite of many investors who see an investment in Gold as protection against economic and political crises or as a hedge against inflation and currency devaluation.

As an investment, Gold has significant shortcomings. Gold has some industrial and decorative utility (as jewellery) but the demand for these purposes is both limited and not sufficient to soak up new production. Gold is also unproductive and does not generate any cash flow and, if you own one ounce of Gold for an eternity, you will still own one ounce at its end. Gold is purchased in the investor’s hope that someone else, who also knows that the investment will be forever unproductive, will pay more for it in the future. This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further.

How does the return from investing in Gold compare to the return from investing in Equities? As shown in the Graph in the below PDF, if $100 was invested by buying Gold at the end of 1968 when the Gold Price was US$84, that investment would have been worth US$2,034 at the end of 2012 when the Gold Price was $1,706. An investment of $100 in the S&P 500 Index at the end of 1968 when the Index was trading at 103.86 would have been worth $5,350 at the end of 2012 with dividends received over the period included. An investment in Equities was therefore worth 2.6 times more than an investment in Gold. It is also worth remembering that the Gold Price at $1,700 (or at any other price) was not supported by any future expected cash flows; Gold does not have any intrinsic value and the price was determined by demand only, which can quickly decrease if investors become less fearful.

When it comes to investing in Gold, it is very worthwhile to give consideration to the views of Warren Buffett as set out in his 2011 Letter to the shareholders of Berkshire Hathaway:

“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. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – Gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A. Let’s now create a pile B costing an equal amount. For that, we could buy 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). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of Gold, current prices make today’s annual production of Gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.

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. Admittedly, when people a century from now are fearful, it’s likely many will still rush to Gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”

We concur with Warren Buffett’s preference to invest in productive assets, whether businesses, farms or property. These assets have the ability in inflationary times to deliver output that will retain its purchasing power. The value of many businesses such as Coca-Cola, MacDonald’s, Woolworths, Commonwealth Bank, IBM and Wells Fargo will be determined not by the medium of currency (paper as is today and perhaps Gold or some other medium in the future) but rather by their capacity to deliver goods and services wanted by consumers. In the future the world population will buy more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce. We believe that over any extended period of time, investing in productive assets will be the runaway winner compared to Gold. More importantly, it will also be the safest.

Disclaimer

The information contained herein is of a general nature and does not take into account the reader’s particular needs, circumstances, financial circumstances or preferences. It is a guide only and based on current legislation. We believe the information contained in this update has been obtained from reliable sources but we cannot be responsible for any errors, omission or inaccuracies. You should seek professional advice before acting on the information in this update.

Please contact your Intralink Wealth Management adviser, on (03) 9629 1100, if you require any clarification or further information regarding this update.

Download Investing in Gold pdf

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