Warren Buffett « Peter J. Cooper’s Weblog

October 22, 2008

Will Warren Buffett buy gold and silver stocks?

Filed under: Gold & Silver, US Stocks, Warren Buffett — peterjcooper @ 5:20 pm

The Sage of Omaha, the world’s richest man has announced that he is back in the market for common stocks for his own portfolio. As ever Warren Buffett has caught the crowd off guard with his investment logic, and there has been no groundswell of buyers following in his path. But equally by his own logic the world’s most successful investor ought to be snapping up gold and silver stocks.

Last Friday Warren Buffett explained his case for buying stocks in a revealing article in the New York Times. Some said it was like the 90 year-old John D Rockefeller buying stocks after the 1929 Wall Street Crash.

Buffett said he could not tell if stocks were at the bottom but saw good value. Plus he is selling his bonds - which are probably at the top of a bull market anyhow - to buy stocks. That makes his decision a search for relative if not absolute value.

It is also revealing why Buffett says he does not want to hold cash. He thinks cash a poor investment in an inflationary environment. That is fair enough. But it still leaves open the question: what type of common stocks will the legendary investor put in his own portfolio?

Inflation coming back

He will clearly want stocks that have been beaten up by the recent stock market falls. But by the same token he will want stocks that stand to benefit from inflation and to show the most immediate recovery. That rules out many financial stocks whose road to recovery looks a long one, so too any other asset class correlated to easy money and low interest rates like real estate and construction.

Step forward the precious metal stocks whose fall has been just as precipitous as any in the recent market crash, but whose potential to benefit from the effects of inflation is unmatchable.

It is a straightforward and pretty uncontroversial thing to note the correlation between rising inflation and rising precious metal prices. The reason is simple: precious metals have a relatively fixed supply and so rise in price with inflation, unlike say a currency whose central bank is injecting trillions to support its banking system.

Now the precious metal stocks are those of the producers and explorers for this commodity. As the gold price rises then the marginal price increase flows straight to the bottom line as pure profit, costs already having been covered. Hence, these share prices are levered against the increase in price in the underlying commodity.

Exploration tip

However, the best share price increases will be reserved for the exploration companies. These companies own the claims or land concessions to search for gold. In a bull market for precious metals the value of this land rises by an even higher gearing to the gold price than a producer’s profits.

Then again consider the position of silver, historically leveraged to any rise in the gold price. And what about a silver producer or explorer for additional leverage. Buffett was a silver investor a decade ago and knows this market.

The question for Warren Buffett is therefore how to buy up these stocks without giving his game away. That is always difficult for an elephant in the jungle. But how about organizing a bit of short selling in the Comex to depress the gold futures market? That would keep the spot price down and give time to gradually accumulate precious metal stocks.

Or it might be that as you are Warren Buffett and the world’s most brilliant investor you do not need to organize this, you just happen to have worked out that this is likely to happen anyway given the current balance of buyers and sellers in the Comex: with hedge funds as net sellers out numbering the growing band of buyers.

Spot falls

Then as the smokescreen of the Comex clears - no doubt aided by the opening of a rival Asian gold futures market in Hong Kong this week - and gold spot prices start to advance, you will have a nice portfolio of precious metal stocks accumulated at low prices.

I have not a clue if this is Warren Buffett’s agenda but it ought to be if we follow the investment logic of his decision to re-enter the market at this stage. For weary gold and silver investors there is an element of annoyance in that this appears to be a case of the second mouse getting the cheese.

Think about that analogy for a moment. The first mouse goes for the cheese and is splattered (i.e sees his gold stocks smashed by the market crash) while a smiling Buffett mouse can then nibble away (pick up the gold stocks cheap).

However, in real life the first mouse will be fine if he holds his position and waits for the second mouse to bite. How long will that take? Only as long as the spot price of gold remains low - and the coin shortage and physical premiums show this can not be for long. And only then we will see if Buffett is back in the precious metals game.

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October 18, 2008

Warren Buffett sees danger in treasury bonds

Filed under: Gold & Silver, US Dollar, US Stocks, Warren Buffett — peterjcooper @ 9:10 am

The headline news on Friday was that the Sage of Omaha had started to buy common stocks for his own personal portfolio (not for Berkshire Hathaway, kindly note). His portfolio was previously 100 per cent in US government bonds.

Buffett has clearly spotted that the bull market for T-bonds is over and is moving his money from a bull market into what he hopes is the bottom of a bear market for equities. In any case if the bond market suddenly tanks under the weight of the bank bailouts, Buffett will still be onto a winner with a timely shift to an asset class that will fall by a lesser amount.

Let me put that in more folksy Buffett language. You sell T-bonds - which foolish investors think is the safest asset class in the world - and buy equities. Buffett makes a fair point in his explanation saying that share prices may not be on the floor yet, and that he has no idea when a bottom might come.

The switch is a question of relative value. Bonds are going to crash, equities have just crashed. So in which class do you put your money? The downside in equities is much smaller than bonds, so you go where you will lose least.

Cash not safe

What about cash? Buffett says you lose over the long term holding cash because it pays hardly any return above inflation. He says it looks the safest asset class now but that is an illusion.

True - as the governments of the world flood the globe with money (as T-bonds or just money) then inflation will soar. This is back to the Weimar Republic days of Germany in the 1920s when in order to pay down the debts of the First World War (read $5 trillion? banking bailout), the government was forced to print money.

In the end it took a wheel barrow of cash to buy a loaf of bread. Then Hitler took over, repudiated the debts, created the Reich Mark and started public works and rearmament that climaxed in World War Two and an almost successful attempt to take over the world.

Hopefully the political consequences of the bank bailout will be less disastrous this time. But the economic impact is an inevitable consequence of the trillions being injected into the monetary system.

Inflation certain

Like Warren Buffett not knowing when the stock market bottom will come we know that it must come. Timing the impact of global bank bailouts on cash and inflation is impossible but we know it will happen.

Buffett’s response is to flee bonds, ignore cash (which does not carry the capital downside of a fixed interest instrument like a bond) and go straight to equities. He will, of course, be highly selective in his buying - and go for companies whose business models make them long term survivors.

It helps, of course, that millions of Buffett watchers will now rush and buy all the stocks that he already owns (a safe assumption is that he will top up these stock holdings first). To that extent when an oracle speaks its words are self-fulfilling.

Gold and silver stocks

However, if you choose to sell treasuries - and this is the wise decision, not buying stocks which is something of a smokescreen - then consider gold and silver shares.

If Warren is right about inflation - and both gold and silver have a fixed supply so they just have to go up in value with inflation - then the currently bombed out shares in precious metals just have to be the best buy in the entire stock market. I expect his own precious metal shareholdings will be kept quiet as he will want to buy as much as possible before anybody catches on.

In the Weimar Republic share prices actually surged with, and even above inflation, while those holding debt saw their investment destroyed by inflation. So joining Warren Buffett in his probably premature shift into shares (although he gives us no information on how much or which stocks he is buying, of course) is not such a bad idea - but do not do it with leverage or you might be wiped out by another down leg.

Some analysts see a recovery in stock prices from now until after the presidential election, with a nice post-election rally, and then another leg down in prices - perhaps to 6-7,000 on the Dow - with a real bottom next spring.

Of course, you could be caught in a bond crash before then, and you should be looking to protect yourself from the dropping of this particular shoe - the biggest capital market in the world. And what will that do to bank capital ratios? They will have to go back to the governments for another bailout, and how will that be funded? None of this is good news, unless you hold precious metals.

For more on gold and silver buy my new book online from this link

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June 10, 2008

Warren Buffett, ADIA turn against the average hedge fund

Filed under: George Soros, US Dollar, US Stocks, Warren Buffett — peterjcooper @ 12:05 pm

Warren Buffett has never been a fan of hedge funds and has just found a taker for his $1 million bet that a basket of five funds of hedge funds would not beat the market over ten years. At the same time, Business Week reported that the largest sovereign wealth fund, Abu Dhabi Investment Authority is halving its exposure to hedge funds.

According to the CNN website Protégé Partners is taking Buffett’s wager with each side putting up $320,000 in zero-coupon treasuries which will be worth a million dollars in a decade.

Buffett’s logic appears to be that over time hedge fund fees will weigh so heavily on overall performance that the basket will under perform the market. By creating a fund-of-funds the focus is on average performance rather than the next George Soros, and it will be interesting to see if Buffet wins his bet.

His argument would probably be that compounding plays such a critical role in the long-term performance of funds that eliminating management fees is more important than the investment skills that they provide in rolling up value over the years.

The Abu Dhabi Investment Authority seems to have reached a similar and presumably independent conclusion. Saeed Mubarak al-Hajeri, AIDA’s executive director, told Business Week: ‘AIDA is keen on identifying real management skills and real talent, and is not prepared to pay the usual fees charged by hedge funds for strategies that can be replicated in an index’.

Another argument against hedge fund out performance is that the leverage used in low-return but rising asset markets of recent years may act in reverse in falling markets characterised by deleveraging. Or in other words funds will be dealing with a deflationary rather than inflationary environment for key asset classes.

I am not so sure. George Soros is supposed to have made $3.5 billion betting against sub-prime loans last year, and Goldman Sachs, more of a hedge fund than an investment bank, managed to do something similar.

Perhaps both Buffett and ADIA are seeking alpha and their point is that the average hedge fund no longer has it. But maybe a top manager will actually be able to deliver out-performance even in a fund-of-funds if they pick the right managers which is quite a skill itself. Could you spot the next Soros?
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April 3, 2008

Follow Warren Buffett, this is a time for the lazy investor

Filed under: US Stocks, Warren Buffett — peterjcooper @ 7:28 am

With due respect to the Sage of Omaha he does not seem to have been over-active recently, apart from making the monocline insurers an offer that they chose to refuse. And if Warren Buffett can not find a good investment in these troubled markets then perhaps for mere mortals this is also time to stay on the sidelines.

If you overlay a graph of the Dow Jones Index from last October on to the start of the 1973 downturn in stocks then you get a good indication of what lies ahead for investors. There is then a pretty bumpy ride down to a market bottom next spring, and for the real economy 2009 will be worse than 2008.

For our old friend the richest man in the world that means he can bide his time almost until he turns 80. US stocks are going to get cheaper and cheaper, and the rest of the world will follow downwards in the wake of the US collapse.

How can it really be otherwise, whatever the optimistic voices on Bloomberg and CNBC suggest? Residential property is the biggest asset base in the US and prices are tumbling downwards, and there can be no end to mortgage write-offs at the banks until prices have bottomed out. And the idea that this whole crisis can unwind without impacting on consumer spending just has to be nonsense.

Stocks can only bottom out when all this bad news is in the market, and we are just not there yet. Ben Graham’s Mr. Market is not just having a bad day this time, he is in serious trouble and while the Fed can smooth the downward path for stocks that is the only road ahead.

Besides quite a big part of the Fed’s corrective medicine is more of the opium that brought on the trouble in the first place: excess liquidity and low interest rates. Feeding an addict the same medicine can ease the pain but it is no cure. Recovery requires a rebasing of asset price levels and an elimination of debt.

Devaluation and inflation courtesy of the Fed’s policies will help to spread this pain widely. But the risk is surely that the US economy struggles over the summer and has a last hurrah before the presidential election, and then truly collapses in 2009.

In this scenario rushing back into financial markets as an investor is likely to prove suicidal. Just wait for the market bottom in the same way that any rational home buyer will wait for the real estate market to stop falling before buying.

But if you are fully invested you should come out while you still can. There will likely be another year of downside like in 1973-4 and you can buy back later at much lower prices.

Why do people believe that the market will bounce back having only hit its high last October? If you look at the 2000-2003 dot-com crash it took three years for stock prices to bottom out.

That is how it goes in bear markets, and unless you are clever at shorting stocks, and few people are that good, this is a time to be a lazy investor and do nothing except sit on cash and wait for the US dollar to bounce.