Monday, June 3, 2013

James Turk Refutes Warren Buffets View on Gold


Wall Street legend Warren Buffett has famously declared that gold is not an investment. He is correct, but he stopped halfway. He did not go on to say what gold really is, perhaps purposefully intending for people to draw their own conclusions.

In my view, there is only one conclusion possible, because there are only two alternatives when it comes to allocating assets in any portfolio, whether that of an individual or an institution. Your assets are either an investment, which gold is not; or money, which gold indeed is.

Mr Buffet defines investing as “…the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power…in the future”. In other words, you put your money at risk hoping that you have made a good decision, so that more money is returned to you from your investment in the future.

Note though that Mr Buffett purposefully uses the term ‘purchasing power’, and not money. He clearly understands that money today is no longer a constant measure of wealth. The purchasing power of £100 today will be less than £100 a year from now because of inflation. Thus, the success of an investment should be measured by purchasing power to determine whether your investment actually increases your wealth.

If money were sound, to use a term rarely heard today, it would preserve purchasing power. When Sir Isaac Newton invented the classical Gold Standard circa 1700, he set into motion a monetary policy that would preserve the pound’s purchasing power, which it did. For more than two centuries the purchasing power of the pound was essentially unchanged – until 1914 when Newton’s invention was abandoned, notwithstanding its remarkable track record. Money has never been the same. But what about gold?

Mr Buffett explains that gold is “incapable of producing anything”. If you take the gold you own, melt it down into a cube, and check back years later, he observes that the cube “…will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond”. But the same can be said of all money.

If you take a stack of pound notes and store them in a vault, and then check back years later, they too will not “respond”. They also will be unchanged, at least as far as their appearance goes. But what about the purchasing power of that stack of pound notes, which is the important question that needs to be asked?

Did that stack of pound notes preserve purchasing power as effectively as gold? The answer can be found in the following table which presents gold’s annual appreciation against nine of the world’s major currencies for the past 12 years.

Gold % Annual Change
USDAUDCADCNYEURINRJPYCHFGBP
20012.5%11.3%8.8%2.5%8.1%5.8%17.4%5.0%5.4%
200224.7%13.5%23.7%24.8%5.9%24.0%13.0%3.9%12.7%
200319.6%-10.5%-2.2%19.5%-0.5%13.5%7.9%7.0%7.9%
20045.2%1.4%-2.0%5.2%-2.1%0.0%0.9%-3.0%-2.0%
200518.2%25.6%14.5%15.2%35.1%22.8%35.7%36.2%31.8%
200622.8%14.4%22.8%18.8%10.2%20.5%24.0%13.9%7.8%
200731.4%18.1%11.5%22.9%18.8%17.4%23.4%22.1%29.7%
20085.8%33.0%31.1%-1.0%11.0%30.5%-14.0%-0.3%43.7%
200923.9%-3.6%5.9%24.0%20.4%18.4%27.1%20.3%12.1%
201029.8%15.1%24.2%25.5%40.2%25.3%13.9%17.4%36.3%
201110.2%8.8%11.9%5.1%12.7%30.4%3.9%10.2%9.2%
20127.0%5.5%4.4%5.9%5.2%11.0%20.5%4.4%2.3%
Average16.8%11.0%12.9%14.0%13.7%18.3%14.5%11.4%16.4%

Against the British pound, gold has appreciated by 16.4% per annum on average. This result far exceeds the interest one could earn from bank deposits during this period.

The difference between what one earned from a bank deposit, and the rising gold price, is particularly striking at the moment because of the near-zero interest rate conditions which central banks are imposing on the market economy. The cumulative detrimental effect on savers from years of suppressed interest rates has been catastrophic. Their wealth has shrunk because they are not able to earn enough interest on their savings to compensate them for the loss of purchasing power from inflation and other insidious debasements of national currencies.

The low deposit rate which has lasted now for several years is one factor explaining why so many people are finding it increasingly difficult to maintain the standard of living which they previously enjoyed. It also explains, along with the above table, why gold may be a prudent alternative to traditional bank savings accounts; or at least be a meaningful diversifier in which to hold part of one’s savings, until bank deposit rates return to normal levels.

Admittedly, gold’s appreciation has not been a smooth ride. Though gold has risen against the British pound in 11 of the past 12 years, the annual rates of change have ranged from a loss of -2.0% in 2004 to an astounding annual gain of 43.7% in 2008, the year of the financial crisis, which highlights another important point.

Gold is a safe-haven. This attribute results from the fact that gold is a tangible asset. It is money that is not based on any bank’s promise or central bank policy.

The collapse of Northern Rock and Lehman Brothers are events that will not be forgotten. But even more lessons have been learned recently from the banking collapse in Cyprus. Depositor money was grabbed by the monetary authorities to bail-out insolvent banks. Even savers with small deposits were hurt by the capital controls that were imposed because these restrictions prevented deposits from being withdrawn, except nominal amounts that could be disbursed through ATMs.

Thus, gold offers two clear advantages over the British pound and other national currencies. It can preserve purchasing power, which is an attribute that is particularly important when the interest rate on bank deposits is not high enough to offset the erosion of purchasing power from inflation. Second, a tangible asset like gold eliminates the uncertainty of not knowing whether keeping money in a bank is safe.

From reading Mr Buffett’s various statements about money and investments, it is clear that he has a nuanced view. He sidesteps gold and its 5,000-year history as money, but you should not. Gold still has an important place in everyone’s portfolio.

Given Warren Buffett's well-known views about gold, it's ironic that one of the few politicians in 20th century America with a clear appreciation of gold's use as money was one Howard Buffett – a four-term Republican congressman from Omaha, Nebraska and Warren's father. For a more detailed examination of the contrasting views of the Buffetts on this subject, readers might be interested in the following essay, published by the GoldMoney Foundation: 'A Perspective on Money from Howard and Warren Buffett'.

In my view, there is only one conclusion possible, because there are only two alternatives when it comes to allocating assets in any portfolio, whether that of an individual or an institution. Your assets are either an investment, which gold is not; or money, which gold indeed is.

Mr Buffet defines investing as “…the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power…in the future”. In other words, you put your money at risk hoping that you have made a good decision, so that more money is returned to you from your investment in the future.

Note though that Mr Buffett purposefully uses the term ‘purchasing power’, and not money. He clearly understands that money today is no longer a constant measure of wealth. The purchasing power of £100 today will be less than £100 a year from now because of inflation. Thus, the success of an investment should be measured by purchasing power to determine whether your investment actually increases your wealth.

If money were sound, to use a term rarely heard today, it would preserve purchasing power. When Sir Isaac Newton invented the classical Gold Standard circa 1700, he set into motion a monetary policy that would preserve the pound’s purchasing power, which it did. For more than two centuries the purchasing power of the pound was essentially unchanged – until 1914 when Newton’s invention was abandoned, notwithstanding its remarkable track record. Money has never been the same. But what about gold?

Mr Buffett explains that gold is “incapable of producing anything”. If you take the gold you own, melt it down into a cube, and check back years later, he observes that the cube “…will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond”. But the same can be said of all money.

If you take a stack of pound notes and store them in a vault, and then check back years later, they too will not “respond”. They also will be unchanged, at least as far as their appearance goes. But what about the purchasing power of that stack of pound notes, which is the important question that needs to be asked?

Did that stack of pound notes preserve purchasing power as effectively as gold? The answer can be found in the following table which presents gold’s annual appreciation against nine of the world’s major currencies for the past 12 years.

Gold % Annual Change
USDAUDCADCNYEURINRJPYCHFGBP
20012.5%11.3%8.8%2.5%8.1%5.8%17.4%5.0%5.4%
200224.7%13.5%23.7%24.8%5.9%24.0%13.0%3.9%12.7%
200319.6%-10.5%-2.2%19.5%-0.5%13.5%7.9%7.0%7.9%
20045.2%1.4%-2.0%5.2%-2.1%0.0%0.9%-3.0%-2.0%
200518.2%25.6%14.5%15.2%35.1%22.8%35.7%36.2%31.8%
200622.8%14.4%22.8%18.8%10.2%20.5%24.0%13.9%7.8%
200731.4%18.1%11.5%22.9%18.8%17.4%23.4%22.1%29.7%
20085.8%33.0%31.1%-1.0%11.0%30.5%-14.0%-0.3%43.7%
200923.9%-3.6%5.9%24.0%20.4%18.4%27.1%20.3%12.1%
201029.8%15.1%24.2%25.5%40.2%25.3%13.9%17.4%36.3%
201110.2%8.8%11.9%5.1%12.7%30.4%3.9%10.2%9.2%
20127.0%5.5%4.4%5.9%5.2%11.0%20.5%4.4%2.3%
Average16.8%11.0%12.9%14.0%13.7%18.3%14.5%11.4%16.4%

Against the British pound, gold has appreciated by 16.4% per annum on average. This result far exceeds the interest one could earn from bank deposits during this period.

The difference between what one earned from a bank deposit, and the rising gold price, is particularly striking at the moment because of the near-zero interest rate conditions which central banks are imposing on the market economy. The cumulative detrimental effect on savers from years of suppressed interest rates has been catastrophic. Their wealth has shrunk because they are not able to earn enough interest on their savings to compensate them for the loss of purchasing power from inflation and other insidious debasements of national currencies.

The low deposit rate which has lasted now for several years is one factor explaining why so many people are finding it increasingly difficult to maintain the standard of living which they previously enjoyed. It also explains, along with the above table, why gold may be a prudent alternative to traditional bank savings accounts; or at least be a meaningful diversifier in which to hold part of one’s savings, until bank deposit rates return to normal levels.

Admittedly, gold’s appreciation has not been a smooth ride. Though gold has risen against the British pound in 11 of the past 12 years, the annual rates of change have ranged from a loss of -2.0% in 2004 to an astounding annual gain of 43.7% in 2008, the year of the financial crisis, which highlights another important point.

Gold is a safe-haven. This attribute results from the fact that gold is a tangible asset. It is money that is not based on any bank’s promise or central bank policy.

The collapse of Northern Rock and Lehman Brothers are events that will not be forgotten. But even more lessons have been learned recently from the banking collapse in Cyprus. Depositor money was grabbed by the monetary authorities to bail-out insolvent banks. Even savers with small deposits were hurt by the capital controls that were imposed because these restrictions prevented deposits from being withdrawn, except nominal amounts that could be disbursed through ATMs.

Thus, gold offers two clear advantages over the British pound and other national currencies. It can preserve purchasing power, which is an attribute that is particularly important when the interest rate on bank deposits is not high enough to offset the erosion of purchasing power from inflation. Second, a tangible asset like gold eliminates the uncertainty of not knowing whether keeping money in a bank is safe.

From reading Mr Buffett’s various statements about money and investments, it is clear that he has a nuanced view. He sidesteps gold and its 5,000-year history as money, but you should not. Gold still has an important place in everyone’s portfolio.

Given Warren Buffett's well-known views about gold, it's ironic that one of the few politicians in 20th century America with a clear appreciation of gold's use as money was one Howard Buffett – a four-term Republican congressman from Omaha, Nebraska and Warren's father. For a more detailed examination of the contrasting views of the Buffetts on this subject, readers might be interested in the following essay, published by the GoldMoney Foundation: 'A Perspective on Money from Howard and Warren Buffett'.

- Source, GoldMoney: