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Buffett Mischaracterizes Gold's Bull Market

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Yes, gold and gold shares will probably flame out in spectacular fashion, but this is closer to 10 years away than one or two years.

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Once again, someone famous is dismissing gold, and once again, that someone is Warren Buffett. In comparing it to the bubbles in housing and Internet stocks, he feels he'll ultimately be vindicated. In his annual letter to shareholders, Buffett trashed gold as a bubble that is being driven by fear of other asset classes. He believes that those who buy today only do so because they believe the "ranks of the fearful will grow."

Fear is a word that is tossed around all too often when ignorant commentators and analysts have to justify a rise in gold. They can't say its a bull market. They can't say it's supply and demand. They can't explain the fundamentals. Fear is an incomplete explanation.

Fear should refer to fear or concern about the value of reserve currencies, not other asset classes. This is not rocket science. The developing world understands the value of gold, as various currencies under the weight of financially weak governments lost significant value throughout the 20th century. Do you think the pound or the dollar has a bad track record? Consider the history of currency destruction in Eastern Europe, Latin America, and Southeast Asia. It is multiples worse.

Generally speaking, Buffett is right: Stocks or businesses are a better investment than gold. They make sense. They produce something; they earn profits. They grow. Even considering the survivorship bias, the trend for stocks historically is always higher. Gold is a speculation and always will be. However, Buffett fails to note the long-term cyclicality between stocks and gold. The inverse relationship is clear, and gold's time is now.

The current case for gold is all too simple. The leading nations of the world must monetize current and future debts to prevent a potentially catastrophic deflationary depression. In a debt crisis, currencies lose substantial value. We are in a global debt crisis, and ground zero is the developed world.

But gold is a bubble! It's gone up 10 years in a row and the public is in. Right?

Did you know the Dow Jones Industrial Average (^DJI) from 1985 to 1999 only had one year in the red, and it was only a decline of 4%? Did you know the global allocation to gold and gold-related investments is barely more than 1%? Furthermore, if gold were in a bubble, we wouldn't be seeing the large-cap stocks trading at 12 times trailing earnings (see Market Vectors Gold Miners ETF (GDX)), nor would we see junior exploration companies trading at multiyear lows relative to gold.

Clearly Buffett doesn't understand gold. He doesn't mention its appeal as an inflation hedge or as a currency. He falsely assumes its rise is a result of only wild speculation and a disdain for everything else. He has no idea how underowned gold is, nor is he aware of the valuations of the shares.

However, you can't fault his reasoning for wanting to own stocks. He believes he can invest in companies that will benefit from inflation or continue to earn profits that will outpace inflation. He has investments in energy companies and agriculture companies. To some degree, those companies are affected by commodity prices. Why not consider an investment in Silver Wheaton (SLW) or Franco-Nevada (FNV)? There has to be someone in Buffett's camp who is intrigued by the precious metals royalty companies. They don't have mining risk. They earn profits and pay a dividend.

In the long run, Buffett will be right. Gold and gold shares will probably flame out in spectacular fashion. The public will get killed. However, this is closer to 10 years away than one or two years in the future. Many were calling stocks a bubble in 1995. Not 1999. 1995! That was when the bubble was just getting started. The next breakout in the gold equities and the metals themselves will serve as a recognition move to the masses. It will be a springboard to an eventual bubble. This is a very volatile, cyclical sector, so one must do Buffett-like due diligence in picking stocks.

Good luck!

Editor's Note: See more from Jordan Roy-Byrne at The Daily Gold.
No positions in stocks mentioned.

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