Before I continue, I just want to make it very clear that Buffett is my ultimate investment idol and I have learned a great deal from his writings and through two short encounters in Omaha. As far as practicing the fundamental principles of Benjamin Graham, there has been no better investor in the world.

It is my opinion that Buffett fully comprehends gold’s historical importance but has chosen to complicate the layman’s understanding of its qualities under an altruistic guise of protecting the investor from rampant speculation.

Technically, since gold is no longer legal money, Buffett’s position is in fact superior to the one I am taking. However, one must take the leap of faith that over the next fifty or even one hundred years the citizenry can fully trust their elected officials to represent the interest of the prudent saver, the capitalist, and the investor when deciding how much fiat money is “just enough” to maintain the mandate of price stability and maximum employment.

In the 2011 Annual Letter which will be fully published in Berkshire Hathaway, Inc.’s (BRK.A) annual report, Buffett makes it very clear that he views current interest rates and fixed income securities as risky due to the lack of return they produce. He then goes on to explain why it is so important for an investor to achieve significant returns on invested capital over time. Buffett produces a fantastic example demonstrating that if a US citizen were to roll his/her cash into US denominated treasuries from 1965 until today they would have only preserved their purchasing power producing no real gain.

Buffett:

Even in the U.S., where the wish for a stable currency is strong, 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… During the same 47-year period, continuous rolling of U.S. Treasury bills produced 5.7% annually. That sounds satisfactory. But if an individual investor paid personal income taxes at a rate averaging 25%, this 5.7% return would have yielded nothing in the way of real income. This investor’s visible income tax would have stripped him of 1.4 points of the stated yield, and the invisible inflation tax would have devoured the remaining 4.3 points. It’s noteworthy that the implicit inflation “tax” was more than triple the explicit income tax that our investor probably thought of as his main burden. “In God We Trust” may be imprinted on our currency, but the hand that activates our government’s printing press has been all too human.

Note the last sentence which I have highlighted. Buffett clearly states the sole reason for this 4.7% hurdle is due to the human element regulating the “printing press”. This point is the crux of the essay as we must understand how flawed our current monetary system is and why it produces so much destruction to the purchasing power of the prudent classes of our society.

A Brief History of Money

For nearly 5,000 years, humans have experimented with a variety of mediums that would efficiently store the value of their labored hours, goods produced, and services provided while in between transactions. The goal was to find a way to store productivity for the future, to avoid a barter based economy where transactions would only occur if two parties needed an exact amount of the same goods or services at the same time. Through all the experiments the only mediums that functioned well over time were silver and gold (Read Passport Capital’s fantastic analysis on the attributes that led to these precious metals becoming the perfect money).

These two precious metals achieved what no other medium of exchange had. They had for the first time enabled humans to trust each other when engaging in commerce and introduced a new element of confidence into the global economy. There is no doubt in my mind that without a stable and fungible global currency the rate of human procreation, mobilization, and innovation would have been slower.

Trust in currency led to progressive economies which in turn led to the development of advanced civilizations with sovereignty and ultimately democracy. Democratization led to free markets, which led to truly pronounced economic cycles that included periods of booms and busts.

As democratic principles flourished, each recession brought with it immense pressure from constituents as the lower classes often representing the majority of the electorate felt most of the pain. In an effort to manipulate the economy several academics in the late nineteenth century began to promote a new economic model based on a central bank that would regulate fiat money and the rate of interest with a stated mandate of maintaining not only price stability (the former chief attribute of money) but also maximum employment.

This novel idea, the academics believed, would prevent the unnecessary recessions and depressions that would follow periods of economic prosperity. For the most part these theories were not taken seriously until after the Great Depression of 1929. Under pressure by the elected officials, economists began to question whether the gold standard was to blame. This led to the first step in the abandonment of the gold standard when the US purposely devalued its currency and confiscated private gold ownership in an effort to prop up the economy. This marked the beginning of the end of gold backed money, which provided thousands of years of price stability.

Next, in 1971, the US formally abandoned the gold standard for a truly fiat money system. Naturally, other nations began to follow suit with Switzerland being the last country to formally abandon the gold standard in 1999. Today all currencies are now a version of the US, 100% fiat, and 100% backed by nothing.

Centrally Planned Economic System

Under the present system, intelligent but generally academic individuals with little business experience sit in an oak conference room on Maiden Lane in Manhattan and arbitrarily decide just how much money is needed to maintain maximum employment and price stability. Whenever any stress to the system occurs, such as a deflationary event, these individuals have the power to digitally create new base money and feed it into the economy, essentially diluting the value of the existing stock of money owned by the saving class. Every time this happens, the prudent saver is sacrificed for the irresponsible debtor.

The idea of fiat money in and of itself is not a terrible one given that the ability to expand or contract the money supply could in fact soften the effects of a recession and provide for important emergency liquidity to the economy in times of distress such as war or natural disasters. Unfortunately, human nature leads to situations where governments engage in fiscal excess to support their constituents and when they cannot pay for these excesses, they resort to the monetization of these excesses by way of printing more money.

This has proven to be the way of the world since 1971. In a sense fiat money supports the lack of fiscal discipline in the government by magically making up the difference between what the government spends and what it takes in through taxation. Sadly, it is the savers that are being punished and the debtors being rewarded under this scenario. It is the capitalists, who have proven economic prowess and prudence, that are being used to subsidize the government or classes that had engaged in financial excess. This is obviously wrong, and as such I have always subscribed to the Austrian school of thought, studying the teachings of Ludwig Von Mises and Murray Rothbard.

In summary, it is my belief that after nearly 41 years of this experiment, human beings are not capable of efficiently regulating a fiat money. It is this understanding that places the onus on the savers to be their own central bank by making investments that protect them from the guaranteed destruction in value of the legal medium of exchange.

Buffett understands this better than anyone but chose to go out of his way to destroy the credibility of the only tool which has effortlessly achieved the role of protecting purchasing power for its owners. Buffett attempts to disqualify gold as an asset while fully comprehending the devaluation of fiat money by man. This is historically disingenuous.

Buffett:

The second major category of investments involves assets 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. Tulips, of all things, briefly became a favorite of such buyers in the 17th century. This type of investment 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. The major asset in this category is gold, 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. 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.

Here we have some more ad hominem logic. Buffett first tries to group gold, one of the rarest occurring element in the earth’s crust (.0031 parts per million), with tulips, which are organic, renewable plants that only require sunlight, water, and seeds to grow out of the earth.

Next, Buffett claims, while completely disregarding any data, that the industrial and decorative demand for gold is “limited and incapable of soaking up new production”. The facts are quite different, with nearly 2,300 tonnes of annual demand flowing exclusively to industrial and decorative purposes each year. Buffett should know better as his entire jewelry business is based on the concept that prosperous human beings in a free market economy will choose to “decorate” themselves with gold and silver.

On the other hand, mine supply has proven inelastic at roughly 2,600 tonnes per annum since 1999, even though the price has quadrupled, and exploration budgets have quintupled. More importantly, to reach that number gold miners have had to mine deeper, lower grading material (moving more tonnes of rock than ever, requiring more fiat money than ever) in jurisdictions that are less stable geopolitically.

Buffett:

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.

Again, I completely disagree. Buffett is attempting to group gold speculators and gold purchasers as one class. While it is true that there is rampant speculation in gold, it is no different than rampant speculation in equities or any other financial asset. The actual amount of gold which is absorbed for investment purposes is done by central banks themselves willing to part with newly printed money for gold, or capitalists who have enjoyed economic prosperity and wish to protect their wealth.

What motivates gold purchasers are gold’s unique attributes as a store of value with no effort required on the part of its owner. Again, the largest testament is the fact that central banks themselves use gold as a reserve. When Alan Greenspan was once asked why central banks hold gold he stated that it was due to its unique attribute of being the only liquid financial asset which does not represent someone else’s liability. In other words, when central banks seek to avoid counter-party risk, they buy gold.

Buffett:

Today the world’s gold stock is about 170,000 metric tons…At $1,750 per ounce — gold’s price as I write this — its value would be about $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 Mobils (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?

Again Buffett attempts to label gold as an “investment” when in fact it is not. Gold at its core is an alternative to money and just as paper money yields nothing unless invested, gold too yields nothing unless invested. Even Buffett’s father Howard, a US Congressman, knew the importance of having gold serve as a currency and the risks of letting humans regulate the money supply.

In mentioning gold’s physical attributes Buffett is taking one of the greatest characteristics of gold: the fact that since the beginning of time only 170,000 tonnes of have been mined, and attempting to quantify it as an alternative to investment. There is absolutely no connection between all the Exxon Mobils (XOM) of the world and the 170,000 tonnes of gold. The Exxon Mobils, farmland, and other $300 trillion in global assets must be valued with a medium of exchange or else there would be no way to transact. If I want to sell some shares of Exxon to buy farmland I need a medium of exchange to do so.

Under law, I am supposed to trust the legal tender which is fiat money. However, an intelligent citizen will note the predicament that over time fiat money loses its value. As such, the holders of 170,000 tonnes of gold currently being valued at $9.6 trillion are essentially taking the view that gold will continue to retain its purchasing power, and for this reason they hold a portion of their excess reserves in gold, while in between transactions that may include ownership of farmland, or shares of Exxon.

Gold is not a speculative tool as Buffett would like to portray it. Gold is a financial asset which serves as the ONLY method for removing wealth from our electronically securitized and interconnected financial system which has consumed nearly every asset and turned it into a bit or byte, carrying with it custodial requirements at best, or counterparty risk at worst.

Coincidentally, the “weaknesses” Buffett cited when discounting gold (not being productive) are in fact fundamental strengths given that nobody in their right mind decides to hoard gold instead of investing in equity shares or real estate. Instead, investors who own significant amounts of gold tend to use it as an alternative for cash usually representing only a small portion of their financial assets. In other words, gold holders tend to do so for the very long-term and often hold their gold forever making few purchases over their lifetime.

Simple math confirms this thesis, as 170,000 tonnes equate to only 5,465,500,000 ounces of gold mined since the beginning of time restricting maximum ownership on a per capita basis to roughly 0.78 ounce per human. But this figure is misleading given that we know nearly 35,000 tonnes or 1,125,000,000 ounces are held by central banks and ETFs. Realistically, only a few hundred thousand people on earth actually hold physical gold for investment or asset protection purposes, while 4 billion people hold some form of the nearly $300 trillion (priced in fiat money which can grow at the whims of the central banker) in global financial assets.

Buffett surely knows how small and insignificant gold ownership is as a portion of the global economy. Buffett’s own company, Berkshire Hathaway has revenues ($136 billion) which nearly match the entire global mining industry for gold ($140 billion). While I have immense respect for Buffett, it may be that he is frustrated on an intellectual level given he has publicly stated since 2001 that gold had no intrinsic value while it has performed better than Berkshire Hathaway shares during the same period.

Funny enough, it was only 1998 when Buffett bought 130 million ounces of silver (10% of world’s supply at the time) citing its “demonetization” in 1971 as one of the reasons. Buffett went on to sell silver for roughly $6 per ounce, and leaving nearly $4 billion on the table, which would have amounted to one of the best investments of his career.

Buffett:

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.

Here Buffett is purposely comparing apples to oranges. The real question should be whether the $9.6 trillion will compound at a rate far superior to that of fiat money because it is in no way competing with productive assets. It would be inconceivable to think that an intelligent investor would allocate their productive capital towards gold as opposed to an investment that could generate a return on invested capital exceeding the rate of devaluation of money (inflation).

Personally, I agree that investors should not consider gold as an alternative to Coca Cola (KO), or See’s Candy and I too agree that both should perform better than gold bullion over time. But these are rare fantastic businesses that command a durable competitive advantage and are able to raise their prices almost as quickly as central bankers are able to devalue their currencies.

Buffett makes the flawed assumption that the average investor is going to select securities as well as he does. Mathematically, this is impossible while it is a certainty that the average investor must transact in fiat money leading to a likely scenario where excess liquidity will lose its value over time. For these investors, physical gold allocation typically represents liquid capital that had been accumulated over the years through prosperous activities and is often found lying around doing nothing. Rarely do investors use gold as an alternative to buying cash flow generating businesses, or productive assets. For exactly the reason that gold does not produce anything and is no longer legal tender it will always be under-owned.

I want to make it clear that I have no idea what gold is worth to the dollar, and I don’t believe one can derive an exact price from available supply and demand figures. Further, I am not advocating investors purchase gold at 1,750 nor am I even advocating the return to a gold standard. The goal of this essay was to refute Buffett’s comments and merely highlight the disregard for history in his belief system.

Under Buffett’s view of the world, post 1971, an investor’s job is to earn a calculable rate of return on capital deployed, and as gold does not fall into that bucket he simply disregards it as an option. This is true for oil, iron ore, and even copper, or any other asset that does not have a balance sheet or income statement attached to it. You will never see Buffett purchasing these commodities outright, instead you may see him purchasing businesses which can earn a calculable return extracting these commodities just as he did with Conoco Phillips (COP) for example. With that said, this view was highly contradicted only 14 years ago when he purchased the silver position for Berkshire Hathaway.

I view things differently. While value investing still forms the foundation of my belief system as it relates to valuing businesses and securities, I have also recognized the fatal flaws of our current monetary system and have developed a view which encompasses the two schools of thought. It is with this belief system that I am comfortable making the following three predictions:

1) As long as the world economies continue operating under a fiat money system, both the monetary base and money supply will compound at rates that will continue to subsidize the debtors and punish the savers. As outlined before, these flaws reflect human nature and the lack of fiscal discipline on the governmental level.

2) This guaranteed destruction in the value of our medium of exchange will lead to higher prices in finite minerals and hydrocarbons which must be physically extracted from the earth’s crust and are essential to our modern industrial society.

3) Gold will continue to function as a store of value due to the fact that it too must be extracted from the earth but is rarer than even the rarest industrial commodity. Or more explicitly, the value of all the gold in the world (“Cube A” in Buffett’s example) will compound at a higher rate than fiat money just as it has done since 1971.

There is currently an equal amount of investment money going into silver as there is for gold, yet the gold/silver ratio is close to 50:1, which means that investors are buying 50 ounces of silver for every ounce of gold. Not only that, but there is nowhere close to as much silver available for investment as there is for gold.

The chart above shows the gold/silver ratio for the last couple of years. This ratio is currently at 50:1 but the historical average over the past couple of hundred years have been around 16:1 which also represents the gold to silver concentration available in the ground. With a 16:1 ratio, silver would be priced over $100 in today’s market, yet there are good reasons to believe that gold is going much higher. With such a strong demand for physical silver it is seems likely that we will once again see a 16:1 ratio, perhaps towards the end of this bull market.

Why is silver undervalued?

There have been a lot of discussions about silver manipulation by the people that are short silver on the Comex and there seems be some truth to this. The events orchestrated in the silver market last April were highly suspicious. It started with a record amount of selling on a Sunday night that sent the price plummeting six dollars overnight. This all happened on a day when the Chinese markets were closed. Then that same week the Comex raised margin requirements four times. This put a tremendous amount of stress on anyone long silver and forced most people out of the paper market.

We may still see some of these raids in the silver market but they cannot to continue forever. There simply isn’t enough physical silver available to continue this sort of manipulation. Right now there is about a billion ounces of silver traded in a day on the Comex, yet the market only produces 900 million ounces in a year. Given these discrepancies there will be a real shortage of silver sooner or later. Perhaps a manufacture will be unable to locate inventory or maybe the Comex will fail to come up with the metal if enough people take physical delivery. When this happens, the physical supply and demand of silver will determine the price and not the buying and selling on the Comex.

There is already a trend of investors moving away from paper derivatives into physical metal, and this trend was accelerated after the collapse of MF Global. If this trend continues at its present rate, it may not be much longer before the physical market determines the price. At that time, the activity on the Comex will become irrelevant. The chart shows the demand for physical silver and other silver derivatives.

Furthermore, a lot of the weak hands and speculators were washed out of the market during the crash last year and only the strong hands remain in the market. Many of these investors own physical silver and are unlikely to sell. Buyers of American silver eagles in particular have been known to hold on to their metal for very a very long time, sometimes for years or even decades.

As silver is consolidating and creating a base for the next breakout I suggest investors buy physical silver and to a lesser extent financial instruments such as, Sprott Physical Silver Trust (PSLV), Central Fund of Canada (CEF) and senior mining companies (streaming company) such as Silver Wheaton (SLW).

1. We’ve had two big pullbacks within the past 12 months, increasing the likelihood that bears have been exhausted out of the market.
2. Silver has spent the last 11 trading days consolidating above the 200-day exponential moving average, suggesting it has found its bottoming support and is ready to rally.
3. Once 35.50 is breached, there are few resistance levels on the way to $44. So, the stage is being set for momentum to gather and for a rapid re-test of previous all-time highs near $50.

I think there are a number of highly favorable risk/reward setups here for those proficient in technical analysis. The chart below illustrates the basic story.

(Click chart to expand)

However, for those with a longer-term mentality, it’s worth thinking about the difference between gold and silver. And to best understand that difference, it’s worth remembering former U.S. President Grover Cleveland.

Known largely for the distinction of being the only U.S. president to serve two non-consecutive terms, Cleveland actually has a distinction that makes him far more significant to U.S. monetary history and to our current times: his battle with the silver industry during his second term.

When Cleveland returned to office in 1893, the U.S. was on the brink of a currency crisis. The Sherman Silver Act, passed in 1890, basically served to re-monetize silver and increase the money supply accordingly. Rich people with savings saw this as a problem, as it was basically the age-old story of inflation of the money supply deteriorating the value of savings; the poor and working class loved this idea because it gave them cheap and easy money, at least on an immediate basis.

The Sherman Silver Act eventually led to the Panic of 1893, illustrating one of many examples in history of how inflation of the money supply results in greater market volatility — often through the creation of asset bubbles followed by a panic exodus. The Panic of 1893 was also preceded by a severe and global deflation, which also serves as an illustration of how severe deflation can lead to banking crises, a loss of faith in the currency, and the onset of hyperinflation via a panic out of the currency itself. When one considers our current situation, it is clear that history does seem to repeat.

To stabilize the currency and prevent even greater problems, Cleveland had to squash the efforts to monetize silver. Savings needed to be preserved and prices denominated in gold needed to come down. Malinvestments would be liquidated, lower savings would encourage consumption and investment, and the economy would be healed.

This story illustrates the big difference between gold and silver: when it comes to which one will officially be re-monetized, either by nation states, supranational government, and/or non-state networks like activist groups, the odds are much greater that gold will be re-monetized instead of silver. And to the extent that gold and silver compete for the crown of true money, gold will likely win, as it has greater commitment from wealthier individuals and thus more capital ultimately behind it.

So what’s this mean? Well, the simple implication is that silver has less buy and hold value than gold (GLD) does. With that said, as we have already seen, it has enormous volatility and thus significant upside potential — if not for its monetary demand then for its industrial usage. But when I think about Grover Cleveland, I have to question how strong the relationship between gold and silver really is, and if the 16:1 historical gold/silver ratio frequently touted by silver supporters will come to pass on a sustainable basis.

Bottom line: if you’re playing silver, enjoy the ride. I do believe it will meet and exceed its previous all-time highs, and consider a move past $100 to be probable. Just don’t forget to get off before the smackdown comes, either from monetary authorities of governments or from those more committed to gold who do not want to see their turf being encroached upon.

Yesterday’s AM fix was USD 1,733.00, EUR 1,304.77, and GBP 1,094.20 per ounce.

The pattern of gold trading higher in Asia and falling just before or at the open in Europe continued again today. Gold ticked a little higher in Asian trade prior to sharp falls before the open at 0800 GMT when gold fell quickly fell from $1,729/oz to $1,715/oz.

A cut in COMEX gold trading margins by the biggest operator of U.S. futures exchanges, the CME Group, failed to start a rally in gold but is short term bullish.

The tragedy that is the Greek debt crisis continues. Although Greek political leaders inked a form of deal in the 9th hour, the bailout is still pending approval of international lenders, leading to jitters amongst investors which should support gold.

European ministers declared that Athens did not meet all targets and demanded more within a week in exchange for a 130 euro billion “bail out” to stave off bankruptcy – at least in the short term.

The Troika gave the debt ridden country yet another ‘deadline’ – until the middle of next week to find an extra €325 million in savings,  and pass the cuts through a divided parliament. They will also seek “written guarantees” that brutal austerity measures will be implemented even after the elections of a new government in April, said Jean-Claude Juncker, the Luxembourg prime minister who chaired yesterday’s meeting of finance chiefs of the 17 euro countries.

US International trade numbers hit the market at 13.30 GMT.

Buffett: “Right To Be Fearful” of “Paper Money” – Favours Stocks Over Cash, Bonds and Gold

Warren Buffett, the billionaire chairman of Berkshire Hathaway, has released an interesting, if contradictory, adaptation from his upcoming shareholder letter – Warren Buffett: Why stocks beat gold and bonds .

In it, Buffett again extols the virtues of stocks over paper money, bonds and gold.

The Oracle of Omaha acknowledges and correctly warns that investors are “right to be fearful” of “paper money.” Buffett said low interest rates and inflation should dissuade investors from buying bonds and cash. “They are among the most dangerous of assets.”

Buffett again reaffirmed his opinion about gold’s “significant shortcomings.” He said that gold is “neither of much use nor procreative.” He also suggested that gold was a bubble and compared it to the internet stock and housing bubbles.

Buffett Incorrect Regarding Gold

Buffett’s thoughts regarding gold are a rehash of similar negative views on gold repeated in recent years.

Buffett criticises gold for having two shortcomings – it is “neither of much use nor procreative”.

This is true, however Buffett completely ignores gold’s primary use throughout history and today which is as finite money, a monetary safe haven asset, as financial insurance and as a store of value.

Buffett contradicts himself by suggesting that those who buy gold are fearful and they believe “that the ranks of the fearful will grow.”

However, in the same article, he says that investors are “right to be fearful” of “paper money.”

Buffett should have a chat with James Grant or other monetary authorities who realise gold is the ultimate form of cash. As Grant says “nothing beats a little cash in a bear market, of course, and the oldest form of cash is gold.”

Buffett suggests that gold is a bubble and that the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis.  He writes that as “bandwagon” investors join any party, they create their own truth — for a while.

His article also shows a lack of knowledge regarding gold – Buffett says that gold is “currently a huge favourite of investors.”

The data and statistical evidence shows that gold remains a fringe investment and remains under owned by retail investors in the western world. This is beginning to change and ownership has increased in recent years but ownership remains miniscule when looked at in historical context and when viewed versus ownership of stocks, bonds and cash today.

Buffett compares gold to the internet stock and housing bubbles.

This is a highly simplistic and dubious comparison. The very uncertain world of 2012, with a myriad of significant investment risks is leading to continuing strong fundamental demand for gold bullion amid constrained global supply.

These real fundamentals driving today’s gold market were absent in the final years of the dotcom and property bubbles.

The fundamentals driving the gold market are not going to disappear in the foreseeable future and may be with us for the rest of this decade.

Also, gold so massively underperformed in the 1980s and 1990s (after huge outperformance in the 1970s and a parabolic price move in late 1979, January 1980) that gold has in effect been playing “catch up” with other assets in recent years.

The charts and tables show that gold’s performance, since the start of Buffett’s Berkshire Hathaway, has been equivalent to that of stocks (MSCI World and S&P 500) and with similar volatility.

Berkshire’s Hathaway’s performance has been phenomenal and must be respected, however Buffett’s over concentration and allocation on stocks since 2000 has cost him and his shareholders dearly – and may do so again in the coming years.

Conclusion

Buffett shows once again he does not understand gold and he does not understand real diversification. He does not or chooses not to understand gold as a safe haven asset in a portfolio.

He does not or chooses not to understand gold as an important diversification. He does not or chooses not to understand gold as a finite currency, as a monetary asset and as money.

“What the wise man does in the beginning, the fool does in the end.”

Buffett is correct when he says that the old proverb will be confirmed once again.

However, today wise men, women and institutions in the US, Europe, Asia and internationally are diversifying into gold because of concerns about “paper money” and other macroeconomic, geopolitical and systemic concerns.

The less informed continue to have a blinkered anti gold bias. They continue to focus solely on gold’s nominal price and assert it is a bubble.

They continue to posit silly “either or”, “stocks good; gold bad” arguments rather than seeing the merits of each asset class.

The uninformed continue to not understand gold as a form of financial insurance in a diversified portfolio. This is changing slowly with a very gradual growing appreciation of gold’s importance as a safe haven asset and money is a world of massive paper and digital money creation.

Putting all your eggs in any one basket in a world beset with risk is unwise. Whether that be in agricultural land, Exxon Mobil, Berkshire Hathaway, stocks, bonds, cash and even gold.

Worried that the Federal Reserve and the U.S. dollar are on the brink of collapse, lawmakers from 13 states, including Minnesota, Tennessee, Iowa, South Carolina and Georgia, are seeking approval from their state governments to either issue their own alternative currency or explore it as an option. Just three years ago, only three states had similar proposals in place.

“In the event of hyperinflation, depression, or other economic calamity related to the breakdown of the Federal Reserve System … the State’s governmental finances and private economy will be thrown into chaos,” said North Carolina Republican Representative Glen Bradley in a currency bill he introduced last year.

Unlike individual communities, which are allowed to create their own currency — as long as it is easily distinguishable from U.S. dollars — the Constitution bans states from printing their own paper money or issuing their own currency. But it allows the states to make “gold and silver Coin a Tender in Payment of Debts.”

To the state legislators who are proposing state-issued currencies, that means gold and silver are fair game, said Edwin Vieira, an alternative currency proponent and attorney specializing in Constitutional law. And since gold has grown exponentially more valuable, while the U.S. dollar continues to lose ground, the notion has become increasingly appealing to state lawmakers, he said.

The state gold rush: Utah became the first state to introduce its own alternative currency when Governor Gary Herbert signed a bill into law last March that recognized gold and silver coins issued by the U.S. Mint as an acceptable form of payment. Under the law, the coins — which include American Gold and Silver Eagles — are treated the same as U.S. dollars for tax purposes, eliminating capital gains taxes.

Since the face value of some U.S.-minted gold and silver coins — like the one-ounce, $50 American Gold Eagle coin — is so much less than the metal value (one ounce of gold is now worth more than $1,700), the new law allows the coins to be exchanged at their market value, based on weight and fineness.

Local currencies: In the U.S., we don’t trust

“A Utah citizen, for example, could contract with another to sell his car for 10 one-ounce gold coins (approximately $17,000), or an independent contractor could arrange to be compensated in gold coins,” said Rich Danker, a project director at the American Principles Project, a conservative public policy group in Washington, D.C.

South Carolina Republican Representative Mike Pitts proposed a currency system that would allow people to use any kind of silver or gold coin — whether it’s a Philippine Peso or a South African Krugerrand — based on weight and fineness. Pitts said in the bill, which currently has 12 co-sponsors, that the state is facing “an economic crisis of severe magnitude.”

Republican representatives from Washington State followed suit in January, introducing a bill that would also allow any gold and silver coins to be considered legal tender based on metal values. Minnesota, Iowa, Georgia, Idaho and Indiana are also considering similar proposals.

Many of the bills would make it possible for residents to exchange the physical coins for goods and services, so you could use coins to buy anything from groceries to a car as long as the store chooses to accept them.

However, most people aren’t going to walk around with such valuable coins in their pockets, said Vieira. Plus, calculating the value of the coins — especially if they come from different parts of the globe and are of different sizes and shapes — will get tricky.

It’s more likely that the states will create electronic depositories and accounts for the coins to make transactions easier, when and if the initial bills are passed, he said.

Utah Gold & Silver Depository is already developing a system where customers could use debit cards linked to their gold holdings. When customers swipe their debit cards to make transactions, physical gold and silver coins would be transferred between accounts in privately-owned depositories (or vaults) based on the market value of the metals.

Before deciding on a specific form of currency, some states — including Minnesota, Tennessee, Virginia and North Carolina — are considering proposals that would first require a committee to review their alternative currency plan.

The future of U.S. currency: The states’ proposals have been gaining steam among Tea Partyers and Republicans, many of whom also endorse a nationwide return to the gold standard, which would require the U.S. dollar to be backed by gold reserves.

Tea Party “father” Ron Paul is sponsoring the “Free Competition in Currency Act,” which would allow states to introduce their own currencies, and rival Newt Gingrich is calling for a commission to look at how the country can get back to the gold standard.

But it will be the individual states that could really get the ball rolling, said Vieira. Even if several of the current proposals get killed, the introduction of so many bills at the state level is drawing national attention to the issue, he said.

Funny money: 11 local currencies

Of all the state proposals circulating right now, Republican-controlled states including South Carolina, Georgia, Idaho and Indiana have the best chance of passing their proposed bills this year, said American Principles Project’s Danker. If just one or two states implement an alternative currency, it could have a Domino effect, he said.

“I think we could get a couple passed in this legislative session, and that would show this is mainstream, popular and it would be a justification for more of the risk-averse states for doing this,” he said.

There are, of course, many people who think the recent push for alternative state currencies should be stopped in its tracks. David Parsley, a professor of economics and finance at Vanderbilt University, said he thinks state-issued currencies are a “terrible” idea.

“Having 50 Feds” could debase the U.S. dollar and even potentially lead the country into default, he said. “The single currency in the United States is working just fine,” said Parsley. “I have no idea why anyone would want to destroy something so successful — unless they actually wanted to destroy the country.” 

With January wrapping up, I’ve looked at some of the sectors in the market to see their relative performance. The January flow of money is interesting to note, as this can indicate where the big funds are placing their bets for the rest of the year. As the clock ticked over into the New Year, the results are that silver and gold have been the big winners in January.

Silver was up approximately 20% and gold up just over 11% for the month of January. In fact, if we looked at the entire precious metals sector, like platinum and palladium, they’ve all had great a great month. Is this more to go for these precious metals? I would say yes, although I wouldn’t rush out and buy precious metals tomorrow, as there are always some consolidation gains before moving up.

With the Federal Reserve stating that they are going to leave rates at these low levels until well into 2014, we’re looking at more monetary stimulus worldwide being implemented over the next couple of years. This will inevitably create inflation and a lack of trust in the faith of paper currencies. This added liquidity will also be pushed into commodities, as it has historically. Just look over the last 10 years and you will see gold and silver prices rising along with additional liquidity (money printing).

This creates value in gold and silver mining companies. Both big-cap and small precious metals miners can offer some value for the investor. Barrick Gold Corporation (NYSE:ABX) and Goldcorp Inc. (NYSE:GG) are huge, diversified precious metals mining firms that have a variety of gold and silver mines. This diversification protects the investor from any problems at one specific mine and the scale of production allows a better ability to predict the flow of revenue from gold and silver sales.

Small- and mid-cap precious metals miners can offer the additional upside of being potentially bought out by the bigger gold and silver miners. Firms like Nevsun Resources Ltd. (AMEX:NSU), which has properties bearing gold, along with copper and zinc, start to look attractive to bigger gold firms that need more precious metals reserves. Plus they pay out a small dividend, which is an additional bonus. Getting paid to wait while the price of gold continues to go up is a nice bonus.

In the silver space, an interesting company is Silvercorp Metals Inc. (NYSE:SVM). This is a company with $1.00 of cash per share, forward price-earnings ratio of 12, and revenue that continues to grow. Profit margins are a healthy 38% and the company has no debt. With prices of gold and silver, as well as other precious metals, continuing to move up, you should look at the miners that have a solid resource base, relatively low level of debt, and a consistent history of hitting their targets.

One area that management can’t control is the actual price of gold and silver. But, thanks to the statements by central bankers and politicians around the world, they’ve essentially laid out the roadmap for the next several years. With more monetary stimulus—meaning more money printing—we will get more inflation. This is a hugely bullish sign for precious metals.

Gold and silver will continue to go up as long as central bankers keep the money tap open.

Spot gold was trading at $1,745.50 a troy ounce at 0540 GMT, up $2.50 from its previous settlement and up around 12% since the start of the year.

A trader in Singapore said Asian speculative demand is returning to gold following a selloff in December, with investor flows signalling further gains in the next few weeks.

“Some of the investment community have come back into gold recently,” he said, tipping support at $1,680/oz and then at $1,650/oz. Gold is unlikely to drop below $1,500/oz this year, he said.

“Gold might look overextended, but then it seems it can always extend some more,” he said, noting that Chinese market participants have been buying dips since the start of the year.

Gold traded as high as $1,752.41/oz Thursday but pared its gains as the euro gave up some ground against the U.S. dollar. The euro was trading around $1.3163 compared with $1.3161 late in New York Wednesday. When the greenback firms, dollar-priced commodities become more expensive to investors holding other currencies.

Market participants said movements in the dollar and macroeconomic indicators from the U.S. and the euro zone will drive gold prices in the next few weeks.

The market may also soon turn its attention to U.S. non-farm payrolls data, which is due for release Friday. A worse-than-expected reading could boost demand for gold as a safe haven, while an upbeat reading could pressure gold if risk appetite improves.

Other precious metal prices were lower Thursday, with silver slipping 11 cents to trade at 33.60/oz. Traders said silver is coming under pressure from profit-taking following its 20% rally in January.

Platinum dropped $2 to $1,615/oz, while palladium fell $4.60 to trade at 691.40/oz.

Mitsui Global Precious Metals said in a note that it expects palladium to rise in the next few weeks as demand for platinum group metals improves.

“Palladium looks set to tackle $700 a troy ounce again, and (in the) medium term, we expect (prices to be) higher,” it said. Palladium last traded above $700/oz in September 2011.

As global automobile demand grows, demand for palladium and platinum is increasing, as both metals are used in the production of catalyst systems. The prices of both metals have rebounded strongly following the brutal sell-offs in late 2008. Before stock and commodity markets entered their correction phase last spring, palladium climbed as high as $860 per ounce – a five-fold increase from the lows reached in 2008. As investors at the capital markets became increasingly afraid that the global economy could fall back into recession, in early summer of 2011 prices of platinum, palladium, as well as non ferrous and base metals came under strong sales pressure.

After hitting a one-year low in October of 2011, the palladium price has recovered by 30% – on Friday palladium closed at $690 per ounce. According to PwC the supply situation at palladium markets will worsen, as in 2011 Russia’s supply from national reserves reached its lowest level in eight years. In recent years, Russia’s palladium reserves have been compensating for possible supply shortages elsewhere.

But as Russian supply dwindles and South Africa – the second largest palladium producing country, accounting for 40% of global supply (To Russia’s 44%) – will probably experience falls in its production, observers believe that the palladium price has a great upward potential. According to estimates from Barclays Capital, in 2012 the total deficit will reach 275,000 ounces. Demand from emerging economies – and especially from China and India – will compensate for a possible decline in European demand. Thus, investors should keep an eye on palladium, as analysts at Credit Suisse are convinced that this year the white metal could gain another 30% to hit $882 per ounce.

The yellow metal is now off to its best start to a year since 1980 when prices rose nearly 70 percent over a period of three weeks to the inflation adjusted record high of $850 an ounce.

For the week, the gold price rose 4.2 percent, from $1,667.00 an ounce to $1,737.30, as spot silver followed up weekly gains of 3.2 percent, 3.5 percent, and 8.2 percent so far this year with an impressive surge of 5.6 percent last week, from $32.20 an ounce to $33.99.

The gold price has now risen 10.9 percent for the year, down just 9.7 percent from its 2011 high, while the silver price is up 22.0 percent in 2012, but remains 31.3 percent below its high last spring. It’s been a remarkable start for 2012 after a disappointing December and this Reuters graphic on central bank gold purchases last year adds to the case for strong metal demand that is not going to go away anytime soon.

click to enlarge

All told, central banks are expected to have purchased a record 450 tonnes of gold in 2011, ironically, about the same amount that European banks used to sell each year before those sales abruptly stopped shortly after the 2008 financial crisis

Note that it is emerging market economies that are adding to their gold reserves, one of their primary motives being to diversify away from large concentrations of U.S. dollar holdings for reasons made clear in comments by Fed Chairman Bernanke last week that, in effect, signaled years of “financial repression” aimed, in part, at liquidating the massive U.S. debt.

Not all analysts are expecting further gains for gold, however, as CPM Group said last week that the rally is likely to be short-lived since it has been driven by short-covering in recent weeks and that gold and silver coin and bar premiums continue to decline.

They went on to note that last week’s Fed policy move:

… did not point toward any development not already largely expected by the market, therefore the temporary increase in asset prices resulting from yesterday’s meeting is not expected to provide a medium- to longer term springboard for prices.

A Q1 2012 Metals Review by Natixis Commodity Markets was also quite bearish, the group saying that gold prices could average $1,450 an ounce this year with the silver price falling from an average of $26 an ounce in 2012 to just $18 an ounce in 2013, both metals failing to attract investment demand after the heightened volatility of 2011.

But, many analysts remain bullish on precious metals, a recent survey by Reuters indicating an average spot price of $1,765 this year, up 14 percent from 2011.

Barclays Capital said last week they remain neutral about gold over the short-term citing cautious investor demand, but that physical demand in Asia has been resilient and the group predicted that a $2,000+ gold price will be seen by the third quarter of this year. Interestingly, they see a similar surge for the silver price through the summer but forecast year-over-year price declines late in the year.

The Outlook for 2012

It’s a bit odd to think back to a month ago when most others were writing about what they expected in the New Year, that is, when the gold price was in the mid-$1,500s and silver looked like it might be headed back to the low $20s.

As the natural resource sector is about to wind up a stellar month of January, it’s a decidedly different base from which projections for the New Year can be made, though, I don’t think recently rising prices have made a substantive difference in what I’d write then vs. now.

For most of the last ten years, I’ve thought the gold price would end the year 10-20 percent higher and that silver could make an even bigger move (though, with much more downside risk) and that’s turned out to be a pretty reliable trend.

My thoughts are no different this year, however, one important distinction for 2012 is that I have gone on record saying the gold price will top the $2,000 mark at some point – a gain of nearly 28 percent from 2011 year-end – and I stand by that prediction.

It won’t necessarily end the year over $2,000 an ounce, but I think we’ll hit that mark.

The one-two punch of surging Chinese demand and a more dovish Fed have driven prices through important technical levels in recent weeks and, while a setback in the European sovereign debt crisis could cause the rally to stall, it should only be temporary.

One of the most interesting aspects of the 2012 surge has been how the mainstream financial media has reacted after all but declaring the gold bull market dead in December – they’ve been quiet. By and large, this group still hates the idea of gold and silver as an investment and, to me, this is one of the best indications that the bull market still has a long way to go and that much higher prices could be in store this year.

As I’ve said many times over the years, when Money Magazine gets fully on board with a 10 to 25 percent recommended asset allocation for gold, that’s when I’ll start thinking about selling, and I expect that time to come at much higher prices.

Asia: Where They Love the Yellow Metal

Year-end commentary in the U.S. as metal prices plunged were a real sight to see. After watching over the last two-and-a-half years as the gold price proved indefatigable, barely experiencing a 10 percent correction during that time, the mainstream financial media pounced on the December swoon, particularly after the supposed “death knell” of breaching the 200-day moving average. Here’s some commentary from mid-December to mid-January that I tucked away for this occasion:

• Dec. 15 – WSJ MarketBeat Blog – Sorry Goldbugs, You’re Losing to Treasurys in 2011
• Dec. 29 – WSJ MarketBeat Blog – Sorry Goldbugs, You’re Only Even With the Dow ’11
• Jan. 9 – WSJ – Exchange-Traded Funds: Is the Golden Age Ending?
• Jan. 13 – MarketWatch – Why gold could lose its glitter in 2012

And these are from publications that I generally consider to be even handed toward precious metals – the Wall Street Journal and MarketWatch.

I’m sure there were many more articles in many more financial publications that expressed a good deal of glee that the gold bull market was finally over and that investment advisers would finally stop being asked uncomfortable questions about the role precious metals should play in their clients’ investment portfolios.

Perhaps the best example of how little has changed in how U.S. investors think about gold came in the wildly popular article here at Seeking Alpha three weeks ago Why, At 28, I’m Going With Dividends. This prompted nearly 250 comments and once again strengthened my belief that U.S. investors are so fixated on equities – “Which companies are looking good? Which ones are you buying? Have you checked out this one?” – that they’ll be the last to the party when it comes to gold, most of them getting in too late and, like the internet and housing bubbles, signaling the end and being saddled with losses.

Again, ask your neighbors and other acquaintances what they think of gold as an investment and you’re likely to hear little dot.com or housing bubble enthusiasm and this means we’re still a long way from the top because, inevitably, the world’s largest pool of investors will not be able to stay away from this market when it really takes on bubble proportions.

But I wouldn’t be surprised to see a full-blown gold-mania develop in China and India this year as it’s been bubbling close to the surface for months now. With a long cultural affinity toward precious metals and living in a very different economic environment – an upwardly mobile society with limited investment options and much higher inflation – you might just see Asia drive gold and silver prices to unthinkable highs as soon as this year.

I’m not counting on that developing and, as always, would be happy with a tamer 10 to 20 percent gain, but, given the November gold import data that from China as discussed here two weeks ago, that’s a real possibility.

The Chinese people and the Chinese central bank will continue to play a huge role in determining the trajectory of gold and silver prices and the recent shift from fighting inflation to spurring growth is profound. A “hard-landing” is still possible, but my guess is that they’ll muddle through somehow, likely concealing how much home prices are falling in the official data and even encouraging a “gold bubble” to help offset the impact of lower property values.

Investment demand in China has surged and they just surpassed India as the world’s largest consumer of gold jewelry, however, India is still a major source of demand and they seem to be overcoming the recent doubling of the gold import duty that had some analysts concerned about denting demand. Wedding season buying was reported to be up last week despite dealers passing on these higher costs to their customers.

Ironically, when the gold price plunged in December and writers in the U.S. were penning obituaries for the gold bull market, it turns out that people in China and India were buying the metal hand-over fist at reduced prices. That much seems clear at the moment and this bodes well for the year ahead.

What we saw in recent months was a long overdue major correction for metal prices – nothing more – and the Fed’s low interest rate promise may just compel more Americans to buy some of the metal now that they know they aren’t likely to get more than a half percent on their savings accounts until 2015.

As long-time reader “DLP” commented at the blog the other day in reaction to “More on Bernanke’s War Against Savers“:

This might just be the thing that really kicks the U.S. gold boom off.

Ten million people buying an ounce or two of gold because they think they might be better off putting that money into gold coins than in a bank – that’s like 500 tonnes of gold.

Sales of gold, silver, and jewelry rose 57.6 percent during the week-long holiday at Caibai, one of Beijing’s best-known gold retailers, according to data released by the Ministry of Commerce on Saturday.

Other jewelry stores across the country also saw sales boom during the period, with customers favoring New Year-themed gold bars, gold ingots, and other types of Dragon-themed jewelries.

“Long treasured by Chinese, gold is no longer owned only by a privileged few, but has become a new investment channel open to all,” said Guan Qiang, assistant manager at Caibai.

The spring festival gives people a chance to preserve and present gold as gifts, offering hopes that it will increase in value and not be impacted by inflation, Guan said.

During the week-long holiday, which lasted from January 22 to 28, the sales volume in Caibai and Guohua, another of Beijing’s top gold retailers, reached about 600 million yuan ($95.28 million).

The figure showed a 49.7-percent increase over that of last year’s spring festival, said a report released by the Beijing Municipal Commission of Commerce.

Caibai began selling gold bars as investment items during the 2008 Beijing Olympic Games, but the trend of buying gold or silver bars during the Spring Festival has really taken off in the past two years, Guan said.

For Guan and his colleagues, the spring festival rush was an exciting but exhausting experience, as customers flooded the store and surprised clerks with their purchasing enthusiasm.

“With customers crowding and rushing in, we did not even have time to eat and drink,” said a sales clerk at the gold bar counter surnamed Li.

She said each shop assistant had received hundreds of customers per day and wrote several times more orders than on ordinary days.

“You can hardly even see the gold bars, necklaces, and pendants in the display case. People seem crazy about gold, snatching it up more like a ‘cheap cabbage’ than such a precious metal,” said Beijing resident Miao Miao. “You have to quickly decide whether to make a purchase or it will be taken away by others.”

Miao was shopping for a pair of gold bracelets to give to her granddaughter as a gift for the New Year.

“When my daughter was born in 1984, we had no means or savings to buy her one as a keepsake. We can finally realize this dream by sending it to her daughter,” Miao said.

However, Chinese do not value gold only in only sentimental terms. The precious metal is also expected to maintain or increase its value, as evidenced by the surging investment demand seen around the country, insiders have said.

“To most Chinese, gold is more convenient than cash in other investment instruments. Despite common investment risks, the price of gold is clear and easy to judge,” said Guan.

Compared to unpredictable investments, such as those in the stock market or housing sector, gold is cherished more by Chinese for its increasing value as an asset as well as the unlikelihood that it will be affected by inflation, Guan said.

China is expected to overtake India as the world’s top gold consumer in the next few years. Strong demand for investments in gold and jewelry will have driven China’s total gold demand to 750 metric tons in 2011, according to the World Gold Council.

Despite the record-high price of gold, the demand for investments in gold and jewelry has continued to soar, with the market expected to reach about 955.2 metric tons by 2020, thanks to a growing middle class and a more affluent society, said Binghai, director of the Shanghai Gold & Jewelry Trade Association.