In December 2007, the legendary investor known as the Oracle of Omaha proposed a bet for charity that would go on to define the investment landscape over the next decade.
Warren Buffett proposed that there would be no hedge fund manager able to outperform the S&P 500 index over the following decade.
He offered a $1 million wager to any hedge fund manager willing to accept. Protege Partners was the unfortunate hedge fund that agreed. The bet, while insignificant is dollar terms, has effectively defined the investment mindset since.
Protege Partners and Buffett each put up $320,000 into bonds that would appreciate to $1 million over the course of the wager. Back then one could invest in bonds that would more than triple in a decade. This wager is one that couldn’t be made without putting up a whole lot more given the state of interest rates in 2020.
Buffett often discussed the two main reasons he believed that he would win. The first, is a point Buffett has made over the course of his career, namely that stocks tend to go higher over time. The second was that the fee structure of a passive index fund was far superior to the fee structure charged by hedge funds, and a near certainty why over time the low-cost index fund would outperform.
The impact of the wager then was far greater than the attention it brought to each of the players charities. Buffett's certainty on the future of America came at a time when investors were fleeing the market due to the housing collapse.
Over the course of the next several years while skittish investors feared jumping back into the market, Buffett dove in head first. While everyone else was sold, Buffett bought. He bailed out AIG, he bailed out Bank of America, and he bailed out Goldman Sachs. He even went “all in” in America and bought a railroad.
Those investments turned out incredibly well for Berkshire Hathaway and further cemented his reputation and legendary status. Buffett would go on to handily win the bet. The exercise brought tremendous affirmation to the investment public that it was safe and still the right thing to invest in America through stocks.
Soon “index investing” became the rage. The Vanguard index fund Buffet chose would go on to provide an over 60% return over the next decade. The impact, however, on the passive investment strategy was far greater than that. Today passive investing controls over 50% of all total stock market capitalization.
Buffett’s cheerleading along the way has only brought more attention to his strategy. When asked about his time horizons on his investments during the first years of the bet, Buffett’s consistent reply was always, “my time horizon is forever.” Investors listened, and stocks exploded higher.
That story, for Buffett, came to an end in 2018 when Buffett moved a large portion of his capital to cash. Since then long-term investors have been waiting for his next move. Buy what Buffet buys has been a great strategy.
Berkshire’s holdings were announced on Friday and shocked the investment world.
Anyone who understands the history of “the bet” should be put on high alert. It has alarmed the passive index equity bulls even more.
The headline on MarketWatch was, “Did Buffett just bet against the U.S economy.” Bloomberg followed with “Berkshire makes bet on gold market that Buffet once mocked.” Fortune followed with “Buffett traded Goldman Sachs for gold.” It seems everyone has noticed the Buffet’s about face U-turn.
Why the reaction? The holdings list decries Buffett's own words. In a speech at Harvard in 1998 Buffett said, “(Gold) gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” Buffett has forever been critical of gold.
We note that since speaking these words the S&P 500 has risen three times. Alternatively, the price of gold has risen nearly eight times in the same period. It seems the Oracle of Omaha has finally woken up to data and to the reality that “you can’t print gold.”
What is Buffett seeing that he hasn’t seen before? The ratio of the price of gold relative to the S&P 500 hit all-time highs nine years ago when it reached 1.7X. Today that ratio sits at closer to .6X. Rarely have stocks been this overvalued, and gold this undervalued on a relative basis.
Buffett’s actions will no doubt drive deeper confidence into gold as the asset class to own, despite the fact that Wall Street still wants us to believe is merely a “pet rock.”
Ironically, on Friday, at the same time as Berkshire announced its holdings list, my new book, “The Great Devaluation,” was listed as the number one best-selling business book in the country by the Wall Street Journal.
I was asked by a dear friend, “How affirmative does it feel to have the number one book in the country?” My reply? “Not nearly as validating as it feels knowing that the greatest investor of our time just bought gold!”
Adam Baratta is the author of the national best-selling books, "The Great Devaluation,” and "Gold Is a Better Way." He is one of the leading voices in the field of investments and precious metals today. Adam is the co-owner of Advantage Gold, the highest rated precious metal firms in the country.
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