From Karlman's Margin of Safety to Graham and Dodd's Security Analysis, Is Gold an Investment?

I typically field questions from the "metals" bulls, while occasionally lending my latest sarcastic indignity to the bears on one other website.  From time to time I review my content there, and I recently came across a question about the potentiality of gold as an investment from a value investing perspective.  Many have deemed it to be speculation.  Let us start with his topical quote from Seth Klarman and line of questioning below.

    

In Margin of Safety, Klarman writes:

"Assets and securities can often be characterized as either investments or speculations. The distinction is not clear to most people. Both investments and speculations can be bought and sold. both typically fluctuate in price and can thus appear to generate investment returns. But there is one critical difference: investments throw off cash flow for the benefit of the owners; speculations do not. The return to the owners of speculations depends exclusively on the vagaries of the resale market."

From the definition, how is investing in PM's speculating vs. investing? Specifically ...

A) Miners

B) Physical Bullion

C) ETF's

Is there a a difference between the three in terms of that definition?

Finally, I am still trying to understand the investment value of gold. I understand that silver has industrial value since it's important in solar energy as an excellent conductor ... but gold?  Under what conditions could ownership of gold be classified as an investment as opposed to speculation?

These were the questions posed.  So I shall respond somewhat formally.


In Security Analysis, Benjamin Graham wrote, "An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."

A) Gold does promise safety of principal inherent in the mining cost and current supply/demand dynamics and the expected environment going forward 5 years. An adequate return has been made for over a decade at over 10% per year ( 9% per year for over 40 years). You simply can not compare gold data before it was traded on the open market as a commodity, pre 1970 data is essentially not much use in projections. 

Gold can,"throw off cash flow for the benefit of the owners" as Klarman worded it.  Below are charts that give some perspective on gold lease rates.  Gold lease rates typically equates the USD LIBOR plus or minus the forward rate on gold (plus for contango, minus for backwardation).

So yes, physical gold is an investment according to Seth Klarman and Ben Graham's respective definitions.  

B) By Graham's definition gold producers with a well structured balance sheet, in a "mining friendly" location, with a five year or greater mine life and an adequate forward earnings outlook meet the prerequisites for Graham's definition of an investment.  These producers would also meet the requirements of Klarman's definition. 

C) In my opinion gold ETF's do not fit in this category, the synthetic structured instruments were built for speculation.

More on why this is... coming soon.