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For a potential reason why Warren Buffett is speculating/investing in
silver, read the following article.
M A R K E T B E A T
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06
February
98
So you think Warren Buffett and silver don't mix, eh? There are good
reasons to think that. Although Buffett hasn't shied away from the
occasional speculative situation in the past--he's always up for a
good arbitrage deal, and he has made a lot of money on troubled debt
such as Washington Power and Supply and RJR Nabisco bonds--he's not
known for speculating in the futures markets.
Indeed, time and again Buffett has described himself as an investor,
not a speculator. The difference between the two, he's always ready to
remind us, is that the investor cares about the intrinsic value of the
investment, while the speculator cares about the price of the asset
regardless of the value of the asset. Investing is all about the free
cash flow the asset generates. The ability to compound that free cash
flow at high rates of return is what creates the asset's value. Long
term, the price of the asset rises to reflect that value. Short-term,
though, price changes reflect what others are willing to pay for the
asset, not necessarily what the asset is really worth. Speculators
hope to earn a return on the asset by riding the momentum of
short-term price swings. The speculator doesn't care what the
intrinsic value of the asset may be, he just hopes to find a
buyer--the greater fool--who will take it off his hands at a higher
price.
Clearly, silver bullion is a speculative commodity. It doesn't have
any intrinsic value beyond the limited demand put on it by the
photographic, X-ray, and jewelry industries. Silver bullion doesn't
generate cash flow, so it doesn't have a value that's separate from
its price. It's literally worth what someone else will pay for it.
Furthermore, silver bullion is about as far away as it gets from the
"franchise" investments that Buffett is famous for. International
Dairy Queen, the fast-food chain Buffett recently purchased is a
quintessential franchise story: good brand name, strong, relatively
predictable free cash flow, solid returns on capital generated with
little debt, all wrapped up in a mundane business that's fairly immune
to business-cycle volatility. Silver bullion, on the other hand,
couldn't be more subject to the whims of the marketplace. With little
intrinsic value to sustain it, silver bullion is about as
unpredictable as it gets.
So if Buffett's not a speculator, just what is he doing with 20% of
the world's estimated annual silver supply? Buffett claims he's not
planning to sell the stake anytime soon. And reminiscent of the days
when he took friendly positions in takeover targets like Salomon and
Champion International, he has even graciously offered to postpone
accepting delivery on some of the silver he recently purchased to help
ease current market tightness in the metal (for a fee, of course).
And therein lies the relationship between Buffett and silver: when you
control 20% or more of anything, you're in a position to call the
shots. And make money doing it. Silver doesn't have an intrinsic
value, but if supply is tight relative to demand--these days demand
for silver is about 1.3 ounces for every 1 ounce in supply--and you
have a big enough position in the metal to affect trading balances,
you can lend out your silver for a cash return. Voila! Your silver
bullion stake now has an intrinsic value; it's spewing out cash flows
that when discounted back at an appropriate rate, reveal the "true
worth" of the metal. Buffett isn't speculating, hoping to sell the
position to a bigger fool, he's investing in a cash-generating
operation that should accrue in value regardless of short-term price
swings in silver. When all is said and done, Buffett's foray into
silver won't mean all that much to Berkshire shareholders; silver
bullion represents just about 2% of Berkshire's holdings. The silver
market, on the other hand, will surely be affected by Buffett's touch.
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Catherine Odelbo is Publisher of Morningstar StockTools. If you've got
thoughts or questions about this column, you can send her an e-mail at
codelbo@xxxxxxxxxxxxxxx .
Comments? Post a message to the Stock Analysts Journal bulletin board.
Other recent entries into the Stock Analysts Journal:
Wednesday 2-4-98 Rika Yoshida
Monday 2-2-98 Haywood Kelly
Friday 1-30-98 Catherine Odelbo
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© Copyright 1998
Morningstar, Inc.
All rights reserved.
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