• There is a time, place and price for every asset class.
• 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.
• The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn't going to do anything for you.... [I]t is an entirely different game to buy a lump of something and hope that somebody else pays you more for that lump two years from now than it is to buy something that you expect to produce income for you over time.
• Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid, you make money; if they become less afraid, you lose money -- but the gold itself doesn't produce anything.
• I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side.... Now for that same cube of gold, it would be worth at today's market prices about $7 trillion dollars -- that's probably about a third of the value of all the stocks in the United States.... For $7 trillion dollars ... you could have all the farmland in the United States, you could have about seven ExxonMobils, and you could have a trillion dollars of walking-around money.... And if you offered me the choice of looking at some 67-foot cube of gold and looking at it all day, and, you know me, touching it and fondling it occasionally.... Call me crazy, but I'll take the farmland and the ExxonMobils.
• 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.
• I have no views as to where it will be, but the one thing I can tell you is it won't do anything between now and then except look at you. Whereas, you know, Coca-Cola will be making money, and I think Wells Fargo will be making a lot of money and there will be a lot -- and it's a lot -- it's a lot better to have a goose that keeps laying eggs than a goose that just sits there and eats insurance and storage and a few things like that.
-- All of the above quotes are from Warren Buffett
In many ways, I have shared Warren Buffett's skepticism on gold, as expressed in his seven quotes above.
Also, in support of Warren's ursine view of the precious metal, is Oaktree Capital Management's Howard Marks, who has written that gold is a lot like religion. In religion, you either believe in God or you don't. In the gold market, you either believe in gold or you don't.
In the past, I have agreedon the subject of gold with both The Oracle of Omaha and The Oracle of Oaktree. In fact, I recently debatedwith Peter Schiff about gold, providing the bear case for the asset class (albeit, at much higher prices).
In essence, the gold market is a state of mind -- the subject of gold is an emotional one. It neither represents a corporate franchise that increases over time as profits are earned and retained such as, say, Procter & Gamble ( PG), with a protected moat -- nor is it a productive asset. As such it is hard to ascertain what the intrinsic value of the commodity is.
On the latter point, gold doesn't produce profits or cash flow and, as such, fails to provide a stream of income. Its future price is simply dependent upon someone willing to pay more for the asset class compared to its price today.
While it might take time for the price of gold to build a real bottom, there is a time, place and price for every asset class.
Why Now?
This morning, I paid $133.30 for SPDR Gold Trust ( GLD) in premarket trading.
Below I will discuss my reasons for building a position in gold over the next few weeks and months.
Expectations for the price of gold are now low and diminished . Gold experienced a speculative blow-off top 18 months ago as the European debt crisis peaked, the threat of a U.S. default ceiling rose and coincident with the debt rating of U.S. being lowered.
A most unpopular asset class provides a contrarian's appeal . Weak price action since September 2011 has created an improved reward vs. risk. Hereis the price of gold since 1833. And below is a chart that follows the price of gold since 1970.
As you can see, the price of gold is more than $500 an ounce below the fall 2011 peak.
Last month's gold selloff looks like a selling price and volume climax . That first day of the mid-April collapse was a near 5 standard deviation move lower (or every 4,700 years) on huge notional volume of $20 billion. On the following Monday, gold took an even greater beating. Over the two-day period, there was a 8 standard deviation event, which occurs statistically about every billion years.
Negative sentiment extreme . The sharp price drop in gold has brought on a growing short position.
With it lies the seeds for a potential short squeeze or perhaps some latent demand from short sellers.
The growing consensus view of an acceleration in the rate of global economic growth may be too optimistic . As such, not only might the recent rise in real interest rates be nearly over (as it holds the seeds for detracting from growth) but it raises the prospects for more QE, lasting much longer than many market participants expect.
The U.S. dollar's recent strength might peter out . A higher U.S. dollar is typically seen as a gold negative. But the recent strength, reflecting a growing consensus of Fed tapering, might be short circuited if global growth moderates.
More currency debasing lies ahead . The currencies of all the major countries, including ours, are under severe pressure because of massive government deficits. The more money that is pumped into these economies (the printing of money, basically), the less valuable the currencies become and more valuable gold is.
Inflation is gold's friend . The world's debt load cannot be paid back in constant dollars. Reflating (and inflation) seem inevitable (though inflation may lie out into the distant future) and is the natural outgrowth of monetary policy.
Tail risks remain . I don't subscribe to the notion that all economic tail risks have been eliminated nor that the shoulders of growth will be borne by monetary policy. Rather I view an upcoming "aha moment," in which it becomes recognized that easing is losing its impact as the Fed is pushing on a string. Again, QE might be with us for a lot longer than many anticipate.
Demand for physical gold is rising . It is interesting to note that when the price of gold had its two-day crash in mid-April, the price for physical delivery (gold coins, etc.) held better (the premium increased) than future prices. (View about 33 minutes, 50 seconds into this presentationby Grant Williams.)
Previously bullish brokerages have given up on gold . Credit Suisse , JPMorgan and Goldman Sachs have recently slashed their gold price projections. I view this surrender as consistent with a possible contrarian signal.
Summary
Recognizing that the intrinsic value of gold is difficult to evaluate, now seems a propitious time to consider diversifying some portion of one's portfolio into gold.
There is probably no better time to consider diversifying one's portfolio into a depressed asset class (e.g., gold) than when the crowd is optimistic about a vigorous and self-sustaining global economic recovery and when the world's stock markets are at record high prices.
Gold, which had a speculative blow-off to the upside back in 2011 (18 months ago), now appears to have had a selling climax last month.
Investor sentiment toward gold probably can't get much worse, and the growing optimism regarding the trajectory of global economic recovery may not get much better in the weeks and months ahead.
Position: Long GLD
Douglas A. Kass
Seabreeze Partners Management Inc.
