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JAD_333
09 Aug 15,, 07:48
I've wanted to post this old article by Warren Buffett, aka The Oracle of Omaha, for a long time. For overall financial advice it doesn't get any better. And it's fun reading.

The part I like best is his subtle, or maybe not so subtle, put down of gold-bugs, people who believe gold is the best place to invest their money. Agree or disagree?




Warren Buffett: Why stocks beat gold and bonds

by Warren Buffett

February 9, 2012, 10:00 AM EDT

In an adaptation from his upcoming shareholder letter, the Oracle of Omaha explains why equities almost always beat the alternatives over time.

http://fortunedotcom.files.wordpress.com/2012/02/warren_buffett25.jpg?resize=240,320&quality=80

Investing is often described as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire Hathaway BRK.A -0.09% we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power — after taxes have been paid on nominal gains — in the future. More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.

From our definition there flows an important corollary: The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability — the reasoned probability — of that investment causing its owner a loss of purchasing power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a nonfluctuating asset can be laden with risk.

Investment possibilities are both many and varied. There are three major categories, however, and it’s important to understand the characteristics of each. So let’s survey the field.

Investments that are denominated in a given currency include money-market funds, bonds, mortgages, bank deposits, and other instruments. Most of these currency-based investments are thought of as “safe.” In truth they are among the most dangerous of assets. Their beta may be zero, but their risk is huge.

Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.



Even in the U.S., where the wish for a stable currency is strong, the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time. Consequently, a tax-free institution would have needed 4.3% interest annually from bond investments over that period to simply maintain its purchasing power. Its managers would have been kidding themselves if they thought of any portion of that interest as “income.”

For taxpaying investors like you and me, the picture has been far worse. During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.

High interest rates, of course, can compensate purchasers for the inflation risk they face with currency-based investments — and indeed, rates in the early 1980s did that job nicely. Current rates, however, do not come close to offsetting the purchasing-power risk that investors assume. Right now bonds should come with a warning label.

Warren Buffett: Your pick for Businessperson of the Year

Under today’s conditions, therefore, I do not like currency-based investments. Even so, Berkshire holds significant amounts of them, primarily of the short-term variety. At Berkshire the need for ample liquidity occupies center stage and will never be slighted, however inadequate rates may be. Accommodating this need, we primarily hold U.S. Treasury bills, the only investment that can be counted on for liquidity under the most chaotic of economic conditions. Our working level for liquidity is $20 billion; $10 billion is our absolute minimum.

Beyond the requirements that liquidity and regulators impose on us, we will purchase currency-related securities only if they offer the possibility of unusual gain — either because a particular credit is mispriced, as can occur in periodic junk-bond debacles, or because rates rise to a level that offers the possibility of realizing substantial capital gains on high-grade bonds when rates fall. Though we’ve exploited both opportunities in the past — and may do so again — we are now 180 degrees removed from such prospects. Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”

The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else — who also knows that the assets will be forever unproductive — will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future.



The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

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 “bandwagon” investors join any party, they create their own truth — for a while.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof ” delivered by the market, and the pool of buyers — for a time — expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce — gold’s price as I write this — its value would be about $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?



Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers — whether jewelry and industrial users, frightened individuals, or speculators — must continually absorb this additional supply to merely maintain an equilibrium at present prices.

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 XOM -1.61% 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.

Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.

http://fortunedotcom.files.wordpress.com/2012/02/fate_of_100_dollars.jpg?quality=80

Our first two categories enjoy maximum popularity at peaks of fear: Terror over economic collapse drives individuals to currency-based assets, most particularly U.S. obligations, and fear of currency collapse fosters movement to sterile assets such as gold. We heard “cash is king” in late 2008, just when cash should have been deployed rather than held. Similarly, we heard “cash is trash” in the early 1980s just when fixed-dollar investments were at their most attractive level in memory. On those occasions, investors who required a supportive crowd paid dearly for that comfort.



My own preference — and you knew this was coming — is our third category: investment in productive assets, whether businesses, farms, or real estate. Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment. Farms, real estate, and many businesses such as Coca-Cola KO -0.36% , IBM IBM -0.77% , and our own See’s Candy meet that double-barreled test. Certain other companies — think of our regulated utilities, for example — fail it because inflation places heavy capital requirements on them. To earn more, their owners must invest more. Even so, these investments will remain superior to nonproductive or currency-based assets.

Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle. In the future the U.S. population will move more goods, consume more food, and require more living space than it does now. People will forever exchange what they produce for what others produce.

Our country’s businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial “cows” will live for centuries and give ever greater quantities of “milk” to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well).

Berkshire’s goal will be to increase its ownership of first-class businesses. Our first choice will be to own them in their entirety — but we will also be owners by way of holding sizable amounts of marketable stocks. I believe that over any extended period of time this category of investing will prove to be the runaway winner among the three we’ve examined. More important, it will be by far the safest.

This article is from the February 27, 2012 issue of Fortune.

bolo121
09 Aug 15,, 10:34
From a western point of view he has a very good point. Gold wont give all that great a return while even in these fallan times over a 7+ year period equity returns are still ok.

From an Indian point of view, gold is everything. It is our last resort and the backbone of any Indian family's financial survival.
Second to that is land.
Our governments always utterly trash the economy and destroy the rupee with inflation.
Unless you are lucky enough in investments to have started in the post liberalisation boom years equities are also hazardous.
Most middle class indians still prefer Fixed Deposits or conservative mutual funds.
Only gold keeps us safe.

Doktor
09 Aug 15,, 11:07
Bolo, I was thinking the same. Keep in mind that his thoughts are from a perspective of a huge fund owner, not from a head of a middle-class family. Gold wont give you back more, but will give you some security if times turn harsh.

bolo121
09 Aug 15,, 11:19
Doc, yes a valid observation he was addressing his fellow oligarch overlords.

From my normal point of view, Gold is not for growing your money. Middle class indians know that at our income level this wont happen from equities either.
Gold is our inflation proof last ditch security.
To grow income we depend on land or property.
For example let us say you took a housing loan and bought a 2 bedroom flat in the 1990s in Bangalore.
It would have cost you around Rs 5 Lakh (INR 500,000).
That same flat 20 years later would cost you 60 lakhs to buy.
A new build flat in the same neighborhood would set you back 1.8 crore (18,000,000 INR)

Land in India is an infallible investment because our numbers grow and grow with no control so no matter what, land in any major city is always going to go only one way: up.
Of course as middle class we have to take care and not acquire too much land or land in too valuable an area. Then the big fish will come to seize it and we will be squished.

JAD_333
09 Aug 15,, 20:47
From a western point of view he has a very good point. Gold wont give all that great a return while even in these fallan times over a 7+ year period equity returns are still ok.

From an Indian point of view, gold is everything. It is our last resort and the backbone of any Indian family's financial survival.
Second to that is land.
Our governments always utterly trash the economy and destroy the rupee with inflation.
Unless you are lucky enough in investments to have started in the post liberalisation boom years equities are also hazardous.
Most middle class indians still prefer Fixed Deposits or conservative mutual funds.
Only gold keeps us safe.


Bolo:

The Indian perspective on gold is not at all out of tune with what Buffett says. It's a horse of a different color. What you described is hedging, not investing. It's the same thing oil companies do when they buy futures to insure they get a favorable yield on the sale of crude. Does India offer investment opportunities through an equities market? Can you put your disposable income in publicly traded equities? And have the best of those equities grown in value over time sufficient to offset inflation and add value? If so, investing in them rather than gold makes better sense in the long run.

Gold prices over the past 5 year illustrate the uncertainty of gold as an investment.

http://www.infomine.com/ChartsAndData/GraphEngine.ashx?z=f&gf=110575.USD.ozt&dr=5y

Now look at growth of the India Stock Market (SENSEX) over the past 10 years. See the difference?

http://cdn.tradingeconomics.com/charts/india-stock-market.png?s=sensex&v=201508071315d&d1=20050101&d2=20151231

Many Indians like many Americans have culturally conditioned outlooks that make them prefer to keep their wealth close at hand. I say whatever makes you sleep better at night is okay for you. Just remember gold has no usefulness for the average person. It earns no return, and it's value totally rests on someone willing to buy it from you.

bolo121
10 Aug 15,, 04:11
Jad,

I believe my second post addressed your point. Indians also consider gold as a hedge.
Just plot a second graph for INR vs USD and you get your answer, gold retains value much better than the poor old rupee.
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For growth we look at land or property.
Do keep in mind that we had horrible inflation levels over the last few years as well. Prices for everything were increasing approx 10% every year. 2012 especially was horrible.
Once you adjust for that the sensex gains are much lesser and a fixed deposit with say 8% return per anum looks like a decent bet.
When doing a quick google, I found that the financial press also said pretty much the same thing.

JAD_333
10 Aug 15,, 05:36
Jad,

I believe my second post addressed your point. Indians also consider gold as a hedge.
Just plot a second graph for INR vs USD and you get your answer, gold retains value much better than the poor old rupee.


For growth we look at land or property.
Do keep in mind that we had horrible inflation levels over the last few years as well. Prices for everything were increasing approx 10% every year. 2012 especially was horrible.
Once you adjust for that the sensex gains are much lesser and a fixed deposit with say 8% return per anum looks like a decent bet.
When doing a quick google, I found that the financial press also said pretty much the same thing.

Yes, I see now where you described what is hedging.

A couple of things I'm not clear on.

- Do you have many publicly-owned companies whose long term share growth beats inflation?

- Can Indians invest in foreign markets?

- Why would your land be taken away if you accumulate too much in one place?

- Why did the pace of gold buying in India start falling off a couple of years ago?

I understand the attraction of gold in periods of high inflation. Likewise land. Still, it's been proven that over a 25-year period, accumulating shares in good companies will yield more wealth than holding gold or land for a comparable period of time. However, it may be that the markets in India make this impossible. How much confidence do you have in your markets?

bolo121
10 Aug 15,, 06:01
Yes, I see now where you described what is hedging.

A couple of things I'm not clear on.

- Do you have many publicly-owned companies whose long term share growth beats inflation?

Yes there are a few like Tata Group, Reliance Group, Aditya Birla and so on. But one would have to invest in the 1990 boom times to get that advantage.



- Can Indians invest in foreign markets?

I believe it was heavily restricted earlier, recently the RBI (reserve bank) has granted a limit of 250000 USD.
High net worth individuals do indeed invest abroad. But for the average IT termite earning 30K to 60k INR a month USD investing is too costly.
His boss earnig between 100k to 200k a month might be able to do so.



- Why would your land be taken away if you accumulate too much in one place?

All cities have a land mafia. It is a nexus of politicians/builders/organised criminals. Any really lucrative spot is always in danger of attracting their eyes.
When they demand we don't have any choice but to accept and sell at their price. The more your land holdings the more likely you will come onto somebody's radar.



- Why did the pace of gold buying in India start falling off a couple of years ago?

Economic hard times is the most commonly quoted statement. INR was in bad shape and also RBI had put many limits on gold purchase from abroad.
Now that gold is falling, people are watching and waiting. If it becomes good once more there will be another big rush to buy.



I understand the attraction of gold in periods of high inflation. Likewise land. Still, it's been proven that over a 25-year period, accumulating shares in good companies will yield more wealth than holding gold or land for a comparable period of time. However, it may be that the markets in India make this impossible. How much confidence do you have in your markets?
If you take 25 years ago it was at the cusp of liberalization. Indian middle class as we know it today did not exist.
In the mid 1990s some more fortunate people were able to get in on the ground floor of the boom period and yes they got huge returns.
However the main middle class population grew up in the next decade the mid 2000s onwards. For these people equity growth vs inflation has disappointed.

I personally having worked in finance sector have zero faith in the markets. Small investors are just the suckers the so called 'smart money' fleeces to get their rewards.
But yes i do keep some smaller investments which I can afford to lose in index tracker mutual funds.