The Motley Fool

Warren Buffett: Hedging With Gold Right Now — Not a Bad Idea!

Image source: Getty Images

Warren Buffett’s recent portfolio addition of Barrick Gold (TSX:ABX)(NYSE:GOLD) has taken the market by surprise. The idea that one of the greatest long-term investors of all time added a gold position raises the question: Is hedging one’s portfolio right now a good idea?

Warren Buffett and his partner Charlie Munger have long talked about how valuations have gotten out of control. Indeed, this market is one which provides few value opportunities today. The levels of exuberance and greed right now are near all-time high levels. Accordingly, Buffett’s mantra of “being fearful when others are greedy” seems to be taking hold.

Investing in gold in general and gold miners specifically are typically viewed as hedges. This is due primarily to the negative correlation gold tends to have with the U.S. dollar and economic growth. From time to time, gold takes off in a bull market, while equities lag.

Accordingly, I think investors need to consider Buffett’s decision to add Barrick to his portfolio as one of two things:

1. Investors need to hedge right now

The number one goal of investing, according to many of the best investors of all time, including Warren Buffett, is capital preservation. It’s not so much the growth aspect that one ought to seek. Rather, it’s the reality that growth is required for one to keep up with inflationary forces that diminish the value of one’s savings over time.

Preserving capital means not only obtaining inflation-beating growth each and every year. It means in down years, one doesn’t lose as much as the market otherwise does. Portfolio hedging, particularly for those with substantial sums invested in the market, is a good way of having a capital preservation-first mindset.

Gold miners like Barrick provide returns that generally align with inflation over time. In a hyper-inflationary environment (what everyone is worried about as a result of the massive stimulus we’ve seen), these stocks do extremely well. In a market downturn, gold also tends to outperform. This sort of growth hedge is one that many long-only portfolios employ. This is because investors are still technically long equities, but can add more gold exposure depending on their bearishness level.

Warren Buffett did trim his stake in Barrick last quarter, so it may be that he has become less bearish overall. The fact remains that being hedged is not a bad idea if one is worried about valuations.

2. Gold miners are simply too cheap to ignore

The valuations of the broad index of gold miners are trading near its lowest levels in three decades. These companies are extremely cheap. Indeed, in a market that is super overvalued, finding these pockets of value can be enticing for value-oriented investors such as Buffett.

I think Barrick is one of those perpetually undervalued companies that may take a long time to be valued properly. That said, if one is holding this company as a long-term investment, patience can be your friend with this stock.

Right now, gold miners are priced as if the long-term average price of gold will be only around US$1,400 per ounce. If you’re more bullish on the long-term trajectory of gold, buying companies like Barrick can provide nice long-term upside. This is, of course, in addition to the hedging value these investments have.

Like this Warren Buffett TSX pick? Here are some other companies Warren Buffett might be interested in:

The 10 Best Stocks to Buy This Month

Renowned Canadian investor Iain Butler just named 10 stocks for Canadians to buy TODAY. So if you’re tired of reading about other people getting rich in the stock market, this might be a good day for you.

Because Motley Fool Canada is offering a full 65% off the list price of their top stock-picking service, plus a complete membership fee back guarantee on what you pay for the service. Simply click here to discover how you can take advantage of this.

Click Here to Learn More Today!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Chris MacDonald has no position in any of the stocks mentioned.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.