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The Gold Riddle: Not Alive But Immortal

31 October, 2013

The Gold Riddle

Since about 2010, renowned investment manager Warren Buffett has been telling a “Pile A - Pile B” story to explain his opinion on gold. Because market conditions affect the numbers, each retelling of this anecdote has featured slightly different values, but the basics are the same. Here’s a synthesized version, drawn from columns published over the past four years.

Pile A and Pile B

If all of the gold ever mined was collected and melded into one block, it would form a cube of about 68 feet per side. (Picture a square six-story building fitting comfortably within a baseball infield.) At approximately $1,300/ounce (the spot price near the end of April 2014), this cube would have a value of more than $7 trillion. Let’s call this huge solid gold cube “Pile A.”

In contrast, let’s take a look at what else $7 trillion might buy. Here is Buffett’s recommendation for “Pile B”:

“For $7 trillion, we can 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).”

Buffett asks: “Which would you take? Which pile is going to produce more value?”

Buffett’s answer: “Call me crazy, but I'll take the farmland and the Exxon Mobils.” We know Buffett’s not crazy, but can you explain why?

Gold Isn’t “Alive”

The gold cube just sits there. It doesn’t grow, it’s not “alive.” If its value appreciates, it means the gold is worth more per ounce in dollars, not that you have more of it. And the only way to realize value from the cube of gold is to shave some of it off and exchange it for something else (like food, shelter or entertainment). Every time you do that, your cube gets a little bit smaller.Other assets can produce value by adding human capital – sweat, knowledge, creativity. A farmer works the land. Exxon applies the intelligence of engineers and managers to extract and deliver fuel. Buffett understands human capital is the catalyst for all wealth creation; this understanding shapes his investment decisions. The 68-foot gold cube isn’t very conducive to combining with human action. As he says, “you can fondle it, but it won’t respond.”

On the Other Hand, Gold is Immortal

Buffet’s ongoing argument against gold has prompted rebuttals. In a May 2013 online commentary, Julian Phillips notes human capital has its limits as well.

“Mr. Buffett’s ability to make money is dependent on the continuation of a growing U.S. economy. More importantly it depends on his mortal skills as an investor. Gold is immortal…Gold will survive if there is no U.S. economy.”

This is an important distinction for Phillips. Because it has a long history as a storehouse of wealth, he concludes “Gold is not bought by people to make money, but by people who have money.”

When Phillips says gold is immortal, he means you can’t destroy it. If you melted down the 68-foot cube, the pool of gold would have the same value. If you pulverized it into dust, a miner could sift and separate to reclaim it. However, if you incinerate a $100 bill, what are the ashes worth? And when Mr. Buffett dies, can his financial value as an investor be resurrected? No. These values are gone.