Over the last few days, I have been doing a deep dive into Warren Buffett (Trades, Portfolio)'s history with commodity investing - I've explored his recent purchase of a gold miner and his foray into the oil futures market in the 1990s. But perhaps the most well-known (and un-Buffett) commodity trade that the Oracle of Omaha has done was his big silver bet. Despite his frequent claims that he avoids precious metals because "they don't pay a dividend," Buffett had a significant position in silver in the mid-1990s.
When supply and demand don't match up
To understand why Buffett went out of his way to invest in silver, we need to look a little further back in time. In the late 1970s, the Hunt brothers (sons of oil tycoon Haroldson Lafayette Hunt Jr.) made a failed attempt to corner the silver market - that is, to buy up enough silver that they would be able to control the price of the commodity.
At their peak, the three siblings are estimated to have owned around a third of the world's publicly traded silver, and bid up the price from around $6 per troy ounce in 1979 to around $49 per troy ounce a year later. Ultimately, regulators stepped in to prevent the scheme from coming to fruition, and the Hunt brothers were forced to declare bankruptcy.
The net result of this market manipulation was to damage the credibility of silver as an investment and store of value. This contributed to a slump in silver prices over the course of the 1980s and 1990s. But this wasn't the only reason for Buffett's decision to jump into the silver market. When Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) started buying silver in 1997, his rationale was simply based on the supply and demand aspects of the market.
At the 1998 annual shareholder meeting, he said that he believed aggregate industrial demand for silver was running at much lower levels than the supply available at the time. Since silver was at the time mostly produced as a byproduct of the mining of other metals, its supply is much less responsive to price changes than other commodities - if you are a gold miner who happens to also produce some silver, you are not going to increase extraction just to meet the increased demand for silver. Buffett predicted that this imbalance could not continue indefinitely.
Berkshire booked a $97 million gain in 1997 as a result of its foray into silver, so it's safe to say that this particular trade turned out pretty well for Buffett and Munger - and all it took was some pretty simple arithmetic.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Warren Buffett's History With Oil
- Looking for Opportunity in the Beaten-Down Shale Sector
- The State of the Oil Industry, Part 3
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