Should I Buy 16 Exxon Mobils, or a Lump of Gold?

Everyone’s caught up in the gold bug these days. They see the meteoric rise in gold (check out the chart below) and their palms get all sweaty, they start breathing heavily, and they yell “GOTTA HAVE THAT AWESOME SHINY STUFF, AHHHHHHHH!!” Gold has risen a whopping 500% since 2000, especially during the last couple of years when everyone got really scared that the world was coming to an end. (I never got the logic of that: the world is coming to an end, and you think a piece of pretty shiny metal is going to save you?)

Even my dad, who got me interested in finance in the first place, turned to me really seriously one night and said “Gold should be an essential part in everyone’s portfolio”. He cited numerous convincing reasons: it’s an inflation hedge, the US dollar is falling, it’s the world’s ultimate reserve currency, etc etc. I didn’t really know how to respond to that at the time – it’s really easy to get swayed by complicated, convincing arguments on why you should buy gold, or junk bonds, or tulips, or Moroccan camels.

And then I came across this awesome article in Fortune Magazine written by Warren Buffett, the world’s greatest investor. It’s an adaptation from his upcoming shareholder letter – if you’ve taken a basic Finance 101 class, you can totally appreciate the obvious, simple truths in it. I loved this one particular analogy:

“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?”

Would you? I wouldn’t.

Today, you can put your money into hundreds of investments – A colleague complained to me once that there are just “waaaaay too many choices out there” – How do you choose? Personally, I find it a lot easier to make sense of the whole mess by taking Warren’s advice and looking at all the investment assets in the world as just three types:

1. Currency-denominated assets: Think bonds, money markets, CDs, or your simple POSB savings account. These are supposedly the “safest” kinds of assets to invest in, but you’re really losing money every day because of inflation.

2. “Bigger sucker” assets: Assets that never produce anything, but are purchased with the hope that another buyer will pay more for them in the future. I call these “bigger sucker” assets. Gold falls in this category, along with oil, internet stocks in the early 2000s, silver, cattle, lean hogs (no, seriously, you can invest in them), art, wine, country club memberships, and tulips during the 17th century. You buy them, and after the price rises, you can sell them to a bigger sucker who will pay more than you did. And yes, houses fall into this category too, if you don’t rent them out.

3. Productive assets: these are assets that produce more and more cash flow as time goes by. Think businesses (which produce earnings), stocks (a proxy for owning businesses since they pay you dividends), real estate (which earns you rents), factories, farmland, etc. Sure, the economy is pretty shitty right now, but is the Coca-Cola company going to stop selling Coke, or is P&G going to stop selling shampoos? Doubt it.

No prizes for guessing the best type of investment to put your money in. Hint: it’s not number 2, or whatever assets that’s hyped up at the moment. It could be tulips in the 17th century, or gold today, or Hello Kitty paintings in the Baroque style in the year 2050 (gawd, I hope not). Investments make a lot more sense when you just focus on the basics: when you invest in something, does it actually produce anything? Will it earn an income for you? If it does, you’re probably on the right track.

To my knowledge, there’s only one type of asset that has stood the test of time with 200 years of history, will allow you to invest in real, tangible productive assets, and is still doing amazingly well today. Ladies and gentlemen, stocks are the clear winner in this race. Name any other asset, and I’m willing to bet that they don’t have as long, or as awesome, of a track record as stocks have had.

Could gold outdo stocks in the next couple of years? Sure. But I’m pretty sure that a lump of gold the size of a baseball infield is not going to be more valuable than 400 million acres of farmland and sixteen Exxon Mobils in the long run, no matter how pretty it is.