Mathew Harrison

On Gold

Given the dramatic drop this week in the price of gold, we thought it timely to revisit Burgundy’s view on the topic.

At Burgundy, we are often asked about gold and, more specifically, why we are reluctant to own any in our portfolios. It’s not that we haven’t considered whether gold would be an appropriate portfolio investment – we have – but we have concluded that we are experts in quality companies, not commodities. An investment in bullion, or any other direct commodity investment, would be outside our circle of competence. Let me explain.

Gold, from our perspective, is almost impossible to value. Like art and rare bottles of wine, gold is only worth what the next buyer is willing to pay. To illustrate, let’s use an example similar to that used by Warren Buffett in a Fortune article from February 2012. If I sold you a bar of gold, you now have a wonderful-looking piece of metal that does not provide you with much of anything besides its good looks. It does not produce anything, nor does it pay you interest or dividends. In fact, you will probably need to pay to insure it and have it stored in a safe and secure location. A few years down the road, you might decide that it is time to sell your gold and approach me to make an offer that is greater than what you paid, plus your expenses to own it. Since the asset has not changed on a fundamental basis over that time – there is no more intrinsic value in the gold bar now than when I sold it to you – the price I offer will be based on a belief system rather than the growing fundamentals of a producing asset.

What if, instead of selling you a bar of gold, I sold you a piece of undeveloped land? If you did nothing with that land before trying to sell it back to me down the road, you would again have a speculative asset not much different from gold. But, as an industrious person, perhaps you decide to take your newly purchased land and clear it of trees and stones. You work the earth and prepare it for food crops. Each year you sell the fruits of your labour and receive an income from your investment. You might even take some of that income and invest it in some new technology that allows you to double the yield from your crops and your future income. As time moves forward, you foresee your crop falling out of favour and shift your production to a new crop with better demand. After a few years of work, you have created a productive, adaptive, income-producing asset that has fundamentally changed from its original state. When you approach me to sell for more than your purchase price, the justification for the higher price is obvious.

As fundamental value investors, our interest and circle of competence lie in purchasing productive assets that become more valuable over time and are able to adapt to an ever-changing environment. Gold simply does not have this ability. We are not suggesting that investors cannot attain profits from investing in gold, but rather that Burgundy will not invest in anything whose intrinsic value cannot be measured objectively. Our clients rely on us for our expertise in valuation and we cannot exercise this expertise on gold.




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