Rick Ferri’s Take on Gold

I recently had the privilege of interviewing Rick Ferri, founder of Portfolio Solutions, an investment management firm in Troy, Michigan. Rick is the author of several excellent books on ETFs, index funds and passive investing, including one of my favourites, All About Asset Allocation (McGraw Hill, 2010), which has just been released in a second edition.

One of the issues Ferri and I discussed was the outrageous popularity of investing in gold. SPDR Gold Shares (GLD) is now the second-largest largest ETF in the world, with more than $56 billion (US) in assets, something that would have been inconceivable five years ago. One of the most common reasons people give for buying gold is that it offers security in the event of financial or economic catastrophe. Here’s Ferri’s take on that logic:

“Everybody is putting their money into GLD. But it’s a piece of paper: they are not going to issue you gold bars. If the banking industry collapses, how are you going to get your gold? If Armageddon comes along you might say, ‘That’s OK, because I own gold.’ But you don’t own gold, you own GLD. I suppose you could go to the vault in London with your piece of paper and ask for your gold — assuming that airlines are still flying. Good luck with that.

“So you say you don’t trust the banking system, and the whole world is going to crap, you don’t trust anything except gold, but then you own GLD? Everything was fine up until the point where you said you own GLD.”

Would you invest in a pile of bricks?

Ferri went on to say that the whole concept of owning gold as a currency of last resort presumes that you own physical gold. But even then, he argues that gold and other commodities are not good long-term investments, comparing them to a pile of bricks:

“You can take a bunch of bricks and pile them in your backyard and look at them every day and say, ‘Go up in value, go up in value.’ But you can’t say, ‘What kind of dividends are my pile of bricks going to pay me this year?’ Because it’s zero. How much interest am I going to get from my pile of bricks? None. Is my pile of bricks going to become two piles of bricks over the next 10 years? No, it’s going to be one pile of bricks a year from now, 10 years from now, and a hundred years from now. You’re just hoping that someone comes along who thinks that pile of bricks is worth much more than you paid for it.

“I want to invest in things that have cash flow. That’s the bottom line. If I’m going to invest for the long term, and not just trade, then all of the asset classes I have are going to have cash flow. They are all going to pay either interest or dividends, or if it’s real estate they’re going to pay rent. With growth stocks, the idea is that they are going to pay dividends in the future. That’s investing: you invest for future cash flow.

“A pile of bricks has no cash flow. To include them in your portfolio, you would have to know something about the supply and demand for bricks. You would have to know that the market for bricks is going to change, and thus the future value of your pile of bricks is going to be more than it is now, even after adjusting for inflation. Unless you are a brick producer, I don’t know how you would know that — and I don’t even think the brick producers would know that. But everybody buying gold seems to know. They know that the economics are changing, and therefore the value of gold is going to be higher in the future. Even though 90% of these people have never owned an ounce of gold in their lives, all of a sudden they are experts on the supply and demand for gold.

“If I am going to have commodity exposure, I would rather own the companies that make money from commodities. Because the company can become more productive or more efficient. The company pays dividends. The company can make money even when the underlying commodity isn’t. There are times when gold does much better than gold mining stocks, but in the long run you’re much better off buying precious-metal mining stocks — and in Canada, you’ve already got that if you own a broad-market index fund.”

21 Responses to Rick Ferri’s Take on Gold

  1. larry macdonald November 3, 2010 at 6:46 am #

    I think if one owns a house, it’s a good alternative to gold as a hedge against inflation. I don’t see why anyone with real property needs to diversify or hedge their financial portfolio with gold.

  2. Michael James November 3, 2010 at 9:22 am #

    The question “What kind of dividends are my pile of bricks going to pay me this year?” made me laugh. That question captures very nicely my reasoning for preferring to own businesses.

  3. Canadian Capitalist November 3, 2010 at 10:43 am #

    If Canadians have a well-diversified portfolio, they’ll already have plenty of exposure to gold through gold stocks. Last I checked, gold stocks accounted for close to 20% of our stock market.

    There is only one reason gold is popular now. It has gone up so much in price in the past ten years. Ten years back, nobody wanted gold. We were all busy chasing US stocks. Now nobody wants to touch stocks in general and US stocks in particular. It is so reassuring that even in a rapidly changing world, investor behaviour remains constant.

  4. Canadian Couch Potato November 3, 2010 at 11:31 am #

    @CC: According to a highly credible source (a random Google search) the reason gold is popular now is that “the approaching Diwali festival on Nov. 5 and the traditional December wedding season [in India] are propitious times for buying gold – as an investment, as an adornment and as a wedding dowry – and merchants have begun stocking up.” Now that is sound, long-term investment strategy of there ever was one. 🙂

    I am thinking of starting a major position on candy cane futures in anticipation of the upcoming Christmas season. I expect that candy canes (as well as peppermint-based commodities) will advance in value as the yuletide season approaches, making this a propitious buy.

  5. Patrick November 4, 2010 at 5:42 am #

    Silver is a better buy than gold. It’s 5x rarer than gold. It’s used in everything, tvs, phones, cellphones, electronics. So there is a demand for it, meanwhile gold is hoarded.

  6. Rob of NY November 5, 2010 at 11:46 am #

    Silver is 5x rarer than gold. Absolutely not true. Roughly 2500 metric tons of gold per year and roughly 18-20,000 metric tons of silver.

  7. Jimbo November 5, 2010 at 4:38 pm #

    Craig disagrees with Ferri:

  8. Lenny November 5, 2010 at 5:38 pm #

    Rick should read up on world financial history. Bricks have not been used as money for the past 3000 years, and the free market has not overthrown government currencies in favor of bricks (with a windfall to brick owners) countless times as it has with gold. Was mankind stupid for 3000 years, or is Rick missing something?

    I placed my bet 8 years ago, and I’m letting it ride….

  9. Jurgen Schwartz November 8, 2010 at 8:54 am #

    Precious metals has a place in my portfolio because it performs well when stocks do not. I do prefer cash flow, but that does little good when the value of your cash is dropping through the floor. You have to look at how different assets perform during different market conditions. This is why the Harry Browne portfolio is the best performing lazy portfolio.

  10. rmch November 8, 2010 at 10:29 pm #

    Re: the last comment in the quote, I own XIC as part of a couch potato portfolio but also bought some XGD shares for fun (yes I do this once in a while). The XGD actually helped smooth out the poor XIC returns over the last few months.

    Also interesting: CGL and GLD basically match each other for the last 5 years — but XGD is quite a ways above it most of the time.

  11. Doc November 9, 2010 at 7:58 am #

    If the world falls apart, as many gold bugs fear, your gold will be worthless than my can of beans.

  12. SLS November 10, 2010 at 10:18 am #

    Was mankind stupid for 3000 years, or is Rick missing something?

    Well… I’m going to go with mankind was stupid for 3000 years and apparently still is.

  13. kevin November 10, 2010 at 3:46 pm #

    This paper clown still don’t get it; it’s like his house starts to burn at its wooden columns or whatever and he’s still saying I don’t see the smoke or smell the smoke. Paper money is becoming more and more worth less until it is worthless — like monopoly money — as Big Ben is very busy doing it, just like his ilk doing around the world. Well, keep accumulating your dividends/interests(paper money) and yourself a few wheelbarrows, Mr. Rick Ferri.

  14. Matt November 10, 2010 at 4:17 pm #

    Rick- You make excellent points when you are referring to a monetized ETF; however, I believe you are missing the big picture. The idea is to ‘hold’ tangible assets, gold and precious metals being the top of the food chain when it comes to tangible assets. This is the whole point of owning gold. I’ll continue to accumulate ‘worthless pile of bricks’ in my backyard made of gold, and when the impending currency war hits the worldwide economy and the financial industries go to he** in a handbasket, I’ll trade my ‘worthless bricks’ for food and other necessities.

  15. WJC November 10, 2010 at 4:36 pm #

    Rick Ferri is certainly correct in a world of low inflation. But when government begins to inflate the economy, the currency will necessarily be devalued. Compared to what? Perhaps to other currencies in countries with sounder fiscal management than we have, but that requires you to predict which governments will act like mature adults. Compared to gold? Since production increases are limited, and there is a demand for gold for a variety of uses (including some of my dentistry), it seems likely gold will appreciate in value against the dollar at least as long as inflation is likely.

  16. Glenn November 11, 2010 at 10:31 am #

    Mr. Ferri is sour on bricks because he didnt buy any 3 years ago…..and…1 billion Chinese have owned bricks for 3000 years…so the price of bricks goes up…simple arithmetic

  17. kp November 13, 2010 at 9:14 pm #

    Mr. Ferri’s approach is fine with me — I like divedends and interest growth and growing companies, too. But there is no doubt that gold and silver are classic hedges against currency failure. Of course, owning good farmland, or diamonds, or other hard assests will get your through a currency crash, too. The point: keep some gold or silver in your basket. Stay diversified. And don’t forget –while gold has risen 400% in the last twenty years, Apple and Google and Baidu have grown even more.


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