A Lesson From Jimmy Buffet
The subtitle is just eye-candy to catch readers who, upon seeing Warren Buffett’s name, would click on to the next item of interest. Warren Buffett’s 2011 shareholder letter is a classic. You have no doubt heard of it and probably even quoted or misquoted from it. Page 17 begins Buffett’s musings on gold. Buffett writes:
“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… The major asset in this category is gold”
In banking we called this the Greater Fool Theory. If a loan became a problem asset, we began the process of managing the borrower out of the bank, hoping that another “hungry” bank/banker would take the problem off our hands. But the problem with cryptos goes farther than that because, unlike gold, they have no commercial or decorative uses AND, this is huge, you can lose them - forever!
Back to Buffett:
“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.”
We have all read stories about crypto owners losing their keys or their cold wallets or hackers stealing their quarry – sometimes into the hundreds of millions of dollars. It would be hard to lose a 68 square foot of gold. The problem is that you would have to store, protect and insure the gold, meaning you lose value unless the price per ounce continually rises.
“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.”
Prophetic, Warren! In January this year, 11 years after Buffett’s letter, you could buy an ounce of gold for less than the $1,750 per ounce that Mr. B wrote about in 2011.
So, as a store of value, cryptocurrencies are exactly like gold without the key benefit that Buffett mentions: “You can fondle the cube, but it will not respond.”
But all of those shortcomings of Bitcoin are not the primary problem.
The problem is the price.
The problem with every cryptocurrency is that it is a currency that trades like a stock. Its value for everyone is set by the single most recent reported transaction. It is subject to supply and demand, fear and greed – the same motivators of every stock purchase and sale. Harvey Salkin, my portfolio management prof at Case Western Reserve University, equated stock investors to a psychotic neighbor who, as soon as you step out the front door, starts screaming that he wants to buy your house alternating with shouts of wanting to sell you his house.
Buffett illuminated the shortcomings of gold and, in corollary, I am drawing the same inference for cryptocurrencies:
“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 (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?”
One share of XOM would have cost you about $90 on the day that Buffett’s shareholder letter was published in 2012. In the 10 interceding years you would have received about $30 in dividends and still have your original investment. Gold and cryptos can only sit idle until exchanged for something else.
Cryptocurrencies trade like stocks – their price is set by the last reported transaction – the price for everyone is set by the single most recent reported transaction. And unlike gold, there is no intrinsic value at all. Cryptos produce nothing. Cryptos have no earning capacity. The only value cryptos have is value that the next person who wants it is willing to pay. And cryptos have unique risks.
Until and unless cryptocurrencies have an independent intrinsic value separate and apart from the most recent reported transaction, cryptos will fluctuate wildly in value, until the last person with the last Bitcoin loses their key and Bitcoin passes from existence.