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Below are several quotes taken from a section of Warren Buffett‘s 2011 letter titled “The Basic Choices for Investors and the One We Strongly Prefer.” I view it as some of his very best work.
“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.”
In the above quote Buffett is identifying the first of three asset types he’ll survey. The risk he is alluding to is the loss of purchasing power from inflation.
“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.”
Gold was identified as the major asset in this category. He expanded on the topic by saying:
“What motivates most gold purchasers is their belief that the ranks of the fearful will grow.”
Saving the best for last…
“My own preference – and you knew this was coming– is our third category: investment in productive assets, whether businesses, farms, or real estate.”
Zooming out, Buffett’s letters have several common themes including: (1) Optimism, particularly about America’s future, is foundational to investment success. (2) Temporary bouts of pessimism will create buying opportunities. (3) Faith in productive assets, such as businesses, is essential for wealth accumulation.
For the balance of this column, I’ll focus solely on stocks (S&P 500) and gold. In summary, generally speaking, optimists favor stocks and pessimists favor gold. How then can the S&P and gold be consistently marking all-time highs alongside one another? It is a question getting a lot of air time recently because it is so unusual.
In my last column I noted that stock valuations (credit spreads) are at near record highs (lows), representative of a high level of market optimism in corporate profitability. The optimism implicit in high stock values is easier to understand. Earnings have been increasing and are expect to continue to do so. Whether or not that optimism is well placed is not clear, but the argument is easy to understand.
Gold is more difficult. A valuation metric cited in this space before is its inflation adjusted price, based on the “golden constant” theory which posits that, over the long-term, the price of gold has a constant purchasing power. Said another way, the primary driver of gold over time is inflation. Per the Bloomberg Composite Gold Inflation Adjusted Spot Pirce, around the end of last year gold took out its prior inflation adjusted high set in the early-1980s. Since then, gold is up a truly stunning 55% year to date. The biggest difference between recent years and past years is central bank buying. Per the World Gold Council, central bank buying was 10 to 15 percent of annual demand during the 2010s. Since 2022 that share has pushed up to 20 to 25 percent.
It is understandable why non-U.S. central banks want to diversify away from Treasury securities somewhat – Sanctions are not a freebie foreign policy tool. However, there is some functional limit to how much of a central bank’s reserves can be maintained in gold.
While I can appreciate the merits of gold and acknowledge it has successfully served as a store of value for thousands of years, I personally prefer to stick primarily with productive assets.
Chas Craig is principal at C.E.C. Wealth Management (www.cecwm.com).
