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All that Glitters is Not Gold

gold_barBoth gold and silver prices have plunged to their lowest levels in almost three years. The spot price of gold stands at US$1,298.60/ounce while the spot price of silver stands at US$20.12/ounce as of 21st June 2013’s close. Gold peaked at US$1,900/ounce in September 2011 and silver peaked at US$45.83/ounce in April 2011.

Gold and silver had been rising for the past few years as they have been backed by many to be a safe haven amidst economic uncertainties. Now with Bernanke saying that US will curb its money-printing policies, holding gold and silver are not seen to be as lucrative as before.

Warren Buffett, during an interview with CNBC in March 2011, talked about his views about precious metals. He said he doesn’t know how to judge the prices of gold and silver but he knows how to judge to “some extent the earning power of some businesses”.

He went on to say that if one were to take all of the gold in the world, it would roughly make a cube 67 feet on each side. That cube of gold would be worth about US$7 trillion. Currently, there are roughly a billion of farm – acres of farmland in the United States. They are valued at around US$2.5 trillion. With the same US$7 trillion, you could have all the farmland in the United States, plus about seven Exxon Mobiles and not only that, you could have $1 trillion of extra cash to deploy elsewhere. The farmland and the seven Exxon Mobiles with be cash flow generating assets whereas the only thing you can do with the cube of gold is look at it once in a while and caress it.

When we invest in a business, though, we can value the business by summing the future cash flow generated by the company, and discounting it to the present value. This value can be compared against the market price to determine if the business is a buy. By buying fractional ownership in businesses like Exxon Mobil, we can partake in the growth of the business and be rewarded through capital gains and dividends.

Some very highly cash-generative businesses listed in Singapore include SIA Engineering Company Limited (SGX: S59), ARA Asset Management Limited (SGX: D1R) and Singapore Exchange (SGX: S68). These capital-light businesses generate lots of free cash flow. The free cash flow can be utilized to reinvest back into the business, do share buybacks, pay dividends or pare down debt.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.