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Worth Its Weight in Gold

For some reason I have received an abundance of subscriber emails this week asking me about my thoughts on the direction of the price of gold. I suppose it might be due to the unexpected breakdown in the commodity's price in the face of rising geopolitical tension around the globe.

Back in the fall of 2011, gold (as an asset class) was embraced as an investment just as energetically as price momentum investors have clutched on to social media stocks today, with gusto from hedge funds (John Paulson et al.), other institutional investors and, of course, the retail lemmings.

Here is the five-year chart of the SPDR Gold Shares (GLD), indicating that GLD peaked at over $180 a share in September 2011 and closed yesterday at a bit over $122 a share. This coincides with the price of gold peaking at over $1,800 an ounce and compares to the price this morning at about $1,270 an ounce.

"[G]old [is] currently a huge favorite of investors who fear almost all other assets, especially paper money of whose value, as noted, they are right to be fearful. Gold, however, has two significant shortcomings, being neither of much use nor procreative."

-- Warren Buffett, 2012 Berkshire Hathaway letter

In theory, gold is thought to prosper and be a valuable asset in a world of too much cowbell (monetary stimulation and solutions), where fear is rampant and the integrity of most currencies is waning in the face of the failure of governments to address fiscal imbalances.

As I have written in the past, gold doesn't produce profits and, as such, fails to provide a stream of income, so it's hard for me to estimate the price level that provides intrinsic value and next to impossible for me to invest or trade it.

Gold is among some other asset classes that will never produce anything but that 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. (For example, tulips were briefly a favorite of speculative buyers in the seventeenth century.)

The success of gold requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. 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.

As Oaktree Capital Management's Howard Marks has written, "Gold is a lot like religion. In religion, you either believe in God or you don't. In the gold market, you either believe in gold or you don't."

Bottom Line

In essence, the gold market is a state of mind. It neither represents a corporate franchise (with a protected moat) that increases in value over time as profits are earned and retained such as, say, Procter & Gamble (PG) nor is gold a productive asset, as it doesn't produce profits and, as such, fails to provide a stream of income.

Gold's price in the future is simply dependent upon someone willing to pay more for the asset class compared to its price today.

The bull market in gold has stalled badly, and it might not return for a while.

My advice? Let the gold believers believe while we search into other (more productive) asset classes in which to invest.


This column originally appeared on Real Money Pro at 7:34 a.m. EDT on Sept. 4.

At the time of publication, Kass and/or his funds had no positions in the stocks mentioned, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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