Warren Buffet’s Berkshire Hathaway shocked the investing world by purchasing shares in Barrick Gold (ticker; GOLD) during the second quarter of this year. Barrick is one the world’s two largest gold miners.

 

Buffett and his company are well known for hating gold. One of his famous quotes questioned why anyone would want to dig gold out of the ground just to put it back in the ground (in a vault) and pay people to stand around and guard it. For Buffett, gold has no utility. Charlie Munger, his curmudgeonly business partner quipped, “civilized people don’t buy gold.”

 

Yet, the boys at Berkshire spent over $560 million on shares of Barrick during the second quarter. This is a very small purchase for Berkshire who owns over $89 billion in Apple (AAPL) stock, but their stake makes them the 11th largest holder of shares in Barrick. What gives?

 

First of all it’s important to remember something about the mindset of Buffett. He and his lieutenants are not short term thinkers. They aren’t trend followers. These guys are died-in-the-wool value investors. When they make a purchase it represents a commitment and they fully expect to receive market beating returns over the long term.

 

Now, it’s important to note that Buffett technically didn’t go back on his word when he bought shares of Barrick Gold. Afterall, he didn’t buy the commodity itself – which would mean he’d have to pay some stiff to stand around and guard it – he bought a gold mining company. As a value investor, Buffett recognizes that a company can mine a perfectly “useless” mineral like gold and still make a profit selling it to people. It’s the potential for profit that attacks the men at Berkshire.

 

Barrick generated over $500 million in free cash flow during the second quarter on an average gold price of $1,725/oz. If the price of gold remains at its current level and Barrick’s production is unchanged, they could produce $700 million in free cash flow this quarter. All things being equal, every $100 dollar increase in their average gold selling price generates an additional $500 million in free cash flow each year.If the price of gold reaches into the multiple thousands like many analysts expect, Barrick’s profits will explode.

 

Conversely, if the price of gold were to plunge, Barrick’s profits would plunge along with it. But remember, the boys at Berkshire are not speculators, they are long term investors. It would seem clear that they expect gold to go much higher in the future and although Charlie Munger may never become an “uncivilized” owner of gold, he’s already a civilized owner of a very profitable gold miner.

 

Why didn’t Berkshire make this purchase years ago? On the five year chart below, I’ve circled the time period when Berkshire made its purchase. They could have bought Barrick at a lower price at any point during the previous five years. Why didn’t they? What changed?

Perhaps the Federal Reserve’s response to the Coronavirus (a multi-trillion dollar handout) and our economy’s unprecedented decline, has convinced Buffet and Co.that money printing has now become a permanent part of United States monetary policy. If so, it will likely erode the dollar’s buying power and could even threaten the dollar’s place as the world’s reserve currency (as many expect).  A declining dollar and the lack of confidence that goes along with it is a very favorable environment for gold. Owning a profitable gold miner like Barrick could make a lot of cents (get it?) in that kind of world.

 

One last thing. Buffett’s entry into the gold space marks an enormous change of philosophy for the huge audience that follows him and aspires to invest like him. This purchase could open the door for untold private investors, as well as mutual funds that mimic the Buffett value approach. In my view, such a development would certainly be bullish for gold mining stocks.

 

See you next time,

Mark