On Jelly Donuts and Gold

Gold is “forever unproductive,” says Warren Buffett, CEO of Berkshire Hathaway.

“Civilized people don’t buy gold,” says Buffett’s sidekick, Charlie Munger. Civilized people, says Munger, “invest in productive businesses.”

So let’s see… Where does that lead us?

If…

A) Berkshire Hathaway invests in productive businesses and;

B) Investing in productive businesses is civilized and;

C) Warren Buffett and Charlie Munger direct Berkshire’s investments;

Then…

D) Buffett and Munger are civilized.

Gee whiz! That’s lucky!

But to make sure the world appreciates just how civilized these two civilized gents are, they continuously (and very publicly) belittle both gold and the uncivilized masses who consider it a store of value.

“Gold gets dug out of the ground,” Warren Buffett famously observed, “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.”

Yes, that’s right, anyone from Mars…or from Berkshire Hathaway headquarters. But most of the other seven billion folks residing on either Earth or Mars understand that gold has at least some utility. At a minimum, they understand that gold possesses more utility than the gold-bashing blather that spills from the lips of Buffett and Munger. Gold may be inert, but at least it’s not toxic.

“When it comes to bashing gold,” writes Eric McWhinnie for Wall St. Cheat Sheet, “few do it as publicly and extremely as the crew at Berkshire Hathaway… Buffett dedicated a decent part of his latest shareholder letter to criticizing gold. He painted an analogy of the world’s gold stock as a useless cube that would fit within a baseball infield. Buffett wrote:

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?

Ummm…maybe…depending on the circumstances in which one finds oneself.

Even Charlie Munger acknowledges that “gold is a great thing to sew onto your garments if you’re a Jewish family in Vienna in 1939.” Although Munger’s tasteless remark was an attempt to disparage gold, he inadvertently paid the monetary metal a compliment. He acknowledged that gold is the “go to” investment during times of crisis. It is the thing to own in uncivilized times.

Clearly, gold was not the very best thing to own when the young Buffett and Munger were launching their careers — a period that happened to coincide with America’s post-WWII, once-in-an-empire, economic boom. At the end of the Second World War, the United States possessed a robust manufacturing infrastructure; its competitors possessed ruble. Not a bad time to invest in America’s “productive businesses.”

But not every investor will find himself in the midst of one of the most powerful, world-dominating economic expansions in human history. Instead, some investors may find themselves in some sort of “Vienna, 1939.” In such circumstances, the ideal investment may not be a share of Coca-Cola…or even a share of Apple (more about which below). It may be an ounce of gold.

“Some Jews in Vienna in 1939 operated extremely productive businesses,” we observed in the May 24 edition of The Daily Reckoning. “Unfortunately, they could not stitch any of those into their garments.”

But gold is not merely a great thing to own amidst extreme circumstances. It can also be a great thing to own amidst merely marginal circumstances, like, for example, if you happen to be living during the tail end of one of the most powerful, world-dominating economic expansions in human history…rather than at the beginning of it. In other words, gold may be a great thing to own in America in 2012 — no matter whether you be Jewish, Christian, atheist or spiritually confused.

“As civilizations lose their civility,” we observed a few days ago, “investing in productive businesses can be a very unproductive activity. As civilizations lose their civility, share prices tend to fall and gold prices tend to rise…which is exactly what has been happening in our beloved U.S.A during the last few years.”

Thus, as we never tire of observing, gold has delivered a much higher return during the last 15 years than Berkshire Hathaway, perhaps the most civilized of American stocks. By any quantitative measure, gold has kicked Berkshire’s rear-end from wherever you happen to be reading this column all the way back to Omaha, Nebraska.

Unlike Buffett and Munger, David Einhorn, founder of Greenlight Capital, believes we Americans are in an era in which gold is likely to reward those who hold it. He recently countered Buffett’s “analysis” of gold by saying, “If you wrapped up all the $100 bills in circulation, they would form a cube about 74 feet per side… The value of all that cash would be about a trillion dollars. In a hundred years, that money will have produced nothing… It will not pay you interest or dividends and it won’t grow earnings, though you could burn it for heat… Alternatively, you could take every US note in circulation, lay them end to end, and cover the entire 116 square miles of Omaha, Nebraska. Of course, if you managed to assemble all that money into your own private stash, the Federal Reserve could simply order more to be printed for the rest of us.”

Einhorn’s dig at the Berkshire boys is merely his latest counter-punch against the anti-gold elite. A few weeks back, he likened Fed Chairman Ben Bernanke’s monetary policy to gorging on jelly donuts.

“A jelly donut is a yummy mid-afternoon energy boost,” Einhorn explained. “Two jelly donuts are an indulgent breakfast. Three jelly donuts may induce a tummy ache. Six jelly donuts, that’s an eating disorder. Twelve jelly donuts is fraternity pledge hazing.

“My point,” Einhorn elaborated, “is that you can have too much of a good thing… Chairman Bernanke is presently force-feeding us what seems like the 36th jelly donut of easy money and wondering why it isn’t giving us energy or making us feel better. Instead of a robust recovery, the economy continues to be sluggish…”

“As a result,” Einhorn concluded, “I will keep a substantial long exposure to gold, which serves as a jelly-donut-antidote for my portfolio.”

Like Einhorn, many other high-profile hedge fund managers are amassing large quantities of gold and gold-related investments. According to filings with the Securities and Exchange Commission, several big hedge funds upped their allocation to gold during the first three months of 2012. Billionaire fund manager John Paulson, for example, maintained his large 17.3 million-share position in the SPDR Gold Trust (NYSE:GLD). He also upped his holding of NovaGold Resources (NYSE:NG) and IAMGOLD (NYSE:IAG).

Daniel Loeb’s Third Point hedge fund maintained its position in “GLD,” while boosting its stake in Barrick Gold (NYSE:ABX). George Soros’ management firm nearly quadrupled its exposure to “GLD” during the first quarter, while also buying call options on Newmont Mining (NYSE:NEM).

Those guys aren’t buying gold because they expect it to be “forever unproductive,” as Buffett asserts, or because it is only useful during a Nazi occupation, as Munger asserts. They are buying it because they believe the American economy of the near-future will not treat investment capital as hospitably as the American economy of the last several decades.

They are buying it because they perceive that important aspects of American civilization are becoming somewhat more barbaric…like, for example, the barbaric fiscal policies that never fail to produce trillion-dollar deficits, or the barbaric monetary policies that always fail to produce sustainable economic activity.

Barbarous times call for barbarous measures.

Regards,

Eric J. Fry
for The Daily Reckoning

[Joel’s Note: Obviously, Dear Reader, the Berkshire Boys are not the only folks pooh-poohing gold these days. In fact, bashing gold is something of a daily Wall Street pastime. And even those folks who feel no need to bash gold are quite content to ignore it. They’d rather buy a “hot stock” like Facebook…ugh…or maybe a proven winner like Apple.

We have no idea who’s right or wrong here or, more importantly, who will be right or wrong going forward. But we’d love to hear your thoughts on the subject…just for kicks. We’d like to hear from you whether gold or Apple will be the better bet over the next five years.

Matt Nesto posed this identical question a couple days ago to his guest on “Breakout,” Lee Munson, Chief Investment Officer at Portfolio, LLC. Munson responded unequivocally, “I’d rather you go out…and buy Apple.” As for gold, Munson scoffed, “When the world looks to be ending, like 2008, people aren’t going to buy gold, they’re going to buy dollars, and if things really get bad, they’ll buy dry food and automatic guns.”

What about you, Dear Readers? Do you side with Munson (and Buffett and Munger)? Or do you think gold might be the better bet? Or maybe you are conflicted, just like Daniel Loeb, the hedge fund manager Eric cites in his column. Although gold is the second largest holding in Mr. Loeb’s hedge fund, Apple is the fourth largest holding. Hmmm…maybe that’s the perfect hedge. Anyway, we’d love to hear your thoughts.]