Monday, September 26, 2011

Lesson 9: Printing money, thoughts on gold.

When I buy a good company, it earns money every year. I don't really care too much what it's doing to make money, as long as it makes money. As an owner, or partial owner, I see benefits from dividends or capital appreciation as a result of an increased retained earnings account. Effectively, when I buy a good company, I am buying a money printing machine.

Here's my issue with gold. If I buy gold, I won't have more gold next year. It does not create or earn money for me. It can never pay interest or dividends. Gold is like an antique painting. If I buy it, the only way I can make money is if I find someone who wants to pay more for it.

When a company earns money for you, it often does so at some rate. The price you buy it for will then determine your rate of return, which is up to you to define what's acceptable. (price divided by earnings) If the rate of return is below what I deem acceptable, I can say it's undervalued, and vice versa. Gold does not earn anything, so this math does not work. As a result, I have no idea if gold is overvalued or undervalued.

Someone might argue that gold is overvalued at 1500... someone else might argue it's undervalued at 1500. If gold hits both 1200 and 1800 in the next 6 months, (I'm not specifying the order) who was right and who was wrong? In my book, you're only right if you make decisions in a sustainable and repeatable method that results in profits over time.

Although stock prices sometimes wildly fluctuate away from their intrinsic value, they always come back near it eventually. The price of gold is in part determined by laws and policies set by politicians. I have a grocery store down my block that's been around for more than 30 years. I can say with 99% certainty that the grocery store will continue to sell groceries for years to come. I can say with 95% certainty that the IPad will be the dominant tablet for the next 2 years. I can only say with 10% certainty about politicians choosing to increase interest rates within the next 2 years, which will affect the price of the dollar, and hence, gold. Since I can't accurately predict decisions of politicians, I stay away from things like gold and silver.

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