Don’t Buy Commodities (i.e. Gold)!
“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….it 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.” – Warren Buffet
So What Are Commodities?
Commodities are typically raw materials/resources such as oil, gold, silver, and corn.
They are inherently different from investments that are financial assets (i.e. stocks, bonds, real estate). The reason why commodities are not financial assets, is because the value of commodities is derived from supply and demand based on global needs for usage/production and its loose ties to inflation. True financial assets, like stocks, grow in value over time because they are an ownership stake in real businesses that generate profit and long-term growth.
So Why Not Commodities?
Fans of precious metals like to point out that government currency is fiat money, and that the only thing keeping something like the dollar going, is based strictly on “faith” and not due to inherent value. I agree with this sentiment, since all currency requires an element of “faith” in the government’s ability to back it up, or no one would use it. But similar to the dollar, or any other global currency, I feel the same argument can be stated for precious metals.
Secondly, in a catastrophic event, I don’t think people will start hauling their gold ingots, bars, and coins to their nearest store to exchange for goods, or when bartering with other individuals. I’m pretty sure canned goods, water, and ammunition will have higher trading value.
Lastly, commodities and precious metals are typically bought as a hedge against inflation and for their low correlation with the stock market. The latter is relatively true, but I’d argue that plain old cash is an even better diversifying asset because it has zero correlation to the market.
How Have the Returns Been on Commodities?
For the past 26 years (since the creation of the Bloomberg Commodities Index), commodities have shown lower returns than cash, with higher volatility than stocks. And for the past 42 years, commodities in aggregate, have been trounced by the US Stock Market (see graph below):
But Gold Has Been Used For Centuries, if not Millennia!
Many argue that gold has intrinsic value because it’s been used for a long time. And that there’s something inherent about gold, that human beings will always be drawn to. So to argue against this, my point wouldn’t be to disagree with the notion that gold has always had allure. I think it still does. If you’ve ever seen or held gold, I do agree that the sheer glitter of gold has a distinct “pull” that feels very primal.
But the point I’m trying to make isn’t that gold has absolutely no value. The point is that it’s not a true financial asset and is a difficult instrument to gauge value on, due to its’ currency-like nature. And lastly because, quite frankly, the returns have been horrendous compared to real financial assets like stocks and bonds, and even cash! See below graphic for data on the growth of just $1 in the past 210 years across different instruments.
“Because gold, unlike stocks, bonds, real estate and other financial assets, generates no income, valuing it is all but impossible. “It’s intrinsically worthless or intrinsically priceless. You can build a financial model to value it, but every input is going to be your imagination.” – Paul Brodsky, Strategist at Macro Allocation
Do you currently have any allocation towards precious metals or other commodities, like gold, silver, or oil? If yes, what was your thought process behind it? But more importantly, did my arguments against commodities introduce a solid enough viewpoint, and did it change your mind? Why or why not?