When all that Glitters is not Gold

“[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” – Warren Buffett

(Photo: DigitalMoneyWorld)

A few years ago I read a great book on history of gold by Peter Bernstein called The Power of Gold: The History of an Obsession. It outlined the history and man’s fascination with the yellow metal. If I invested in gold back when I read the book, I would have doubled by money by today.

Gold has been the most consistent store of value for thousands of years and has risen in price over 200% over the last decade, compared to the 12.6% return of the S&P500. $3000 invested in gold ten years ago would be worth over $15,000 today.

Here is an interesting graph of gold prices in British Pounds dating all the way back to the year 1265. (courtesy of Zerohedge)

With all the talk and the incredible run up in gold prices the question might be “why did I miss the rally and why am I not investing in gold today”? The answer to both questions is that I simply don’t know and don’t understand how to value gold and frankly I have yet to meet anyone else that does.

When you buy a stock you, have some idea of the value of the stock based on presumed earnings and growth of the company. With bonds you know what yield you are receiving but gold, at most, retains its value and increases with inflation but produces nothing. Gold is basically whatever someone else will pay for it.

 Let’s take a look what happened to the price of gold once the United States got off the gold standard.

The chart above shows inflation adjusted price of gold in 2011 dollars and goes all the way back to 1791. As you can see in the early 1970’s once US got off the Gold Standard, the price of gold jumped almost 300% only to come crashing down. If in hind sight it is safe to say that gold was in a bubble in late 1970’s, I don’t understand why it is not safe to say that gold is in a bubble now, since in 2011 dollars they are trading at roughly the same levels.

There’s no logical reason for gold to increase in value over that of inflation for a very long period of time. Gold might still continue to go up in price but there is no reason for it to outperform true inflation in the long run.

The argument of “The government will only print money” to justify any gold price is similar to “There is only so much waterfront property” to justify any price for a waterfront real estate. The argument might be correct but it avoids the big question, “At what price?”

The other factor that bothers me is that there are just too many people talking about gold, all using the same clichés. This reminds me of the 90’s internet stock bubble and make me suspect that this might end in a similar fashion.

But I think Warren Buffett had the best quotes about how to view gold:

“I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion dollars – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion dollars…you could have all the farmland in the United States, you could have about seven Exxon Mobils, and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils.”

Have I missed a big rally in gold? Yes, but I have missed many good deals and will continue to do that in things that I don’t fully understand. I would rather not make money in something I don’t fully understand than make a lot of money in something I don’t fully understand. The latter gives you a false sense of confidence, which in the long run always ends badly.

On a side note, last year I crossed another thing off my Bucket List, which was to hold an actual gold bar in my hands. At the time, it was worth over half a million dollars! If you are ever in London, I highly recommend visiting the London Banking Museum and doing the same, it’s an opportunity of a lifetime. Then walk over to Olde Cheshire Cheese and grab a pint or two, or for even more fun do it in reverse order.

Michael Page

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  1. Hi Mike
    just wondered if you had read or listened to any of Mike maloney’s stuff, interested in your take on him
    kind regards

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