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Tell
me why are we, so blind to see
That the ones we hurt, are you and me
-Artis Leon Ivey Jr. (aka Coolio)
I'd like
to sincerely thank Warren Buffet for so clearly making many of the points I've
been trying to make lately in his most-recent submission to Fortune magazine.
If anyone hasn't read it yet, it's called 'Why Stocks Beat Gold and Bonds'
and you can read it here. Of course, with the King of Bonds himself ringing
the closing bell on
the bond market just last month, I'm guessing that Warren was aiming at
gold more than at bonds with this piece. Bless his heart. Yo
Warren B, you're so OG (but
your aim ain't quite what it used to be)!
Alrightythen, let's just tear into this
juicy carcass and have us a feast!
Indeed it is! And "saving" (unlike
Warren's "investing") is the forgoing of consumption now in order
to PRESERVE that purchasing power for a later date. The difference between a
saver and an investor is that saving is the passive activity of most people
while investing requires a tolerance for the risk of loss and active,
specialized knowledge and focus. As I wrote in both Glimpsing the Hereafter and The Studebaker Effect:
"A saver is different from an investor or a trader/speculator. A
saver is one who earns his capital doing whatever it is he does, and then aims
to preserve that purchasing power until he needs it later. Investors and
traders aim to earn more capital by putting their already-earned capital at
risk in one way or another. This takes a certain amount of specialization and
focus."
Warren B:
From our definition there flows an important corollary: The riskiness of an
investment is not measured by beta (a Wall Street term encompassing
volatility and often used in measuring risk) but rather by the probability --
the reasoned probability -- of that investment causing its owner a
loss of purchasing power over his contemplated holding period. Assets can
fluctuate greatly in price and not be risky as long as they are reasonably
certain to deliver increased purchasing power over their holding period. And
as we will see, a nonfluctuating asset can be laden
with risk.
Very good! Yes! Risk is the reasoned
probability that you will lose purchasing power over a period of time. Listen
up if you happen to be a Berkshire Hathaway investor reading this. I have
been spending the last three years working out the reasoned probability
that you will lose purchasing power in the near future with your BRKA
investment. And over that same holding period, physical gold in your
possession is "reasonably certain" to deliver a massive increase in
purchasing power. Warren is correct, nonfluctuating
assets can be laden with risk while at certain times, the
very safest asset will be revalued. Again, as I wrote in both Glimpsing the Hereafter and The Studebaker Effect:
"Today the system is in transition, so you can throw your ideas
about these differences out the window. There is no safe medium for simple
preservation of purchasing power when the entire system shifts from the old
normal to the new normal. When systems implode, the safest place to be pays
off big time!"
Warren B:
Investment possibilities are both many and varied. There are three major
categories, however, and it's important to understand the characteristics of
each. So let's survey the field.
Investments that are denominated in a given currency include money-market
funds, bonds, mortgages, bank deposits, and other instruments. Most of these
currency-based investments are thought of as "safe." In truth they
are among the most dangerous of assets. Their beta may be zero, but their
risk is huge.
Over the past century these instruments have destroyed the purchasing power
of investors in many countries, even as these holders continued to receive
timely payments of interest and principal. This ugly result, moreover, will
forever recur. Governments determine the ultimate value of money, and
systemic forces will sometimes cause them to gravitate to policies that
produce inflation. From time to time such policies spin out of control.
Yay! Warren and I agree again! Investments
denominated in currency may be nominally safe—if you expect to have a
million dollars after a given holding period, you WILL have a million dollars
at that future time, but you may only be able to purchase a single roll of
toilet paper with that million—but their risk in real terms (purchasing
power terms) is HUGE… especially today! It almost seems like Warren has
been reading some FOFOA. In any case, here are a few applicable posts that he
might have studied:
Moneyness
Deflation or
Hyperinflation?
Big Gap in Understanding Weakens
Deflationist Argument
Just Another Hyperinflation Post -
Part 1
Just Another
Hyperinflation Post - Part 2
Just Another
Hyperinflation Post - Part 3
Warren B:
Even in the U.S., where the wish for a stable currency is strong, the dollar
has fallen a staggering 86% in value since 1965, when I took over management
of Berkshire. It takes no less than $7 today to buy what $1 did at that time.
Consequently, a tax-free institution would have needed 4.3% interest annually
from bond investments over that period to simply maintain its purchasing
power. Its managers would have been kidding themselves if they thought of any
portion of that interest as "income."
Yup! Warren's been around for a long time, alright.
And it just goes to show how tough it has been during our entire lifetime for
a saver who simply wants to preserve her purchasing power. She has to chase a
4.3% yield every year just to stay even! Crazy, isn't it? What if there was a
way to perfectly preserve your purchasing power over any time horizon without
chasing a yield? To what percentage of the population do you think that would
appeal? Better yet, to what percentage of Warren B's clients do you think
that would appeal? Just sayin', what if?
Warren B: For
taxpaying investors like you and me, the picture has been far worse. During
the same 47-year period, continuous rolling of U.S. Treasury bills produced
5.7% annually. That sounds satisfactory. But if an individual investor paid
personal income taxes at a rate averaging 25%, this 5.7% return would have
yielded nothing in the way of real income. This investor's visible
income tax would have stripped him of 1.4 points of the statedyield,
and the invisible inflation tax would have devoured the remaining 4.3 points.
It's noteworthy that the implicit inflation "tax" was more than
triple the explicit income tax that our investor probably thought of as his
main burden. "In God We Trust" may be imprinted on our currency,
but the hand that activates our government's printing press has been all too
human.
Word. The one-time tax on nominal gains is bad
enough, but the vanishing of savers' purchasing power through inflation is
the real killer over long time-frames. But why you gotta
conflate the issues of real income from an investment and simply protecting
one's purchasing power with the least risk, OG? Is this part of your game?
Why yes, I dare say I think it is!
Word. The one-time tax on nominal gains is bad
enough, but the vanishing of savers' purchasing power through inflation is
the real killer over long time-frames. But why you gotta
conflate the issues of real income from an investment and simply protecting
one's purchasing power with the least risk, OG? Is this part of your game?
Why yes, I dare say I think it is!
Holla, G!
Maybe the warning label should read – Nothing about this bond,
packaging or color should be interpreted to mean safer? How 'bout this one
for Berkshire Hathaway – Savers beware, we will try to do more than
preserve your purchasing power at the risk of losing your purchasing power,
but either way, I was in first, I'll be out first and I always get my cut?
Warren B:
Under today's conditions, therefore, I do not like currency-based
investments. Even so, Berkshire holds significant amounts of them, primarily
of the short-term variety. At Berkshire the need for ample liquidity occupies
center stage and will never be slighted, however inadequate rates may be.
Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for
liquidity under the most chaotic of economic conditions. Our working level
for liquidity is $20 billion; $10 billion is our absolute minimum.
I will only note here that, although the link leads
to data about bonds, Warren specifically wrote bills
which usually means a duration of one, three or six months. Since
there is no FDIC protection for cash accounts with $20 billion, T-bills are
the guaranteed cash equivalent. This, of course, brings to mind OBA's Time-Currency Theory referencing
the subzero-bound $IRX as well as my conveyance of
his theory over the years.
Warren B:
Beyond the requirements that liquidity and regulators impose on us, we will
purchase currency-related securities only if they offer the possibility of unusual
gain -- either because a particular credit is mispriced, as can occur in
periodic junk-bond debacles, or because rates rise to a level that offers the
possibility of realizing substantial capital gains on high-grade bonds when
rates fall. Though we've exploited both opportunities in the past -- and may
do so again -- we are now 180 degrees removed from such prospects. Today, a
wry comment that Wall Streeter Shelby Cullom Davis
made long ago seems apt: "Bonds promoted as offering risk-free returns
are now priced to deliver return-free risk."
Ah, now here we start getting a glimpse of Warren's
actual game! Notice the word "mispriced" in the above category.
This is a key to Warren's strategy, which begins to expose the reasoning
behind why he would choose to share this part of his shareholder newsletter
with the general public. I realize he's talking about bonds here, but this
principle applies to stocks as well (although not necessarily to gold).
Warren likes to buy and sell things that are "mispriced". That is,
he knows better than the market the true value of things. And if they are
"mispriced" he is, in fact, making money off of the mistakes of
others if he turns out to be correct. Bear in mind that I'm not judging him
on this issue per se, but simply exposing his game in a way that was most
definitely concealed in this latest "newsletter".
Warren, like his lieutenant Charlie M, wants you in the same paper he likes to buy and sell
so that he can capitalize on your "mispricing" mistakes. As I wrote
in The Value of Gold,
price and value are two different things, and that's Warren B's game:
"Probably the most common misconception is that price and value are the same thing. They are not. They are related but
different. Price can be precisely known, but true value can only be estimated
or guessed. And because price changes, price is always wrong while true value
is always right, even though it is unknown. So price and value are always
different. Value is always either higher or lower than price."
Warren will tell you that it's not just about capital gains. Warren LOVES
yields, be they high rates of interest or dividends from stocks. But the
thing about chasing yields is that the more people chasing, the lower the
yield goes, and that's when Warren strikes. That's when things become
mispriced. If he was only after yields, he would not want to let the world know
what he's doing. But since he's publishing his drive-by on gold in Fortune
magazine, I can only assume he's really after the capital gains that will
come from the mispricing that will result from millions of people following
his "advice".
Warren B: The
second major category of investments involves assets that 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. Tulips, of all things, briefly became a favorite of such
buyers in the 17th century.
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.
Owners 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.
What Warren is referring to here are sometimes
called "hard assets". They are durable, physical items that
generally hold their value well because people always seem to want them. Like
well-preserved classic cars, quality antique furniture or rare baseball
cards, hard assets do not generate yields like stocks and bonds. And so
Warren is invoking the greater fool theory with
regard to hard assets (before even revealing to you the specific one he's
targeting) to lay the foundation that YOU are the fool if you think these are
a wise way to store your savings.
In fact, if you click on the greater fool link above, you'll find Warren's
name right there in the last line. You might also want to click through and
read the Keynesian beauty contest principle of stock investing. Warren tells
us later just what beautiful stocks look like. They look like Coca-Cola and
See's Candy. But if too many people chase those yields, they disappear and
even great stocks like that can become mispriced. And that, my friends, is
when OG sells!
For example, Berkshire just sold out of its entire position in ExxonMobil
after the price surged 17%. Berkshire also sold off Johnson & Johnson and
Kraft shares. Fine companies with lots of earnings, so why sell? As for
Coca-Cola, that's one of Berkshire's biggest holdings right now! Just sayin'.
What Warren is referring to here are sometimes
called "hard assets". They are durable, physical items that
generally hold their value well because people always seem to want them. Like
well-preserved classic cars, quality antique furniture or rare baseball
cards, hard assets do not generate yields like stocks and bonds. And so
Warren is invoking the greater fool theory with
regard to hard assets (before even revealing to you the specific one he's
targeting) to lay the foundation that YOU are the fool if you think these are
a wise way to store your savings.
In fact, if you click on the greater fool link above, you'll find Warren's
name right there in the last line. You might also want to click through and
read the Keynesian beauty contest principle of stock investing. Warren tells
us later just what beautiful stocks look like. They look like Coca-Cola and
See's Candy. But if too many people chase those yields, they disappear and
even great stocks like that can become mispriced. And that, my friends, is
when OG sells!
For example, Berkshire just sold out of its entire position in ExxonMobil
after the price surged 17%. Berkshire also sold off Johnson & Johnson and
Kraft shares. Fine companies with lots of earnings, so why sell? As for
Coca-Cola, that's one of Berkshire's biggest holdings right now! Just sayin'.
AMEN! Thank you brother. "If you own one
ounce of gold for an eternity, you will still own one ounce at its end."
Warren's words, not mine. But I'll bet you that I will be milking this quote
for a long time to come!
Remember earlier I asked, "What if there was a way to perfectly
preserve your purchasing power over any time horizon without chasing a yield?
To what percentage of the population do you think that would appeal?"
Well, what if physical gold, that singular hard asset that is also held by
central banks (precisely BECAUSE it has the fewest industrial uses), was on
its way to becoming the singular global reference point for purchasing power,
instead of the dollar with everyone chasing a 5.7% annual yield making it
harder and harder to catch?
"If you own one ounce of gold for an eternity, you will still
own one ounce at its end." In other words, perfectly
preserved purchasing power. See? Please read my post Reference Point Revolution for
more on this transition that's already underway.
Here is what I am suggesting. That Warren Buffet is the one, regardless of
his protestations to the contrary, who is practicing the greater fool theory
and the Keynesian beauty contest principle of investing while we, my friends,
are the ones who are smartly front running the network effect (aka
demand-side economies of scale)
and the focal point transformation
of the biggest thing in a thousand years.
Warren B:
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.
On the contrary, homey, it's that the dollar is so
overvalued because of the sheer weight brought on by the fact that all dollar
"wealth" has a counterparty, and that those counterparties in
aggregate can't POSSIBLY perform to expectations in real terms, that a
massive adjustment is not only inevitable, but long overdue. EVERYTHING is
mispriced right now because the dollar is so massively overvalued at present.
And while I can't speak for all gold investors, I'm not buying gold because I
think the ranks will grow. In fact, I think the ranks will ABANDON
"gold" at the worst time in all of history.
As I wrote in a recent comment, "My scenario… ALL TRADERS
dump ALL gold, paper, physical, whatever, in my scenario. It has nothing to
do with insiders. It has to do with traders and weak hands." But
that's a difficult concept to wrap your head around. If you'd like to try, I
wrote about it in my 2010 post, The Shoeshine Boy. The point here is that the true gold thesis is not
"the belief that the ranks of the fearful will grow." That is
simply Warren Buffet's unfortunate misunderstanding of the gold thesis.
Warren B:
Over the past 15 years, both Internet stocks and houses have demonstrated the
extraordinary excesses that can be created by combining an initially sensible
thesis with well-publicized rising prices. In these bubbles, an army of
originally skeptical investors succumbed to the "proof" delivered
by the market, and the pool of buyers -- for a time -- expanded sufficiently
to keep the bandwagon rolling. But bubbles blown large enough inevitably pop.
And then the old proverb is confirmed once again: "What the wise man
does in the beginning, the fool does in the end."
It is so incredibly striking to me that "the
best of the best," the Oracle of Omaha himself, is still reciting these
same tired old arguments. It simply defies logic that Warren Buffet is
comparing gold to the housing and dot-com bubbles to save you out of the goodness
of his heart. If he doesn't want you engaging in a "bubble", it's
only because he wasn't there first. In fact, there are plenty of gold bugs
who actually THINK gold will eventually be a bubble, and that's precisely why
they're in it. But not me.
More than two years ago I debunked the ridiculous and shallow comparison of
gold to past bubbles in Gold: The Ultimate Un-Bubble:
"And since gold production cannot be ramped up to meet demand
like it can in bubblicious items, there is no
reason for gold to fall back. Gold mining does not debase gold in the same
way that dollars, tulips, homes, Dot Com IPO's or government bonds are
debased through production. Mine production is taken from known reserves that
are already valued, owned and traded, and all gold on the planet Earth is a
fixed amount, the same fixed amount it was a million years ago. All we do is move it around, like poker chips on a table, to those
savers that value it the most.
Furthermore, the price of gold is completely arbitrary. This means that gold
can go as high as the people of Earth want to take it without EVER exceeding
objective valuations by common metrics like earnings, interest or the sum
value of its component elements. Gold IS the element. It cannot be broken
down further, except perhaps by the LHC.
One of the most common criticisms of gold's use as an investment is that it
cannot be valued the way stocks, bonds and real estate can. They are all
commonly valued by their yields, and gold has no yield, therefore it cannot
be fairly valued, or so the argument goes. But if we invert this argument
then gold can never be OVERvalued either, whilst
those other things can, and are... in a bubble!
The price of gold is arbitrary, ergo, there is no such thing as a gold
bubble."
Of course that is not the whole story, it's only a
teaser from the post. But the point is that if Warren Buffet is truly
avoiding gold because he thinks it's a bubble like Pets.com or Miami condos,
you should really question EVERYTHING that comes out of his mouth. Now I will
admit that PAPER gold is a bubble, but physical gold? Never!
Warren B:
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 about $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?
No, and neither
can I imagine a saver with a regular job, a life to live, an aversion to risk
and a desire to merely preserve his purchasing power wanting to own a bunch
of oil and farming companies. Besides, if Exxon Mobil is so profitable, why
did Warren just sell his entire stake in it? Could it be that even profitable
companies become mispriced (overvalued) when everyone is chasing a yield?
Okay Warren, can I imagine an investor with $9.6 trillion buying all the gold
in the world? Of course not. No choice could be more stupid if such a person
could exist. As I have written many times, gold would be completely worthless
if one person (or even just a few people) owned it all. Gold's greatest value
comes from its widest distribution amongst savers, and the greater the value,
the more efficiently gold performs its primary function. It is a virtuous and
self-sustaining feedback loop. From Relativity: What is Physical Gold
REALLY Worth?:
"One of the unique characteristics of gold that sets it apart
from commodities is that its primary use - store of value - has no weight or
mass requirements. In commodities, where industry is the primary user, weight
is critical.
[…]
One ounce [of gold] could do just as good of a job as 100 ounces. In fact,
one ounce would do a BETTER job than 100 ounces! The less gold it takes to
store your value, the better it does its job. This particular “gold
dynamic” sets it apart from all commodities.
One ounce would store your value more efficiently and stably than 100 ounces
because A) your storage and security costs would be lower (efficiency), and
B) if one ounce is worth $100,000 then that infers gold is being valued by
many more people relative to when it was $1,000 per ounce. This wider
distribution brings with it a more stable base of valuation and less relative
volatility in price (stability).
Comparing this “gold dynamic” to any industrial or food commodity
we can see a stark difference. What commodity could perform its job BETTER at
a price 100x higher than today? Can you name one?"
And from a comment in
2009:
"Gold would not be valuable if one person owned all of it. It is most
valuable in its widest distribution possible, the wealth reserve, which
requires a much higher valuation than it has right now. A higher valuation
denominated in hard assets, not just fiat currencies!"
And another comment
from 2010:
"Just look at the BIS' own gold actions. Their owned gold hoard has
shrunk from 194 tonnes to 120 tonnes
over the last 6 years, as has the entire Eurosystem's
hoard over the last decade (from 12,576 tonnes down
to 10,833 tonnes). Most gold movements in Europe
have either been lateral reshuffling or dishoarding and encouraging citizens
and other entities to start hoarding physical gold themselves.
I have written this before... if you were King of the World with 35,000 tonnes of gold in a world of 160,000 tonnes,
you would gladly - happily - reduce your "stash" to 10,000 tonnes if that reduction came with a 50x revaluation.
Trying to get ALL the gold into your hoard is a fool's strategy."
Like I said, Warren, buying all the gold in the world would be about the
dumbest thing such an investor could possibly do, kinda
like a doctor owning an oil company and calling it savings.
Warren 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.
Hahaha!
B's worried about who's gonna buy up the annual
physical gold production? How about who's gonna
keep buying the annual paper production bearing dubious counterparties in the
upper left-hand corner? I think it's Warren B who is worried about who's gonna keep buying the stuff he's into.
With well over $100T in cash, cash equivalents, debt and equity investments posing
as savings for the risk-averse, I think it's more than safe to say that
ANOTHER had it exactly right when he said that the paltry $160 billion flow
of gold is (and has been for a long time) cornered. Heck, nearly a third of
that is going to India alone,
and they aren't even one of the surplus nations like Saudi Arabia, Germany or
China!
Warren 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 (XOM) 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.
Fondle the cube? Alrightythen,
no more Mr. Niceguy here either. Once again,
Warren, why did you sell Exxon if it's so great and saving money is all about
dividends and earnings rather than taking (OPM) money from the greater fool?
What a hypocrite! Is it also possible that companies can be mismanaged, like,
say, BAC?
Here are a few other "good companies" that Berkshire dumped
since it (BRKA) took a 50% nose-dive in
2008 (actually late 2007 to early 2009): Nike, Comcast, Lowes, Home Depot.
And in case you are still under the illusion that OG is all about solid,
benevolent analysis rather than political monies for OG's pocket, his company
is still the largest shareholder in Wells Fargo (NYSE: WFC) and "he has practically bought at any chance he
gets." Nothing against Wells Fargo (I have an account there) but this,
combined with his drive-by assault on gold (the hard asset preferred by those
who actually produce stuff) should settle any debate about whether or not he
carries a bias in his baggage.
Warren B: 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.
"Pile A" does not compound. It simply
remains. Remember? "If you own one ounce of gold for an eternity,
you will still own one ounce at its end." That said, there's no guarantee that pile B will be worth more than
pile A in 100 years. A lot can happen in 100 years, wars, hyperinflations,
companies go bankrupt… If you were to be put into a deep sleep
coma-like state for a century, and you had trillions in wealth, which pile
would you pick to shuttle your wealth through 100 years?
Warren B: Our
first two categories enjoy maximum popularity at peaks of fear: Terror over
economic collapse drives individuals to currency-based assets, most
particularly U.S. obligations, and fear of currency collapse fosters movement
to sterile assets such as gold. We heard "cash is king" in late
2008, just when cash should have been deployed rather than held. Similarly,
we heard "cash is trash" in the early 1980s just when fixed-dollar
investments were at their most attractive level in memory. On those
occasions, investors who required a supportive crowd paid dearly for that
comfort.
And finally, here's the argument that only Helen
Keller could believe, that today's contrarian is staying as far away from
gold as possible. Especially that physical gold. Look at the lines to buy gold
at the dealers. They wrap around the block. You can't find a place to eat
these days without having some dolt at the next table talking about gold.
Heck, even the shoeshine boy can tell you what coins are best and where to
buy. It's obviously a bubble. Yeah, right.
Warren B: My
own preference -- and you knew this was coming -- is our third category:
investment in productive assets, whether businesses, farms, or real estate.
Ideally, these assets should have the ability in inflationary times to
deliver output that will retain its purchasing-power value while requiring a
minimum of new capital investment. Farms, real estate, and many businesses
such as Coca-Cola (KO), IBM (IBM), and our own See's Candy meet that
double-barreled test. Certain other companies -- think of our regulated
utilities, for example -- fail it because inflation places heavy capital
requirements on them. To earn more, their owners must invest more. Even so,
these investments will remain superior to nonproductive or currency-based
assets.
By superior, he means that he views investing as
superior to saving. He is, after all, an extraordinary investor. But most of
his audience is, in fact, made up of savers. As far as savings go, for the
near future (i.e., the transition period) gold will be far superior to
Warren's investments as the transition brings REAL gains of tremendous value
to those who hold the goods. And in the distant future, physical gold will be
a far superior savings medium as it will be the very benchmark of purchasing
power everywhere. In that future, owning companies will potentially bring you
real returns whereas gold will not. But it will also carry risks and
responsibilities. And if you carry gold from here into that future, you will
be one of the fortunate few faced with that choice.
Warren B:
Whether the currency a century from now is based on gold, seashells, shark
teeth, or a piece of paper (as today), people will be willing to exchange a
couple of minutes of their daily labor for a Coca-Cola or some See's peanut
brittle. In the future the U.S. population will move 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.
Absolutely true! In fact, this is the Debtors &
Savers Zone he is describing. The
part of the pyramids occupied by everyone!
What's missing in his description is what the savers
will trade amongst themselves to perfectly preserve their purchasing power
during periods of deferred consumption. Sure, someone will own all those
companies OG loves so much. And like I said, if you
carry some of that physical gold from here into that future, it might just be
you!
Warren B: Our
country's businesses will continue to efficiently deliver goods and services
wanted by our citizens. Metaphorically, these commercial "cows"
will live for centuries and give ever greater quantities of "milk"
to boot. Their value will be determined not by the medium of exchange but
rather by their capacity to deliver milk. Proceeds from the sale of the milk will
compound for the owners of the cows, just as they did during the 20th century
when the Dow increased from 66 to 11,497 (and paid loads of dividends as
well).
Of course they will, Warren! No one at this blog is
predicting the collapse of
modern society. The gold thesis discussed here is about that which is
mispriced (overvalued or undervalued) coming back in line with reality. The
dollar is overvalued and physical gold is undervalued. I described it as a
seesaw in The Studebaker Effect:
"Devaluations play out like a seesaw. There is a force (the
crisis devaluation), a fulcrum (what is being devalued against), and a load
(the beneficiary or the winner)."
That fulcrum is the physical plane of goods and
services in aggregate. Everything is mispriced today, some things more than
others. But if we look at how Warren's favorite investments, company stocks,
carried through past devaluations, we find that while they obviously do much
better than currency or currency-based investments like bonds, they don't do
quite as well as hard assets and they don't even preserve purchasing power.
Perhaps it's because an overvalued currency also tends to overvalue its
economy.
Here's a bit from my post Greece is the Word on
how Warren's equities might fare during the currency devaluation he expects:
"But what about the stock market? Someone emailed me saying,
"During a currency crisis in the western world, we may see a very
powerful stock market rally as equities are a form of real asset. Better to
own a piece of Procter and Gamble than a unit of currency that can devalue quickly.
Look to the Argentina general equity market MERVAL index during the peso
crisis. It shot up – although not as much as the 3:1 currency
devaluation."
The writer answered his own point. The stock market shot up LESS than the
currency devalued. So while the stock market in Argentina performed MUCH
better than debt fixed to the value of the currency, it only chased - and
lagged - actual inflation. (Actually, short term hyperinflation.)This is
partly because the economy is usually in shambles at the time of a currency devaluation. So while you would expect real
things like real companies to compensate for a falling currency, you must
also weigh in any previous bubbling that might deflate and any economic
factors that might reduce company profits.
But Argentina is still a good example for us to look at. In January of 2002
the currency devalued 3:1. At the same time the stock market rose in response
to the devaluation and then stayed up (because the currency stayed down). But
what is interesting about Argentina is that just prior to the devaluation, in
December of 2001, inflation dipped into negative territory (deflation?) and
the stock market dipped as well. Then they almost immediately exploded out of
this head-fake in an unexpected devaluation. See the charts. The first is the
MERVAL and the second is CPI:
Hmm... look familiar?
Bottom line: The stock market, because it represents equity not debt, will
fare much better than the rest of the paper world. But the stock market does
suffer from dilution, manipulation and bubbles. Expect the stock market to
languish in economic chaos as it chases real inflation only to fall a little
short.
But gold is different. The system desperately needs a counterweight, and gold
is it. The counter is already in place, only the
weight is yet to come. And once we have seen the reset in gold as it performs
its phase transition from commodity to wealth reserve, it will then chase
(hyper)inflation along with the rest of the
"non-dollar" world, only it will be the ONE AND ONLY THING that
will be immune to the economic mess that will still need to be worked
out."
So what we can do is to place Warren's favs just to
the left of the fulcrum on the seesaw. They won't devalue much in real terms,
but they also won't fare even as well as boring old hard assets like antique
furniture (I'm sure he'll just love this one):
Warren B:
Berkshire's goal will be to increase its ownership of first-class businesses.
Our first choice will be to own them in their entirety -- but we will also be
owners by way of holding sizable amounts of marketable stocks. I believe that
over any extended period of time this category of investing will prove to be
the runaway winner among the three we've examined. More important, it
will be by far the safest.
And thus ends Warren B's drive-by assault on gold.
What do you think? Did he hit his target?
So where is Warren coming from?
Try to imagine a bizarro world where we
simultaneously encourage everyone to consume as much as possible through debt
(because, ldo, consumption is the engine of the
American economy) and also to save that same debt through ERISA and 401(k)s. What you end up with is a whole society of people
deferring consumption (saving) on the one hand, and pulling into the present
that very same future consumption they saved on the other. You end up with
underwater homeowners with negative net-worths and
hundreds of thousands sitting in their 401(k) or IRA.
With everyone chasing a yield, be it through interest rates on currency investments
or dividends from equities, you eventually drive all those yields to zero.
Luckily for the Warren Buffets of the world, most of that "savings"
knows no better than to float around in Warren's world, where Warren not only
gets his management cut, but he can also make amazing capital gains as those
"savings" slosh around mispricing one thing after another.
Now think about that person, let's call him Bob, with $201K in debt and also
a $200K pension or IRA through work. In essence, he could be almost debt-free
were it not for his "savings". But then if that were the case,
Warren wouldn't have that $200K sloshing around in Warren's world. This is,
of course, only a mental exercise in how inane (or should I say insane?) the
Western financial system really is.
Which camp do you think Bob is in? The Debtors or the Savers?
And what would be the state of Warren's company valuations were it not for all this additional "savings" sloshing around?
How about the yields available for real savers? Perhaps there would be some
yields to be found were it not for Bob and his "savings"?
The point is that companies are not de facto good investments just because
they make things. They can become overvalued when chased by too much money
and that's when Warren sells. Warren talks a good talk about compounding
dividends, but what he's really after is your money. Either you're with him
(investing in BRKA) and he takes his cut while using your financial weight as
his own, or you're against him out there on your own. And then he's looking
for areas where you've mispriced something so that he can buy it from you or
sell it to you.
I can tell you which camp OG is in. He's in the easy money camp (the debtors)!
He's in debt to easy money:
Warren Buffett is on Squawkbox
right now defending the bailout, which he wrote an op-ed about in today's New
York Times.
Then he dropped this line, which sounds like an exaggeration: "If the
government hadn't acted, I would be eating Thanksgiving dinner at
McDonald's."
(Business
Insider)
Perhaps he wasn't exaggerating:
A good chunk of his fortune is dependent on taxpayer
largess. Were it not for government bailouts, for which Buffett lobbied hard,
many of his company’s stock holdings would have been wiped out.
Berkshire Hathaway, in which Buffett owns 27 percent, according to a recent
proxy filing, has more than $26 billion invested in eight financial companies
that have received bailout money…
…It takes remarkable chutzpah to lobby for bailouts, make trades
seeking to profit from them, and then complain that those doing so put you at
a disadvantage.
Elsewhere in his letter he laments “atrocious sales practices” in
the financial industry, holding up Berkshire subsidiary Clayton Homes as a
model of lending rectitude.
Conveniently, he neglects to mention Wells Fargo’s toxic book of home
equity loans, American Express’ exploding charge-offs,
GE Capital’s awful balance sheet, Bank of America’s disastrous
acquisitions of Countrywide and Merrill Lynch, and Goldman Sachs’
reckless trading practices.
And what of Moody’s, the credit-rating agency that enabled lending
excesses Buffett criticizes, and in which he’s held a major stake for
years? Recently Berkshire cut its stake to 16 percent from 20 percent.
Publicly, however, the Oracle of Omaha has been silent.
(Reuters)
So maybe you are starting to see why Freegold is not such a welcome development for an OG like
Warren B. But don't worry too much about Warren. He'll still be a
multi-billionaire come Freegold. And if you follow
him, at least you won't be broke (see the seesaw above). I suppose there
might even be something altruistic about leaving the Freegold
revaluation windfall for others. But that's not Warren's motivation.
Warren's power comes from keeping as much of other people's savings as
possible in the stock market where he plays. It doesn't matter if it comes in
through his company or on its own, just that it's in there. And that's why he
wrote this piece trashing gold. Because when you buy a tube of gold coins and
put it in your sock drawer, it's out of OG's reach.
Sincerely,
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