Munger and Buffet Are Wrong

(Editor’s note: Here is a few articles from Drew Mason at

Dear Warren,

While your investment record is spectacular, last week Charlie Munger made some inflammatory comments about gold and your recent comments completely misclassified the metal. Your sound bites confuse many investors about what may prove this generation’s most critical financial topic as your perspective compares vastly different asset classes through the same lens. Your words and Charlie’s words left thousands of your followers believing gold is a poor use of capital.

Investors believe you endorse the most widely held asset in America, dollar cash, and they hear you denounce its antidote, gold. You do this despite your own admission that dollar cash has been a disaster. If you are wrong on this singular point, as history suggests you will be, your spectacular investment legacy will be tarnished as millions of affluent investors holding concentrated positions in “safe” dollars could be pushed towards poverty.

In a recent letter you appropriately dismember the flawed mantra spewing from the nation’s top business schools and infesting Wall Street, namely the belief that dollar cash is “low risk low return.” As you highlight with words that should be read in every school (see letter linked above):

…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 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 … a nonfluctuating asset can be laden with risk.

…money-market funds, bonds, mortgages, bank deposits … 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…This ugly result, moreover, will forever recur. Governments … 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…if an individual investor paid personal income taxes at a rate averaging 25%, [a] 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.

Thus far in your letter, you sound like your father – acutely aware of the historic devastation caused by holding dollar cash. And as it relates to bonds, you continued with a truth that somehow slips through every compliance department on Wall Street (same letter linked above):

Right now bonds should come with a warning label.

I don’t know if anyone has highlighted the risk of dollar cash and bonds better in recent years. From there however you miscategorize and malign the world’s greatest cash – Gold. “Gold isn’t cash,” I can hear you saying, to the delight of Wall Street.

But as quick as I am to say that it does not matter in the least that I personally believe gold is cash, it is equally true that it does not matter that you believe gold is not cash. The only vote that matters is the market’s vote on the definition of gold. Today the market is the central banks of the world and even more so, it is the emerging private wealth of Asia and the Mideast. Both emphatically believe that gold is cash. Good luck if Wall Street or the US government thinks they are going to invent a derivative or other paper cash proxy that will change the emerging markets’ view. The Asian and Mideast perspective that gold is cash literally spans millenniums and as a result gold enjoys a uniquely powerful advantage – the network effect of emerging world wealth. That reality will outlive both of us.

Asian investors sometimes go so far as to say that gold doesn’t lose value. “Naive investors,” Americans paternalistically sneer. But history says they are much closer to being right than we who believe our cash is safe in American banks. You highlighted what a disaster it has been to hold dollar denominated investments since you took over at Berkshire in 1965. Contrast that miserable experience with the resiliency of gold during that period. Or if you prefer a longer study you can even go back to Roman manuscripts that highlight menial labor would receive one ounce of gold cash for a month’s work. If you pull out your nearest cocktail napkin and scribble in the “menial labor” rate (minimum wage), and multiple it across a six day week without union hours you will see gold has done a stunning job in delivering the ultimate promise of cash: maintaining purchasing power so that its owners can buy ExxonMobil (XOM) or farmland when cheap.

Despite having highlighted that dollar cash is a graveyard for capital, you suggest holding ample dollar cash so that you can sweep in and buy equities on their lows during market sell-offs. Why wouldn’t you counsel your throng of adoring listeners to practice what you do with your equity portfolio – diversify? While you are famous for concentrated positions Charlie would never have let you put 100% of the portfolio in one stock. The risk would have been insane – and that risk management need is glaringly obvious even as it relates to risk capital. How much more does capital earmarked for safety deserve some risk management through diversification?

Beyond the enhanced safety investors would derive from holding some beautifully uncorrelated gold currency rather all dollar currency, even you would have done notably better in your illustrious career if you had simply diversified your cash holdings into 80% T Bills and 20% gold cash.

To highlight this we went back to 1965 when you started at Berkshire Hathaway (BRK.B), the time frame you chose to reference in your letter. Since that time we observed nine stock market sell-offs of 20% or more, seven of which came during periods when gold has traded freely. We created a theoretical cash hoard and grew the cash over the years using the three month TBill rate. We then looked at the equity trough prices and used the corresponding gold price as the stock market bottomed.

What we observed was that in six of the seven free market sell-offs, investors with gold cash allocations would have been better positioned to buy distressed equity markets that those who held 100% dollar cash. That alone makes a strong case for holding gold within a cash allocation but if you consider that the sole outlier occurred post the internet mania when gold was bottoming from a 20 year bear market, the rarely practiced case for owning some gold as a cash diversifier is stunning. Furthermore the difference in value between the two portfolios was less than 1% on the lone occasion gold did not add value. In contrast the average difference in the portfolios on the other six equity lows where gold was held provided more than 20% incremental buying power, a notable divergence.

What if investors want flexibility for purchasing power outside of intense stock market sell-offs? Of the 40 year-end observations we have since you took the helm of Berkshire while gold has traded freely, a cash portfolio containing 20% gold currency would have benefited from more purchasing power than 100% dollar cash in 37 cases. The three exceptions were 1999-2001, again the trough of the gold cycle and the zenith of the equity markets. That is exactly how an owner would hope gold cash would perform – an uncorrelated asset that withers in the face of blossoming democracy, capitalism and public sector restraint, yet is a bedrock fortress of wealth preservation when those virtues fade from the investment landscape.

Further from a qualitative perspective your statement: “What motivates most gold purchasers is their belief that the ranks of the fearful will grow” is patently untrue. What motivates gold purchasers is the awareness of your point – throughout history politicians debase paper currencies and paper currencies are graveyards of capital. So we again come back to the simple question, why would a rational investor use fatally flawed paper currencies to hold 100% of their “store of wealth” rather than diversifying with gold cash?

You may concede what I have laid out is true but appropriately argue that as the manager of Berkshire you need the liquidity of $10 billion on a phone call. I concede this point to you and admit you have better liquidity today in T Bills for that size than you do in gold cash. But from being on the front lines with investors, what you probably don’t realize is happening is that individuals and smaller institutions that can realize the liquidity they need via the gold markets are behaving as if they need to fill $10 billion on a wire with their allocations. For virtually all investors, the liquidity of physical gold is more than sufficient to fill on a phone call. You would do your followers a benefit by highlighting this truth for them given the significant performance and diversification benefits of holding some gold.

Finally we must consider your representation that gold is a “huge favorite of investors.” You even go so far as to lump gold in with other financial bubbles from history. With all due respect, how can gold be a huge favorite of investors if its market capitalization is 1% of global wealth and physical gold is only held by 1% of investors? How can there be the leverage necessary to characterize a bubble in the physical markets when for all intents and purposes investors cannot get any leverage on the physical? And how can the price suggest to you a bubble when you have held numerous investments that have outperformed gold’s rise over the last decade? Indeed gold is still more than 50% below its prior real peak using classic CPI.

I submit to you a more realistic portrayal is that gold has been so completely shunned that not even a dozen pensions own a physical ounce today in the US (as opposed to paper claims). I believe the greatest financial irony of our times may be when the world realizes the unexpected upside one can derive from the safest of assets. Why? In the realm of asset safety, gold is the rare beachfront property comprising just 1% of investable opportunity and no syndicate desk can alter that supply reality. Gold allocations would need to rise fivefold to approach prior cycle peaks and physical volumes are down in excess of 80% from prior peaks.

You said “What the wise man does in the beginning, the fool does in the end.” (see link to letter above) Who will be the wise man who gets his S&P Company to begin holding gold as a current asset? Virtually none do in the S&P, and all are subject to the same vagaries of withering cash with their dollar hoards that you highlighted. Does that make sense? True, today the conflicted American accounting regulations would not treat gold as cash like international accounting regulations … but such accounting flaws are why you point investors to cash earnings rather than reported earnings – the key metric is the creation of value. The day will come when this will change, however, and when the exception turns into the trend, we will have a gaiting problem.

Let’s say that seven American companies decided they wanted to move 20% of their cash (current assets less current liabilities) into gold. If those companies were Microsoft (MSFT), Apple (AAPL), Johnson & Johnson (JNJ), General Electric (GE), Dell (DELL), Cisco (CSCO) and Oracle (ORCL) it would take almost two years of global gold production to fill their orders. And such a timeline is naively optimistic even if there weren’t any other gold buyers in the world because today’s production numbers are confined to the world of academia. The reality is that the list grows of nations that do not release their gold to the global markets because gold is too strategically important to export. Imagine, China not exporting something that it leads the world in? Such is the unrivaled intrinsic value of gold from the vantage of Asia.

There is no more important financial topic today than gold/dollar weightings within cash allocations because the dollar is the most widely held asset in America. If paper cash continues to whither, as we both expect it will, having some gold will be crucial for those holding high cash positions. I invite you to join me and cast our nets into deep water on this topic via a public forum. Investors need to make a more informed decision about cash protection than they can get through your sound bites on this key topic.

1 comment to Munger and Buffet Are Wrong

  • Ed_B

    What a great article! Concise, informative, and absolutely powerful. Kudos for such a perfect answer to the stock guys, including Buffet and Munger. Almost all stock guys hate gold and silver because they know that once money leaves a profitable stock account for investment in precious metals it rarely, if ever, returns. Stock guys make their living by buying and selling stocks, so anything that threatens their livelihood is bad and anything that enhances it is good… for them, anyway.

    I have made my share of money in stocks, so am not denigrating them as a good investment. What I do say to others, though, is that one needs diversification among different asset classes if one is to successfully ward off most of the bad things that can happen in this crazy casino we call the stock market. Commodities are one of the best investments out there. They represent REAL value and not some cobbled up paper value that may or may not be worth the paper upon which it is printed. Oil, gas, timber, food crops, cattle, land, cloth crops, precious metals, etc. are all in demand and will continue to be as the world’s population continues to grow.

    One thing not mentioned enough these days is that gold and silver ARE alternative currencies. If they were “just commodities” as some suggest, why then do they occupy space in many bank vaults? We do not see any other commodities placed in bank vaults, so what makes gold and silver different from wheat, oil, or rubber? The fact that they are M-O-N-E-Y has everything to do with it! And the central banks around the world are loading up on gold by the ton. Could it be that they know something that most investors do not? You better believe it!

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