Gold prices have been plummeting for some time, but is this enough to convince people that gold is not the safe haven it is widely believed to be?

In a classic case of, ‘Be careful what you wish for,’ when the King Midas of classical myth was offered whatever reward he chose, this was his request: “May everything I touch be turned into gold.” This worked very well when he touched household items and roses, but less well when he tried to eat or, tragically, when he embraced his beloved daughter.  He quickly learned that gold cannot love you back.

Few objects, outside of religious texts and artifacts, are imbued with the powerful symbolism of gold.  Perhaps nothing speaks a more universal language. Our daily conversation is riddled with it: individuals have the golden touch, a heart of gold, are as good as gold. From the beginning of recorded time, gold has represented light, purity, incorruptibility and, perhaps most potently, wealth. People have hoarded gold, died for it, killed for it.

For centuries, gold was not simply symbolic of wealth but was the almost universal currency by which an exchange or trade was valued. Gold was quite literally money. Gold also had the capacity to store wealth, so it was hoarded and carefully guarded. 

In the 19th century, major currencies were based on the world gold standard system. This has not been the case in Canada since 1931, but people continue to hoard gold as if it were. The historical significance of objects and traditions often linger long after they have ceased to have power in real life.

All this is to give the context in which investors run to gold when they are fearful, as when they want to hedge against inflation. Gold is considered a safe investment because it is still seen as a timeless way to protect and build your wealth.

In perhaps the most convincing rebuttal of this view, Warren Buffett makes this proposition.  Given the choice between all the gold in the world and the equivalent value in land and corporations it would buy, which would you choose?  Before you jump to an answer, let’s hear him out:

Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this [in his Berkshire Hathaway shareholder letter, February 2012] – its value would be about $9.6 trillion. Call this cube pile A.

Let's now create a pile B costing an equal amount. For that, we could 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). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

When you invest in pile B – as you do when you buy equity in the world’s greatest companies on the stock market – you are purchasing value-producing assets with huge potential for wealth creation. Decade after decade, the farmland will continue to produce valuable crops and generate the wealth to invest in other productive industries.  The companies will continue to produce goods and services people need and want, adapting to changing circumstances and thereby continuing to add to their assets and deliver dividends to their investors. People will continue to exchange what they produce for what others produce, using whatever currency is relevant at the time.  As an investor, your wealth will grow as your assets continue to produce value and retain their purchasing power. 

The massive cube of gold, on the other hand, will remain fundamentally unchanged and unproductive.  If you own a bar of gold, it will not pay you interest or dividends.  It’s true that if enough people turn to gold when they become fearful, its value will rise, but only in relation to its inherently emotional value to a very large number of people.  What is the value of a fine painting or a classic car?  Only what another person is willing to pay.  If that painting or car is then resold at a higher price, it is not because either has changed in some fundamental way but because both buyer and seller believe their value has increased.  Similarly, gold cannot be valued objectively.  When you buy gold to grow or store your wealth, you are counting on many others subscribing to your belief system that gold has an intrinsic value, outside of whatever practical use it may offer.  However, emotions are fickle.  In Mr. Buffett’s pithy aphorism, “As ‘bandwagon’ investors join any party, they create their own truth – for a while.”

Of course, there are other ways of owning gold other than hoarding it as a stand-in for money.  A well diversified investment portfolio might well include gold mining stocks, which would give you ownership in productive assets.  The difficulty, of course, is that the product of these mining companies has the limitations discussed above.  Additionally, gold is valued for its rarity, so production has to be controlled.

It is hard to escape the conclusion that buying gold or gold stocks is speculating, rather than investing.  You gamble with your wealth in guessing what value people will place on gold at some point in the future.  Better to own companies with their metaphorical feet planted firmly on the ground.

Daryn Form is a Senior Financial Advisor with Assante Capital Management Ltd. providing wealth management services to principals of family-owned and privately held companies. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and is registered with the Investment Industry Regulatory Organization of Canada.  The information mentioned in this article is for general information only. Please contact him to discuss your particular circumstances prior to acting on the information above.  The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd.  Rates are not guaranteed and are subject to change at any time without notice.