Seth Klarman on Gold Part 2

So what then would be a good hedge against inflation if Gold isn't quite doing the trick?

The second part of Mr Klarman's answer as to that question is real assets.

Let's examine what real assets are: Investopedia defines real assets as "Physical or identifiable assets such as land, equipment, patents, etc."

The only way one can gain ownership of many of these assets is through ownership of REITs or companies that use patents or manufacture equipment.

I submit to you that ownership of companies that own real assets is one way of combating the bit of inflation on your assets. This means not every company is going to benefit from inflation. Only the ones with real assets that can raise prices when inflation comes around.

The problem with most companies is that in an inflationary period, they raise their prices but they also suffer from increased costs. So at best, they can pass on their increased costs to their customers. Or they might not be able to pass on the full cost increase to their customers and it'll start to eat into their profit margin. That would really be bad. There's a good piece by Buffett on this issue.

So you're look for companies that really have pricing power, you'd be looking at monopolies, at companies selling commodities and at real estate related companies. Finally, inflation protected securities or inverse treasury ETFs.

The last two are a bit iffy. Simply 'coz Treasury Inflation Protected Securities (TIPS)'s yield is linked to the CPI index. The CPI index is a poor tracker of inflation because it doesn't have the price of oil in the index. Inverse Treasury ETFs are also difficult because the yields might not exactly match inflation.

So the time is now for us to starting hunting. I've defined the areas so we need to do our digging in those areas.

Seth Klarman on Gold

My buddy goes to MIT's Sloan Business school to do his MBA. Somehow he is doing a class at Harvard and his professor got Seth Klarman to come in and talk to the class! That's awesome! I managed to ask my buddy to ask Mr Klarman a question.

Simply put:
Does he believe that Gold, even at today's high price, is a good hedge against inflation? If not, what would be a good hedge against inflation?

This is his reply: Mr Klarman said he does think is gold overvalued. He said the best long-run hedge against inflation is real assets.

I agree. I have a lot of difficulty valuing Gold. There's no long term predictable cash flow. There's no business prospects to evaluate. So how can I as an analyst figure out the long term price of gold?

What's the difference between gold and collecting art or wine then? One of the reasons why value investors don't buy art or wine is 'coz they don't have long term predictable streams of cash flow. Hence they can't be considered an investment.

There are 3 main uses of gold - jewelry, manufacturing and financial. The first 2 uses have seen dramatic drops in demand and they normally account for 2/3 of the total gold demand. Currently, what is driving the gold price is mainly financial. Financials can only sustain the gold price for so long. Once markets get back to normal, pp are going to want to go back into other assets, like stocks as their price goes up. That will probably lead to a decrease in the gold price. So the pp who bought it as a retention of real value, just found themselves buying gold at its peak, only to put their capital at risk of permanent loss.

The other thing is I don't quite like buying stuff when everyone else is buying it. Esp if I'm buying the stuff at a multi-year high. Call me a contrarian. But Gold is trading at a multi-year high. I'm not hot on following the crowd. 'coz you never know when the crowd will turn and leave you holding the ball.