Warren Buffett, the CEO of Berkshire Hathaway (NYSE: BRK-A), is currently worth about $44 billion, according to Forbes' list of the world's richest people. This makes him the world's third-richest person, behind Bill Gates and Carlos Slim.
Buffett is famous for some great stock picks over the years -- picks like Coca Cola (NYSE: KO), American Express (NYSE: AXP) and IBM (NYSE: IBM), each having increased more than 110% in the past 10 years alone.
But the Oracle of Omaha is also well known for avoiding certain investments -- especially gold.
The answer has to do with the difference between what Buffett calls productive versus nonproductive assets.
He considers gold a nonproductive asset because it doesn't produce anything of value. To illustrate this point, Buffett proposed this thought experiment in his 2011 letter to Berkshire shareholders:
"Today the world's gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce -- gold's price as I write this -- its value would be $9.6 trillion. Call this cube pile A.
"Let's now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world's most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?
"A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops -- and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond."
So, instead of nonproductive assets such as gold, Buffett prefers productive assets like farmland or companies that generate enormous wealth for shareholders -- companies like Exxon Mobil (NYSE: XOM), Coca-Cola or See's Candy.
And he clearly explains why:
"Our country's businesses will continue to efficiently deliver goods and services wanted by our citizens. Metaphorically, these commercial "cows" will live for centuries and give ever greater quantities of "milk" to boot. Their value will be determined not by the medium of exchange but rather by their capacity to deliver milk. Proceeds from the sale of the milk will compound for the owners of the cows, just as they did during the 20th century when the Dow increased from 66 to 11,497 (and paid loads of dividends as well).
"I believe that over any extended period of time this category of investing will prove to be the runaway winner… More important, it will be by far the safest."
This last sentence is important. Investing in productive assets carries less risk.
That's because, in the past, irrational exuberance has caused all sorts of nonproductive assets to suddenly skyrocket beyond any sane measure of intrinsic value. The run-up on the prices of tulips in the 17th century is one colorful example.
Action to Take -- > In contrast to the "boom and bust" cycle seen in commodities like gold (or tulips), productive assets will never go "out of style," as Buffett says.
After all, people will always need goods, consume food and require a home to live as they do now. In Buffett's own words, "People will forever exchange what they produce for what others produce."