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Weekend reading: Warren Buffett warns on bonds and gold

Weekend reading

Some great reads from around the Web.

I don’t have to even pause to think what’s going to be my post of the week today – not when star pitcher Warren B. of the Omaha Value Raiders is knocking them out of the park.

In an excerpt from his upcoming shareholders’ letter in Fortune magazine, Buffett pours scorn on today’s mania for cash, and for US, German and UK government bonds with their likely desultory real yields:

Most of these currency-based investments 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, even as these holders continued to receive timely payments of interest and principal. This ugly result, moreover, will forever recur. Governments determine the ultimate value of money, and systemic forces will sometimes cause them to gravitate to policies that produce inflation. From time to time such policies spin out of control.

But before you pack your portable stove to join the gold bugs in the hills:

Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, 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.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct.

Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth — for a while.

So what does hard-to-satisfy Buffett like? Real assets such as shares and productive farmland, of course:

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, whatever the currency may be. Exxon Mobil (XOM) will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons).

[In contrast a] 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Pure passive investors will still want to hold and rebalance their chosen portfolio allocations, of course, and not dump all their bonds and any gold they have elected to carry. The idea here is to be smart by acting ‘dumb’…

…rather than being dumb like me by trying to be smart and running down your bond portfolio, only to see gilt yields drop in 2011 to almost unbelievably low levels that we’ve not seen since the 1960s.

I still think gilts are over-priced, however, and that Buffett will prove correct in the medium to long-term. He usually is.

If you were to write a novel about a super-rich investor, you’d surely have him doing all kinds of clandestine activities. Nobody could understand his trades, or how he made it look so simple.

Buffett – who is the world’s richest self-made investor – spends half his time telling anyone who will listen exactly how he does it.

Yet far from turning more Buffett0-esque in their approach, hedge funds and the like are investing in ever more cutting-edge technology and whiz kids to execute positions that they hold for a few seconds at a time.


From the money blogs

Book of the week: The Magic of Thinking Big is very American in its go-getting, varmit-shooting ways, but it has the nod from one of our finest trans-Atlantic cousins, Mr Money Mustache. Good enough for me!

Mainstream money and investing

  • Penny stock scam: You’re better off igniting a pile of money – Fool.com
  • Government bonds: No longer so simple – The Economist
  • $1 billion manager: Stocks will fall as US population ages… – Gazette.com
  • …Allan Roth disagrees, points out demographic-driven ETF failure – CBS
  • Larry Swedroe: The reasoning behind the market’s rise – CBS
  • Managers turn more bullish on equities [Uh oh!]FT
  • Offshore ‘gifts’ come under HMRC scrutiny – FT
  • Fears of backdoor commission after RDR – FT
  • Test of nerve for holders of defensive stocks – Merryn / FT
  • Danny Alexander wants to cut higher-rate pension tax relief – Telegraph
  • Don’t expect to turn £1 into £1,000 by investing – Telegraph
  • Mortgage approvals highest for two years – Telegraph
  • House prices added £68,500 to average wealth in 10 years – Telegraph
  • Lloyds TSB launching Junior ISA paying 3% – MoneySavingExpert
  • When shared ownership goes sour – The Guardian
  • How Wall Street got its name CNBC

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{ 17 comments… add one }
  • 1 Rob February 11, 2012, 1:00 pm

    How to build an orchard on a budget:

    Buy a tree… take the fruit of said tree and try to grow more trees… then take the fruit from those trees to grow more trees… repeat a few times… eat lots of fruit.

  • 2 The Accumulator February 11, 2012, 2:23 pm

    Love these quotes from the Buffet piece: Today, a wry comment that Wall Streeter Shelby Cullom Davis made long ago seems apt: “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.”

    And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

    Great article. If you were to recommend one book by or about Warren Buffett which would it be?

  • 3 maria@moneyprinciple February 11, 2012, 2:51 pm

    Great article and thank you for the quotes – I tend to agree with Buffett (she says grandly). The touch of genius is that it all seems so common sense at the end – land produces and reproduces; gold doesn’t; currency is speculation and better go to a casino.

  • 4 MultiMillionaireRoad February 11, 2012, 2:56 pm

    Buffet is my hero. After I read his biography I was blown away. However I don’t think anyone can do what he did. He is abnormally intelligent, honest with himself and unusually patient. I don’t think anyone can just replicate these traits, sometimes you’re just born with it.
    I would recommend his biography ‘The Snowball Effect’. Great reading for anybody with any interest in Buffett.

  • 5 Matty February 11, 2012, 4:55 pm

    I found the Snowball very boring to be honest and wasn’t able to finish it, but this is a great post Mr. Monevator and Buffett speaks A LOT of sense… XOM, USB and others have great growth and dividends… Wonder if there’s a future bonanza in store if some of the BRIC state owned energy companies liberalise and it becomes even easier for us to buy foreign stocks…

  • 6 The Investor February 11, 2012, 5:27 pm

    I really liked The Snowball, too, though it took a while to want to plough through the micro-family detail. But it’s incredible to see how far back his personality was forged, and how it naturally unfurls higher and higher up the echelons of power as his wealth and influence grows.

    He is absolutely unique. Average investor thinks “I like Coca-Cola, I like everyday companies, I like buying a bargain!”

    They forget: “I have a photographic memory! I can sum profit and loss accounts in my head while eating Fritos! I have read the accounts of the biggest US 7,000 companies!” 😉

    He’s also borderline (or more) autistic. Certainly Aspergic. That’s obvious from The Snowball.

    I say we learn what we can, but knowing our limits.

  • 7 ermine February 12, 2012, 12:46 am

    how can a geezer that subsists on coke and fries be autistic? OTOH how can someone who does that get to 80+ 🙂 Whenever I think I ought to eat less, drink less, and cycle more, I think about WB and his unhealthy ways. Or half my grandparents and wonder what their collective secret is… Living their values and not worrying too much is probably a good start.

    He’s unusual, for sure. But a little but too human for some of those labels

  • 8 The Investor February 12, 2012, 9:47 am

    @ermine — Well, I said borderline and perhaps used it a bit loosely. 🙂 But I don’t really consider it a critical label as such. I think men in particular run along a spectrum through Aspergic into (in extreme) autism, and that they’re all manifestations of increasingly intense/focused personality / brain functionality. I think modern medicine has ‘diagnosed’ a lot of humanity like this.

    Agree with your comments about your grandparents. The trouble is, there’s no determinism to this mind/body interaction, or at least not that we can easily see. Have infection, take penicillin, infection cured. Have ennui, live life to full, still keel over of something or other while your grumpy neighbor next door makes it to 102… I think about this subject a lot, but have personally reached no conclusions except that our minds and bodies (and what we would have once called souls) are much more united than I learned at school.

    Anyway, all that’s a bit OT. Here’s a bit more Buffett for the curious:

  • 9 Moneyman February 12, 2012, 11:48 am

    Great post and lots of links to read on a cold, lazy Sunday in bed!

    The Snowball is a long read but gives the best description of the man himself, although it doesn’t really clarify his investing approach – which does tend to be opportunistic (in the best sense of the word). For him, money clearly has no great meaning, as he is giving it all away. It is the *making of money* that he finds fun – skipping to the office every day. In addition to his great nose for a bargain is his ability to sit on his hands if there is nothing that excites him.

    I’ve never been keen on gold either – or funds:

  • 10 Rob February 12, 2012, 12:03 pm

    “although it doesn’t really clarify his investing approach” – this might be of interest…


    Essentially it combines all his Berkshire letters into a book broken down into clearer sections explaining his investment strategy.

  • 11 Moneyman February 12, 2012, 10:42 pm
  • 12 jennypenny February 13, 2012, 1:49 am

    There is an audio version of The Snowball narrated by Alice Schroeder. It is much easier to get through than the book. It’s almost 40 hours but (I think) worth the time.

  • 13 Brian February 13, 2012, 5:03 am

    Intelligent Investor by Ben Graham is a great read to understand Buffett.

  • 14 Dave February 15, 2012, 11:27 am

    I have a bit of an ongoing grapple with myself over gilts / gold. On the one hand, there’s plenty of opinion that says they aren’t worth investing in (this post being a case in point), but on the other hand, the price represents the product of the wisdom of millions of much smarter people than me.

    Going along a permanent portfolio slant, I bought into some gold and long gilts even though rationally, I can’t imagine interest rates doing anything other than going up, steeply, well before I’d unload them otherwise. Bonds issued by HMG against a 0.5% central rate aren’t going to look very attractive when the central rate is 5%…

    At the same time, I can’t help feeling that the price already takes this risk into account, and I shouldn’t try to think myself smarter than all other investors…

  • 15 Ben February 15, 2012, 12:29 pm

    off topic but I just notcied Jacob of ERE fame has retired and gone back to business – a quant no less…

    I think thats fascinating and I’m sure theres a lesson or two in there somewhere

    I thought his book applied some complex maths to things that didn’t really lend themselves to the application of complex maths so I think he will excel as a quant.

    I notice he explicitly passed the baton to MMM who is an easier (slightly saner) read

  • 16 The Accumulator February 16, 2012, 1:07 pm

    @ Dave – I guess if there’s another lost decade or two then no one will be sorry they bought bonds. Vanguard have written extensively on bonds in this environment and I would recommend taking a look. I read an excellent piece by Vanguard a while ago that calculated how long it would take bond funds to recover from a price drop, cushioned of course by rising yields. It was a few years, but nowhere near as painful as many commentators portray the situation. I can’t find the link at the mo, sadly.

    What gives me pause for thought is that bond prices have essentially been manipulated by governments through QE and the UK looks very much like it’s inflating its debt away.

    The only way I can resolve this is by remembering the role of bonds in my portfolio. They’re designed to keep me in the game by dampening volatility enough so I don’t panic and do something dumb when everything’s going to hell. The last 12-months have been a text book example of bonds role as non-correlated asset to equities. They cushioned the fall nicely as equities were on the slide but equally they’re going to be a drag as and when equities head up.

    @ Ben – yes, I was sorry to see that. Jacob is a novel thinker and his blog inspiring. His lifestyle was too hardcore for my tastes though and I’d love to know if he’s slackening off a bit on a Quant’s salary.

  • 17 Ben February 16, 2012, 5:22 pm

    @Dave, A

    I’d agree last year was great example for me of how uncorrelated gilts are with equities, and conversely how massivley correlated equities are across the various countries/indexes.

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