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When Dot-Coms Were The Craze Buffett Was Buying Commodities

March 15, 2011 | About:
Josh Zachariah

Josh Zachariah

36 followers
In the 1997 annual report, Buffett noted an usual investment he made during the year:

“Last year, we purchased 111.2 million ounces [just less than a third of the market]. Marked to market, that position produced a pre-tax gain of $97.4 million for us in 1997. In a way, this is a return to the past for me: Thirty years ago, I bought silver because I anticipated its demonetization by the U.S. Government. Ever since, I have followed the metal's fundamentals but not owned it. In recent years, bullion inventories have fallen materially, and last summer Charlie and I concluded that a higher price would be needed to establish equilibrium between supply and demand. Inflation expectations, it should be noted, play no part in our calculation of silver's value.”

The price per ounce of silver in 1997 ranged from $4.4 to $6.2 as the graph below shows. Buffett likely purchased the silver closer to the $4-5 range and that would have produced a pre-tax return of about 15%. The magazine Time wrote a piece on this particular investment and noted he had increased his stake to 129 million ounces in 1998.

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1SilverBullionInventory.gif

This may come as a surprise to some as Buffett has tended to shy away from commodities and gravitated towards cash flow producing assets. The valuation of commodities is all the more difficult and you certainly won’t find any explanation of that topic in Security Analysis. However, commodities like all assets are governed by the basic laws of economics. If household formations significantly outnumber housing starts over a period of time you can bet in the long run, house prices will rise. Buffett had used this logic in predicting house prices increases in the next year or so. In the latest shareholder letter he also commented on the low price of natural gas. Low prices naturally attract consumers and he made the safe bet that we’ll likely be using more natural gas in the near future.

Silver and other commodities are no different. Quoting from the Time piece, “Buffett says in a statement that he saw a huge imbalance between the amount of silver available and the demand for it to make things like jewelry, photographic supplies, electronic components, mirrors and batteries. So he began buying because "equilibrium between supply and demand was only likely to be established by a somewhat higher price."

Buffett regularly comments that he invests in companies and their industries in which he can have a good idea of what the economics will look like in 10 years. Economics is an integral part of business and one often overlooked. I see this deficit of economic understanding most clearly in the gold and commodities euphoria of present day. The John Paulsons, Seth Klarmans and Jim Grants are all notable investors who have championed gold recently. But the most seasoned of investors has been sitting out the gold and commodities boom.

Disclosure: Long Berkshire Hathaway

Josh Zachariah

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 3.6/5 (20 votes)

Comments

TorontoJoe
TorontoJoe - 3 years ago
Who are these most seasoned investors you speak of?

Seth Klarman, David Einhorn, George Soros, Jim Rogers, Howard Marks, Eric Sprott, Ray Dalio, are all in the belief that gold is money.
AlbertaSunwapta
AlbertaSunwapta - 3 years ago
129 million ounces! If only Buffett and Munger had been buy and hold investors. :-)

Josh Zachariah
Josh Zachariah premium member - 3 years ago
I was referring to Warren Buffett as the most seasoned. Those investors you mention do hold gold, but I wonder if they feel as Soros does that it's in a bubble.
thomas crown
Thomas crown - 3 years ago


So, let me ask you this. Are we in a secular commodity or equities market? Do you know how long these secular cycles run for? What was the M3 data, national debt, REAL GDP and unfunded liabilities in 1998 vs. today? What in the world today makes you think, with a nation drowning in debt (both private and public), continuing home value declines (i work in the industry) no real manufacturing jobs to speak of (which is what gives real value to a nations GDP and currency), unrest in the middle east (oil ticks up 5% and countries shit themselves), the euro crisis (greece, spain, portugal, ireland), now japan our 2nd largest investor in treasuries (has to invest a trillion to fix their aging and broken economy) and that somehow, gold's in a bubble and APPLE stock and US treasuries are a good investment? lol wake up bro. You live in candy land and strawberry shortcake won't be waiting for you in the end. Go long US Dollars and Twitter. Call me in 5 years...

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