There are several reasons why investors may wish to add gold to their portfolio. Over time, gold prices will not only rise but they can also hedge inflation and increase diversification.
Having said that, gold does not match Warren Buffett’s investment philosophy. Allows Buffett to incorporate Berkshire Hathaway Inc. (NYSE: BRK-A) (NYSE:BRK-B) into the current dominant principle of a large group of companies that do not include gold and most of them are considered For other assets worth of storage.
The following brief description of Warren Buffett’s investment style and his views on gold will help describe why you should not expect to see the gold bars in Berkshire’s portfolio in the near future.
Warren Buffett does not invest in gold. Warren Buffett invests in three main things: Berkshire Hathaway’s capital and his own funds: the entire company, the shares of listed companies, and cash equivalents waiting to be invested in both. If you look at Berkshire’s portfolio, you will find many subsidiaries and stock investments, but gold is nowhere to be found.
Buffett’s three types of investment
Before we delve into the reasons why Warren Buffett does not invest in gold, it is important to discuss how Warren Buffett views investment.
Specifically, Oracle Omaha divides all available investments into three categories:
Currency-denominated investments: Includes savings account deposits, money market funds, bonds, and other similar investment types. These assets are usually considered “safe” by investors.
Non-productive assets: This is the category to which gold belongs. Essentially, the theme behind investment in non-productive assets is that others are willing to pay more for the future than to pay the price today. Other precious metals such as silver and platinum are also examples of non-productive assets such as collectibles and cryptocurrencies.
Productive assets: productive assets can not only increase in value over time, but also generate other valuable assets. For example, if you own a stock, it can create dividend income for you, and the value of the stock itself will increase over time. In addition to stocks, examples of productive assets are corporate and leased real estate.
Buffy uses currency denominated investments for a specific period
Buffett believes that the first type of currency denominated investment may be the highest risk. In particular, although these assets are in fact guaranteed not to lose value, they tend to produce insignificant returns. In fact, the returns are so small that they cannot even keep up with the timing of inflation and weaken the purchasing power of investors. (However, Buffett did not oppose these investments when interest rates made up for inflationary risks – as they did in the early 1980s.)
For example, suppose you deposit $10,000 in a savings account that pays 1% interest (for the sake of simplicity, we assume annual compounding). After 30 years, your deposit will be worth $13,478. It’s good for a completely safe investment, right? error. Assuming a long-term inflation rate of 3%, the actual purchasing power of your $13,478 account balance (in today’s dollars) will be only $5,404. Therefore, although your account balance is slowly increasing, you are actually losing money.
With all this, you may be surprised that Warren Buffett often uses these types of investments. In fact, the $116 billion Berkshire Hathaway Capital invested in these currency-denominated investments represented by short-term Treasury bonds.
In short, investing in currency-denominated liquidity has the advantage of liquidity, which means that if necessary, it can be quickly sold at full market value. Buffett has allowed Berkshire’s cash to accumulate until he finds an attractive investment opportunity. Even small returns from short-term treasury bills and money market funds are better than nothing.
You won’t be surprised by Buffett’s favorite category
Not surprisingly, Warren Buffett’s favorite thing about Berkshire Hathaway’s capital is investing in productive assets. Specifically, Buffett’s first choice is to look for the entire company to acquire, and as an alternative, he is willing to invest in the common stock of other companies. As of April 2018, Berkshire has more than 60 subsidiaries, followed by a portfolio of stocks worth about $176 billion.
Warren Buffett likes to create wealth assets. Gold and other non-productive assets may hold wealth, but they do not create wealth.
This is a simple example of wealth creation assets. Assume that you own 1,000 shares that pay 4% dividend income. For the next 30 years, assuming you reinvest all your dividends, your 1,000 shares can become 3240. So, before considering any appreciation of stock prices, your investment has more than tripled.
The key is that Warren Buffett has invested Berkshire Hathaway’s capital in productive assets and currency-denominated investments while he is waiting to find more productive assets to buy. He does not invest in non-productive assets such as gold.
Buffett’s view of gold
Although Buffett is not a fan of any form of production-free assets, he has discussed the reasons why he specifically avoided gold.
In a letter sent to Berkshire Hathaway shareholders in 2011, Buffett pointed out that gold is “the favorite of investors and they are afraid of almost all other assets, especially banknotes.” To be fair, Buffett admits that investors have reason to worry Banknotes are value reserves, especially because of inflation.
Regarding gold, Buffett discussed two major shortcomings. Like all non-productive assets, gold is not a “genital organ.” In other words, in this regard, gold will never produce more gold or anything else of value. In contrast, a well that Berkshire purchased will produce a series of valuable oil. A garment factory loses clothes as long as it runs. Equity investment can pay dividends, and then you can use it to buy more stocks. But the one ounce of gold you buy today is still only an ounce of gold in 400 years.
The second shortcoming discussed by Buffett is the lack of practicality of gold. Of course, it is used to make jewelry and there are other applications, but a wide range of gold demand does not exist. Buffett’s view is that non-productive assets with wide industrial applications, such as copper or steel, can at least rely on this demand to increase prices.
In his 1998 Harvard conference speech, Buffett said:
(It) was dug out in Africa or somewhere. Then we melt it, dig a hole, bury it again, and let people stand up and guard it. It is useless. Anyone watching from Mars will scratch his head.
Which do you prefer to own?
To illustrate his point of view, Buffett uses two hypothetical portfolio examples. The first batch contained all of the world’s gold supply, and Buffy’s close-up was worth about US$9.6 trillion. The second group includes assets of equal value – all crop-producing farmland in the United States, 16 Exxon Mobil Corporation and one trillion US dollars in working capital. (Note: Exxon Mobil was the most profitable company in the world at the time of Buffy’s close-up letter.)
This is an idea. Over time, these assets not only add value, but farmland will generate US$200 billion in annual revenue, and 16 Exxon Mobil companies will generate US$40 billion in profits each year, with an annual gross output value of US$84 billion. Invest in other productive assets.
In fact, it is this logic of production and reinvestment that has allowed Berkshire Hathaway to evolve from struggling textile manufacturers in the 1960s to becoming one of the largest companies in the world today. It can be said that if Buffett simply invests Berkshire’s capital in gold after he has taken control of the company, then the same will not happen.
Not a good investment, but…
So, in order to answer the initial question, Warren Buffett does not invest in gold. However, this does not mean that gold and other precious metals have no legitimate purpose in a comprehensive portfolio.
Specifically, gold can be used (a relatively small amount) as a hedge against inflation and stock market crashes. Gold tends to keep up with inflation – at least better than cash – so during periods of high inflation, gold can help maintain purchasing power. In addition, gold tends to outperform stocks during the shock as investors seek more secure assets. For example, when the financial crisis struck in 2008, the Standard & Poor’s 500 Index fell by 38%, but in fact it rose more than 4% during the year.
The bottom line is that most investment portfolios should invest in productive assets, some of which are cash and equivalents, waiting for attractive investment opportunities using other productive assets. However, there is nothing wrong with investing in a small portfolio of gold or other precious metals to prevent inflation and increase diversification.