Financial innovation continues to provide investors with a seemingly endless supply of new investment options. At Alman Partners, part of our job is to determine whether a particular asset class (new or old) should form part of a client’s portfolio.
Starting on a Role
For us, properly evaluating whether something belongs in your portfolio begins with specifying the role it is expected to play. These roles come down to a) increasing your expected return, or b) helping manage risk.
If the objective is to increase expected returns, what is the case for the asset in question accomplishing that? It is easy to link a positive expected return with shares, for example, as stock ownership gives you a claim on companies’ future cash flows. Similarly, bondholders expect to receive periodic interest payments and the return of their principal as stipulated in the bond’s covenant. But an asset that lacks a sound foundation for delivering a positive expected return should give investors pause, regardless of its past performance.
From time to time, we receive questions about the merit of investing in asset classes where the economic rationale for receiving a positive expected return is less robust. Some of these queries relate to assets that we would label as “unproductive assets.” In our eyes, unproductive asset 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.
Gold
A major asset in this category is gold, a huge favourite of investors who fear almost all other assets, especially paper money. Discussion of gold as an investment option has seen a resurgence in the media recently, mainly due to its increase in price over the past twelve months. Back in 2011, legendary investor Warren Buffet penned his concerns about the growing infatuation with this asset class. The numbers he references in his comments are dated, but his message is of timeless importance:
“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 – its value would be $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 Mobil’s (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?
Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewellery and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.
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 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 Exxon’s). The 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.
Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.”
At Alman Partners, we believe a portfolio should maintain a focus on productive assets (i.e. shares, bonds, real estate). Whilst investors may see positive returns over the short term from unproductive assets, we believe that over any extended period of time, this category of investing will prove to be the runaway winner.
James Alexander (CFP® Professional, GradDipFP, MFinP, BBus [Fin, Mgt]) is a representative of Alman Partners Pty Ltd, Australian Financial Services Licence No: 222107.
Performance data shown represents past performance or simulated performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost.
Note: This material is provided for GENERAL INFORMATION ONLY. It has not been taken into account your personal objectives, situation or needs. The information is objectively ascertainable and is not intended to imply any recommendation or opinion about a financial product. This does not constitute financial product advice under the Corporations Act 2001 (Cth). It is recommended that you obtain financial product advice before making any decision on a financial product such as a decision to purchase or invest in a financial product. Please contact us if you would like to obtain financial product advice.