Gold Is No More Of An Investment Than Beanie Babies

My last column, Don't Be Silly, You’re Not Investing When You Buy Collectibles, argued that
postage stamps, baseball cards, beanie babies, and other collectibles are not real investments
because they don’t generate any income. I received several responses, public and private, arguing
that gold, expensive jewelry, scarce coins, rare books, and fine art are investments—evidently
because many people own them and their value has gone up over time.

For a value investor, an object is not an investment just because its price has gone up. A value
investor thinks of an investment as a money machine that generates income; for example; a stock
that pays dividends every quarter or an apartment that generates rent every month. The intrinsic
value of such a money machine is how much you would be willing to pay in order to get the
income forever. No one holds stocks or apartments forever, but thinking this way forces value
investors to focus on the income and not try to predict ups and downs in prices.

A speculator, in contrast, buys stocks, real estate, or other things to sell for a profit. To
speculators, something is worth what someone else will pay for it, and the challenge is to guess
what others will pay tomorrow for what you buy today. This sort of guessing game is derisively
called the Greater Fool Theory: you buy something at an inflated price, hoping to find an even
bigger fool who will buy it from you at a still higher price. Or as John Burr Williams, the original
value investor, put it, a speculator intends “to profit only by finding another buyer who was a
‘bigger sucker’ than himself.”

Speculators may profit from their speculation, but they should realize that it is just that—
speculation—not value investing. Think about gold, a historically attractive and sometimes
profitable investment. The most salient fact about gold is that it has no intrinsic value, in that it
generates no cash whatsoever. In fact, it has a negative intrinsic value to the extent that investors
must pay storage and security fees to safeguard it.

In a 1998 speech at Harvard, Warren Buffett said that gold “gets dug out of the ground in
Africa or someplace. 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.”

In his 2011 letter to Berkshire Hathaway shareholders, Buffett estimated that if we were
collect the world’s gold stock and melt it into a giant 170,000-ton cube, it would be about 68 feet
on a side and fit inside a baseball field easily. At the 2011 price of $1,127 per ounce, it would be
worth about $9.6 trillion.

For that $9.6 trillion, we could instead buy all U. S. cropland, which generates $200 billion in
revenue each year plus 16 Exxon Mobils, each earning $40 billion, and still have $1 trillion left
over to buy other revenue-generating assets. Buffett concludes with his usual wisdom and wit:

A century from now the 400 million acres of farmland will have produced staggering
amounts of corn, wheat, cotton, and other crops—and will continue to produce that
valuable bounty, whatever the currency may be. Exxon Mobil will probably have
delivered trillions of dollars in dividends to its owners and will also hold assets worth
many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be
unchanged in size and still incapable of producing anything. You can fondle the cube, but
it will not respond.

Value investors do not invest in gold, diamonds, or other metals and gems—no matter how
precious—because they are not money machines: they do not generate income.

The same is clearly true of coins, books, and art. Feel free to speculate, but please don’t call
it an investment. Ditto with the argument that it is fun to collect things—stamps, coins, books,
bottle caps, seas shells. Feel free to call it a hobby, but please don't call it an investment.

Some people argue that they buy art because they like to look at it. I, too, decorate my home
with paintings and photos, but the pleasure I get from these decorations is worth hundreds of
dollars not millions. People who are considering spending a million dollars on a painting because
they say they enjoy looking at it should ask themselves how much they would pay to rent the
painting. If they are willing to pay $50,000 a year ($137 a day), increasing by 5 percent annually,
to rent the painting, then the intrinsic value at a 10 percent discount rate is indeed a million
dollars. If they aren’t willing to rent it for $50,000 a year, increasing by 5 percent annually, then
the viewing pleasure isn’t worth a million dollars.

The argument for buying fine art for the viewing pleasure is contradicted by the fact that an
original piece of art is worth millions, while a forgery is worthless, even though only an expert
can tell the difference between the two. Going further, why is a painting worth so much more if it
has a famous signature? Isn’t the viewing pleasure the same?

Several years ago, an Australian art professor took me to a Melbourne museum and showed
me some aboriginal art. One was a piece of bark decorated with several seemingly randomly
placed red dots. I asked the professor what he would think if I were to paint the same thing,
which I surely could. His reply was immediate and dismissive: “Well, then it would be rubbish,
wouldn’t it?”

In the modern-art market, people pay tens of millions of dollars for pieces of canvas painted
a single color—if the paint is applied by a celebrated artist. If you or I were to paint the same
thing, it would be rubbish.

How can we conclude anything other than the Greater Fool Theory?