Will Warren Buffett buy gold and silver stocks?

Posted on 22 October 2008 with no comments from readers

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.

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