Warren Buffett & Howard Marks on gold

The other side of the gold story

In the mid-1970s, a man hunted for a lottery ticket with the last two digits ending in 48. He found a ticket, bought it, and won the lottery.

When asked why he was so intent on finding that number, he replied, "I dreamed of the number 7 for seven straight nights. And 7 times 7 is 48." This story comes from Michael Mauboussin's book The Success Equation.

What this story captures is a common human tendency.

Confirmation bias makes us look for data that only supports our beliefs. The man wanted 48 so badly that he convinced himself 7 × 7 equals 48, blissfully unaware that the real answer is 49.

Often, we all get carried away. In investing, that tendency can come at a real cost. So, let’s challenge our views?

This newsletter is on gold.

After the strong rally over the last few years, many believe that nothing can go wrong with gold and that there is only upside ahead. Especially now, with global uncertainties and Trump in the picture, it might seem like gold can only shine brighter.

Here are the demerits of gold through the lens of Warren Buffett and Howard Marks, two highly successful people in the field of investing.

By the way, if you enjoy finance and good writing, Warren's letters to shareholders and Howard's memos make for a blissful reading experience. Working on this piece reminded me of that again. Make sure you add them to your to-do list :)

With that, let’s turn to their views on gold. I’ve framed them in a Q&A format to give this story some structure. Other than that, this is just a compilation of their thoughts.

1. What makes gold fundamentally different from other assets like stocks?

Warren Buffett: 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.

Comparing gold and farmland, he said:

A century from now, the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty. (On the other hand, a cube of) Gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

“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.”

2. So how exactly does gold derive its value?

Howard Marks: Gold has no financial value other than what people accord it. There's no analytical way, in my opinion, to value an asset that doesn't produce cash flow . . . and especially one that doesn't at least have the prospect of doing so.

What I mean is that it's more challenging to value an empty building than a rented one; or an empty lot compared to one with an office building on it; or a young company relative to an established, profitable one. But at least you can attempt to value the former asset in each case on the basis of its potential to produce cash flow. How do you put a value on an asset that will never throw off cash?

Gold is only worth what buyers will pay for it.

3. But isn't strong demand enough to justify gold's current prices?

Howard Marks: Gold is nothing but a shiny metal. Since its real-world applications are limited to jewelry and electronics, very little of its value comes from actual usefulness.

Also, an investment becomes good or bad depending on what price you pay for it. Consider this conversation:

Howard: How do you feel about gold here at $1,400 an ounce?
Gold bug: Great. I’m sure it will hold its value from here and keep up with inflation.

Howard: Would you be equally sure if it were $2,000?
Gold bug: A little less, but yes.

Howard: At $5,000?
Gold bug: That’s a tough one.

Howard: And at $10,000?
Gold bug: No; there it would be ahead of itself.

Howard: So the price of gold matters?
Gold bug: Sure.

Howard: Then how can you be sure it’s fairly priced at $1,400?
Gold bug: Hmm . . . . .

4. What about gold's historical track record? Hasn't it consistently gone up over time?

Howard Marks: There’s no quantifiable value against which to compare price in the case of gold. Either you agree with those statements or you don’t.

The gold bug points to a past price for the metal and how slowly or quickly it moved from that price.

For example, gold was about $850 in 1980. How do we know gold was priced reasonably in 1980 (in the first place)?

After the 2008 financial crisis, people looked for something safe in the uncertain world. That search led many to look to gold.

Warren Buffett: The rising price has generated additional buying enthusiasm. This attracted purchasers who see the rise as validating their investment thesis. As “bandwagon” investors join any party, they create their own truth, for a while.

5. That means gold prices are just random?

Howard Marks: Quoting an observation of Maynard Keynes about markets in the short term:

A London newspaper once ran a contest with photos of several young women, asking readers to pick the five prettiest. The winner wouldn’t be the one who chose the “prettiest” based on actual beauty, but the one who best guessed who most readers would pick. The smart strategy, then, was not about beauty itself, but about predicting others’ perceptions of it.

Investing, including in gold, often works the same way. It isn’t so much about whether gold has intrinsic value, but about whether people collectively decide to assign value to it.

Warren Buffett: (Gold and similar assets) are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future.

Owners are not inspired by what the asset itself can produce (it will remain lifeless forever) but rather by the belief that others will desire it even more avidly in the future.

Wrapping up

Stocks and gold are, at their core, very different asset classes. While stocks derive their worth from a company’s earnings growth over time, gold’s value comes mainly from what people choose to attribute to it (demand and supply are only part of that story).

Interestingly, both Warren and Howard acknowledge that gold has “worked” in the past and that it might continue to do so.

Howard puts it this way:

“Gold has ‘worked’ for hundreds of years; it probably will keep on doing so. It might not do so forever, but what’s the probability this will be the year it stops? So I wouldn’t bet against it, and I might recommend a position ‘just in case.’ Not because I view gold affirmatively as a moneymaker, but rather as a useful contributor to safety through diversification.”

Warren, on the other hand, is more straightforward. He would rather park his huge cash pile in treasuries, earning almost nothing, than make a meaningful bet on gold.

The point of this piece isn’t to cast gold as the villain of investing. And absolutely not a prediction on whether gold will do well in the future or not.

We’ve written before about how it has repeatedly been a reliable asset in periods of uncertainty.

Gold tends to rise in crises—whether in 2008 or during the pandemic in 2020—offering some relief when everything else is falling.

But when an asset performs well (like gold does now), we often forget its role and get carried away. Just a reminder to keep the blinders off and look at the bigger picture.

(PS: The excerpts from Warren Buffett are from his 2011 shareholder letter, and those from Howard Marks are from his 2010 memo. They’ve been lightly edited for readability without changing the meaning. While central bank demand—now a major driver of gold—rose significantly after these were written, the points they made remain just as relevant today.)

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This Newsletter was written by Satya Sontanam.

Do read What was the RBI's Gulf Rupee? newsletter on our Side Notes by Zerodha Varsity.

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