Last month Warren Buffett published his annual shareholder letter in which he explained why he doesn’t like gold:
“What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As a ‘bandwagon’ of investors join any party, they create their own truth – for a while”.
Why Warren Buffet doesn’t like gold
Buffet is a value investor and he was taught and mentored by the father of value investing Benjamin Graham, a man who is widely considered to be one of the greatest investors of all time. Key to the value investing approach is determining intrinsic value, and therein lies the problem.
Unlike with a stock where you can analyse such metrics as PE ratio, price-to-book ratio, debt/equity ratio, free cash flow, and price/earnings to growth ratio (PEG Ratio), with gold you have none of these things. This is the reason Warren Buffet doesn’t like gold. He cannot determine its intrinsic value and therefore he cannot decide if it’s under, or over valued.
This means that Buffet is missing out on what (in my opinion) will be one of the greatest bull markets in history.
How to value gold
A recent study by Ray Dalio of Bridgewater Associates, one of the most successful hedge fund managers in the world, examined the relationship between the global money supply and the price of gold. Dalio, who oversees over $100 billion, took the combined money supplies of the worlds largest economies and overlaid the price of gold.
His analysis revealed that there is a 90% correlation between the global money supply and the price of gold. His work also revealed that gold is now 20% below where it should be given the huge increase in the global money supply we have seen in recent months.
Traditional analytical methods cannot be applied to gold. Gold investors need to understand the historical relationship between the supply of paper (fiat) money, and the value of real money, i.e. gold. Gold is the opposite of paper money (British Pounds, Euros, US Dollars, etc.) and gold’s value increases as paper money becomes worth less and less.
In short, gold will continue to rise because governments and central bankers will continue to print money in an attempt to solve the world’s problems. Gold’s rise has nothing to do with investors jumping on the bandwagon, and everything to do with more and more of them taking steps to protect their wealth.