Friday, February 10, 2012

A Golden Quote

Here's an interesting article from Warren 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 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?

What is interesting to me is that we could probably conduct a similarly absurd exercise with the world stock of diamonds in Pile A. Buffett's statement is about the total value of the stock of gold relative to Pile B, but prices in a free market do and should reflect the marginal value. Phrased this way, Buffett exhibits a classic paradox in economics (the diamonds and water paradox). What Buffett means to say -- that the price of gold is too high given the marginal value of the product -- may also be true (and I think it is), but one could prefer Pile B over Pile A and the price of gold could still be "right" at the margin.

HT (Sean "Golden")

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