Janet Tavakoli on Gold and Warren Buffett

Janet Tavakoli, one of the world's foremost experts in credit derivatives, complex derivatives, interest rate swaps, collateralized debt obligations, and securitizations, and president of Tavakoli Structured Finance, sends a log a link to her latest commentary. She writes:

Warren Buffett, CEO of Berkshire Hathaway and one of the most successful investors in world history, riffed gold in his 2012 shareholder letter. Yet he acknowledged: “the dollar has fallen a staggering 86% in value since 1965, when I took over management of Berkshire. It takes no less than $7 today to buy what $1 did at that time.” Buffett didn’t mention that most of the weakness in the dollar occurred after Nixon took the dollar off the gold standard in 1971.

Buffett claimed that for most people, gold is only a fear trade and that people afraid of every other asset run to gold and hope the “ranks of the fearful will grow.” Based on my observations, Buffett’s notion does not represent diversified investors.

Buffett may or may not be right about gold, but he has a reason to be biased. He’s the beneficiary of massive post-crisis bailouts and the Fed’s hyper-aggressive monetary policy the past five years. If U.S. taxpayers hadn’t bailed out many of the stocks in his portfolio (US Bancorp, Bank of America, American Express, Goldman Sachs, Wells Fargo), his performance would have suffered, and he wasn’t alone.

Shares of Lehman were worthless. Bear Stearns’ shares (now part of JPMorgan Chase) and Merrill Lynch’s (now part of Bank of America) plummeted along with the shares of Freddie Mac, Fannie Mae, Citigroup, MBIA, Ambac, AIG, and many more.

Savvy investors like Buffett are ever mindful that the financial system hasn’t dealt with its problems. Investors are looking for diversified temporary stores of values—and that may include gold and U.S. Treasuries.

Buffett claimed gold, a non-productive asset, is in a bubble. Perhaps both gold and U.S. Treasuries are in a bubble, and they are both non-productive assets, but they both have financial utility. Buffett keeps his powder dry by investing a working level of $20 billion in U.S. Treasuries—and never less than $10 billion—for liquidity. The same aggressive zero interest rate policy (ZIRP) that has destroyed safe savings and encouraged investors to buy riskier assets (thus benefiting Buffett’s stock portfolio) has resulted in a negative real return for U.S. Treasuries. But Buffett invests in treasuries for the same reason other diversified investors invest in some gold: because he believes it is a prudent strategy.

Many reasonable diversified investors, including Ray Dalio of Bridgewater, the largest money management firm in the world, own a portion of their diversified holdings in gold. Gold doesn’t pose credit or counterparty risk, and unlike many U.S. stocks, it has never been worth zero. Gold isn’t viewed as an alternative to productive assets; rather investment in gold is another way to diversify.

The recent drama over a possible technical default of U.S. debt, cast doubt on the liquidity of T-Bills, and reignited concern about the dollar’s reserve currency status. The most shocking development was this: “HKFE Clearing Corporation, part of Hong Kong Exchanges and Clearing, increased the haircut on US Treasury bills from 1% to 3% for maturities of less than one year.” The Commodity Futures Trading Commission is considering a regulation that could double liquidity facility costs; clearinghouses may have to back Treasuries pledged as collateral with bank credit lines. The CFTC claims that in a crisis, it may take too long, up to a day, to liquidate Treasuries. Yet Congress foolishly refuses to rule out the future possibility of a technical default. Perhaps Warren Buffett should diversify Berkshire Hathaway’s liquid investments even more.

Central Banks: Global Printing Destroyed Money Standards

There is no longer a stable currency benchmark for the largest economies in the world: the United States, the Eurozone, China, Japan, or any other country. Relative value is a rapidly moving target. No one can adequately track it.

Central banks still use gold as a form of money. Dr. Mario Draghi, President of the European Central Bank, is the former governor of the Bank of Italy, the fourth largest owner of gold in the world. Draghi stated:

“I never thought it wise to sell it, because for central banks this is a reserve of safety; it’s viewed by the country as such. In the case of non-dollar countries, it gives you a fairly good protection against fluctuations of the dollar. So there are several reasons, risk diversification, and so on…the experience of some central banks that have liquidated the whole stock of gold about ten years ago, was not considered to be terribly successful from a purely money viewpoint.”

Dr. Draghi suggests some gold ownership is a prudent strategy at a time when global currencies have become unmoored.

Trouble is Opportunity

The world population is approaching 7 billion. Every day we wake up hungry, and we all have needs. We will have trouble. Liars, thieves, and bullies will always be with us. But so will productive people and productive assets to supply growing needs. There will always be opportunities for sound investments.

It is in everyone’s interest to keep the production-to-corruption ratio as high as possible. Our leaders failed us, but the human will for survival may result in a push to rebalance the scales.

Those of us who have lived through tremendous upheaval know that people don’t want cash, gold, or other liquid assets for their own sake. These are simply a means of storing value so that you can invest in productive assets at a reasonable price.

Read her full analysis here.