Buffett Says US Wealth Creation Machine Will Not Be Stopped

Today’s Money Morning will look at both ends of the investment spectrum — speculation and investing.

First up, speculation.

This is when you make a bet that prices will rise. There is no fundamental valuation going on. It’s an assessment based on supply and demand expectations.

Not surprisingly, the commodities sector is where much speculation occurs. It’s all about future supply and demand.

The recent emergence of the electric car industry and the growing demand for electric batteries to fuel this new sector has set off fireworks in the commodity sector.

The hottest metals on the market right now are those that play a part in the battery production process. And hedge funds know it. They are beginning to hoard strategic metals in the expectation that this will exacerbate the supply demand imbalance.

As the Financial Times reports:

Suppliers to Tesla and other electric carmakers are scrambling to secure shipments of the key battery material cobalt after a group of hedge funds amassed a large stockpile of the scarce metal. In a bold wager on higher prices, half a dozen funds, including Swiss-based Pala Investments and China’s Shanghai Chaos, have purchased and stored an estimated 6,000 tonnes of cobalt, worth as much as $280m, according to the investors, traders and analysts. The stockpile is equivalent to 17 per cent of last year’s global production of the metal.

This is how bubbles form. And it’s playing out exactly as Resource Speculator Editor Jason Stevenson said it would. That is, he predicted that a few strategic metals would soar in price, but that you need to get in early to make the most of the bubble.

Well, some hedge funds are clearly in on the act as well. Their actions will only make the situation worse, if you’re a buyer of these metals — or better, if you’re a speculator.

You can check out Jason’s report on the battery metals here. But remember, this is pure speculation. It could go pear shaped. Having said that, only pure speculation can deliver the potential for hundreds of percent gains in a short space of time. If you’re game then, jump on board!

The whole hoarding of strategic metals thing is a bit rough, though. This is what happens when you flood the global economy with money. It ends up in the financial sector as a plaything of hedge funds taking huge risks.

The actions of the hedge funds drive up prices for a while, by putting an artificial squeeze on supply, but the air will eventually come out of the bubble. So there are no lasting price rises that come from pumping more money into ‘the economy’, only price volatility.

The way for inflation to really take hold is via rising wages. But wages growth, in Australia at least, is nowhere to be seen. That means any price rises in other parts of the economy simply take purchasing power away from the consumer.

Anyway, that’s a discussion for another day. Let’s move on to the opposite of speculation, investing.

I bring it up because Warren Buffett’s Berkshire Hathaway released its famed investor letter on the weekend, along with its earnings result for the year.

Buffett is often described as the greatest investor of all time. If we’re simply talking returns, that is arguable. There are others who have generated huge gains that would even dwarf Buffett’s enviable record. (Check out those profiled in the book Market Wizards for details.)

But you could also argue that those huge returns came from trading, not investing.

How the best do it

Which is the point, I guess. It’s all in the word. If we’re talking about adherence to a definition, then yes, I would agree that Buffett is definitely the best investor of all time.

His understanding of the essence of investing is unrivalled. What’s more though — and this is what makes him unique — is that he has the emotional disposition to carry out his investment philosophy over long periods.

Most people profess to be long term investors. But then a panic hits and they are anything but.

Buffett and his partner, Charlie Munger, are true long term investors. They can psychologically handle a big fall in asset prices, and step up to buy more when everyone else is selling. From his latest letter…

Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.

Buffett spent a good part of the letter talking about book value and economic goodwill. Once you work your way past the jargon, you’ll see that this is the essence of his investment philosophy and is how he creates enormous value for shareholders over the long term.

Let me try and explain Buffett’s ‘secret’ for you simply.

He wants to buy businesses that earn a high return on capital…or at least a higher return than the cost of capital. The difference is value creation. When you get more than what you pay for, the difference is profit, or value creation.

This is how Buffett explains it…

At the start of Berkshire’s letters, there are three columns. The first states the change in Berkshire’s per share book value. The second states the change in Berkshires per share market value. And the third is the performance of the S&P 500 index, for comparison.

Now, Buffett mentions the increase in per share book value first. This represents how much equity capital is in the business, and how much it is growing.

But he says that thanks to Berkshire’s ownership of very high returning whole businesses (that aren’t listed on the stock exchange) per share book value no longer resembles the company’s true, or intrinsic value. The market value of the stock is the best barometer for that…

Today, the large — and growing — unrecorded gains at our winners produce an intrinsic value for Berkshire’s shares that far exceeds their book value. The overage is truly huge in our property/casualty insurance business and significant also in many other operations.

Over time, stock prices gravitate toward intrinsic value. That’s what has happened at Berkshire, a fact explaining why the company’s 52-year market-price gain — shown on the facing page — materially exceeds its book-value gain.

The overall gain in Berkshire’s book value from 1964–2016 is 884,319%. The gain in Berkshire’s per share market value over the same time is 1,972,595%.

These gains are so extraordinary because Buffett has compounded his wealth. Berkshire doesn’t pay a dividend. All earnings are retained by the business and redeployed into new businesses.

As long as those new businesses continue to generate high returns on capital, Buffett’s extraordinary record will continue.

And judging by his commentary on the prospects of the US economy, his record will continue.  

This economic creation will deliver increasing wealth to our progeny far into the future. Yes, the build-up of wealth will be interrupted for short periods from time to time. It will not, however, be stopped. I’ll repeat what I’ve both said in the past and expect to say in future years: Babies born in America today are the luckiest crop in history.


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Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

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