I continue to be intrigued by David Einhorn's recent disclosure that his Greenlight Capital funds are now significantly long gold and gold miners. Read his 2008 letter to investors for his reasoning. I don't disagree with any of it.
But Einhorn is a value investor, one of the best-known and most successful of our day. His skill is in finding and buying undervalued companies (and shorting overvalued ones). His bet on gold is not in that vein (no pun intended), but is rather a macro bet, a bet on the state of the world in the future. It's not a particularly cheap one either.
When I (very timidly) asked Einhorn about his gold bet at the CIMA conference, he stated that it, like all other investments, should be evaluated in terms of its opportunity cost. It seems to be, however, that Einhorn's opportunity cost of holding gold is not the return on cash or treasuries, but rather the expected return from doing what Einhorn does best: value investing.
Consider the following mini-case study. History doesn't repeat itself but it does rhyme: the 1973-1974 bear market in stocks coincided with a bull market in gold. President Nixon moved off the gold standard and inaugurated the era of paper money, Vietnam-era "guns and butter" spending led to increased inflation, the Yom Kippur war highlighted the vulnerability of the west to commodity shocks, Watergate threatened everyone's faith in government, etc. Gold traded up from its old fixed price of $35 an ounce in the late 1960s to about $150 in late 1974. Stocks of course plummeted, even those held by the great value investors of the time. I don't remember it but others do. It was pretty bad.
What happened then? The rest of the 1970s were outstanding for gold, although you had to wait until the latter part of the decade to start making money. It performed amazingly well, hitting a high of $850/ounce on January 21, 1980 (I read somewhere that Jacqueline Kennedy Onassis bought gold during this period and made a fortune, on the advice of her companion Maurice Tempelsman. If the story is true, he belongs in the Hall of Fame of Investors' Consiglieri. But that's for another post). If you bought gold at $150 in late 1974 and managed to sell at the top, you more than quintupled your money, a compound annual return of over 41%. The gold bugs, in short, were absolutely right.
But not so fast. How did the top value investors of the day, the David Einhorns of yesteryear, perform in the footrace againt gold from 1975-1979? As far as I know, none of them made any significant bet on gold at this time--they were just doing good old fashioned value investing. Here is the record, taken from the Berkshire Hathaway annual report and Warren Buffett's famous essay "The Superinvestors of Graham-and-Doddsville":
Berkshire Hathaway 34% (book value growth)
Walter Schloss 43%
Tweedy, Browne 32%
J.P. Guerin 51%
Yes I'm cherry-picking the data here, but on balance I'm giving gold a head start by assuming you sold it at the $850 top, which occurred only briefly. If you only managed to sell at $675, the average price during January 1980, your five-year return went down to 35%.
My conclusion is that old-fashioned value investing, as practiced by its best practitioners, was remarkably competitive with gold during one of the latter's greatest bull markets.