Worth of Gold

The safe heaven gold evokes a mixed emotion among the investors, the question to be asked is what the actual worth of gold is?

In an interview on CNBC, Charlie Munger, Vice chairmen of Berkshire Hathaway once stated that “Gold is a great thing to sew into your garments if you are a Jewish family in Vienna in 1939. Civilized people don’t buy gold. They invest in productive businesses.”

What’s the value of Gold?

Gold neither earns anything nor has any cash flow like equities. Financial theory states that the intrinsic value of an asset is the future cash flows that the business generates discounted to present year. Since gold has no cash flows which can be discounted back, investment in gold becomes completely speculative. The worth of the gold is nothing but what the buyer is ready to pay for it as it has no intrinsic value.

Many people consider gold as a safe haven asset. The market price of gold goes up when the stock market trend is extremely bearish. This happened during the referendum in UK. People of Britain voted for the exit of Britain from the European Union. The price of gold suddenly rose when stock markets all over the world crashed because gold is considered a safe asset. The price of gold is dictated by the mood of the market and not because it has an intrinsic value. It has no intrinsic value as it is not a productive asset.

Intrinsic value of an asset is arrived at by discounting the future cash flow to present value by the required rate of return. All productive assets have associated cash flows. Bonds give us interest and the maturity value at the end of its term. Equities give us dividends. If the company is not declaring a dividend the earnings get added back to reserves and this addition generates a return in the future. This is the reason that Warren Buffett calls equities as having growing coupons. Investment in Real Estate Assets generate rent. As all these assets have cash flows and we can arrive at their intrinsic value. As gold is not having an associated cash flow it is difficult to arrive at its intrinsic value.

In a 2012 interview, Warren Buffett explained his anti-gold stance: “When we took over Berkshire, it was selling at $15 a share and gold was selling at $20 an ounce. Gold is now $1,400 and Berkshire is $210,000.

If you buy an ounce of gold today and you hold it for a hundred years, you can go to it every day and you could coo to it and fondle it and a hundred years from now, you’ll have one ounce of gold and it won’t have done anything for you in between. You buy 100 acres of farm land and it will produce for you every year. You can buy more farmland and all kinds of things, and you still have 100 acres of farmland at the end of 100 years.

"You could buy the Dow Jones Industrial Average for 66 at the start of 1900. Gold was then $20. At the end of the century, it was 11,400, and you would also have gotten dividends for a hundred years. So a decent productive asset will kill an unproductive asset.”

When comparing holding gold to stocks such as Coca-Cola and Wells Fargo, Buffett once commented that “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.”

One should invest in gold for the purpose of diversification of the portfolio. Whether gold prices will soon tumble or go higher cannot be told. What one can say for certain is that the ETPs/ETFs (Exchange Traded Products/Exchange Traded Funds) backed by physical gold are an excellent way to gain exposure to the yellow metal for investors and speculators alike.