Warren Buffett: Forget gold, buy stocks

These types of arguments, positioning gold against productive assets such as stocks, have a tendency loosen the weak hands from the secular trend right about the time ‘connected money’ quietly covers more of their controlling short positions. We’ve seen this argument before. Would you take this big cube of metal that produces nothing and yields no interest, or a productive asset such as an equity investment?

It’s not that Buffet is wrong. Over very long periods the logic of this argument is correct. The upward sloping trend or angle of ascension of large- and small-cap total return index to gold ratio illustrates this out performance.

U.S. Large Cap Total Return Index (LCSTRI); S&P 500 Total Return Index to Gold Ratio


U.S. Small Cap Total Return Index (SCSTRI) to Gold Ratio


A close inspection of these charts by astute investors, however, reveals periods (better classified as cycles) of massive underperformance of productive assets. Clearly, there are times when that big cube of metal that produces nothing and yields no interest, significantly out performs productive assets such as stocks for an extended periods of time. Here lies the other side of the argument that if often selectively withheld, because it wouldn’t scare the hell out of you.

During periods of aggressive devaluation, which I characterize as depressionary boxes, gold significantly out performs both large- and small-cap stocks for decades. This devaluation, often a byproduct of today’s quantitative easing used to combat the massive debt burden of the previous expansion, can send stocks soaring in non-constant or nominal currency terms. The growth in the trend, however, is an illusion based on currency devaluation. This is an illusion that the Germans know far too well.

It’s not that Buffet is wrong about the secular trends in place. Stocks tend to out perform gold over long periods of time. The only exceptions are depressionary boxes which are characterized by aggressive currency devaluation. The suggestion to forget gold and buy stocks recognizes the long-term trends in place but ignores the reality currency devaluation (quantitative easing) across the globe with a depressionary box that started in 2000. The "Forget Gold and Buy Stocks" strategy which is certain to be repeated numerous times in the coming years will continue to frustrate investors betting on the resumption of the long-term trend. The fourth depressionary box since 1871 won’t reach is cyclical low for another 5-6 years.

My first question, as I sit there on the couch in his office, is: "What about gold? Is this a classic bubble or what?"

"Look," he says, with his usual confident laugh. "You could take all the gold that's ever been mined, and it would fill a cube 67 feet in each direction. For what that's worth at current gold prices, you could buy all -- not some -- all of the farmland in the United States. Plus, you could buy 10 Exxon Mobils, plus have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?"

Source: money.cnn.com