Building An Ark

November 10, 2003 – “Predicting rain doesn’t count – building an ark does.” So says Warren Buffett.

Long-time readers of these letters know that I hold Mr. Buffett in the highest possible regard. Though I have never met the man, I admire him from afar, and I continue to marvel at his exceptional track record. Here is the latest result:

OMAHA, Neb. — Berkshire Hathaway Inc. said third-quarter earnings before realized investment gains rose 38%, driven by revenue from a grocery distributor and strong earnings from its insurance companies.

The holding company, multibillionaire Warren Buffett’s investment vehicle, said third-quarter earnings surged to $1.35 billion from $977 million a year earlier. The holding company said Friday that net income rose to $1.81 billion, or $1,176 a share, from $1.14 billion, or $744 a share.

By any measure these are simply outstanding results. But they are just one quarter in an exceptional 50-year record that predates Mr. Buffett’s taking control of Berkshire.

In the last newsletter I had a quote from an important article in Barron’s about Mr. Buffett. The key point is worth repeating:

“Buffett, who has spent a lifetime successfully playing the percentages, says that buying Treasury bonds at current levels probably isn’t a smart move. He noted that Berkshire could be earning $1 billion more annually on its investment portfolio if it shifted its cash holdings into longer-term Treasuries, but Buffett doesn’t believe the risk is worth the added income.” [emphasis added]

I went on to say in the last newsletter that: “Buffett is walking away from $1 billion a year because he says the risk of US Treasuries isn’t worth it. Therefore, US Treasuries are to be avoided. In fact, in my view, avoid all US dollar denominated debt instruments.” Interestingly, that is basically what Mr. Buffett is now saying.

In an article written by Mr. Buffett and published online by Fortune on October 28^th, he says:

“Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in and today holds several currencies. I won’t give you particulars; in fact, it is largely irrelevant which currencies they are. What does matter is the underlying point: To hold other currencies is to believe that the dollar will decline.“

This is BIG !!! In the past couple of years a number of respected leaders in finance and investing have recommended diversifying out of the US dollar. They include Soros and Templeton, and now Buffett has joined the parade. For the first time in his life, this top name of finance is betting against the US dollar.

It’s not too hard to envision what these guys are seeing. We have been focusing on the dollar’s problems in these letters for some time. I could list all the deteriorating fundamental factors that are causing the dollar to be debased, but the accompanying chart of the US Dollar Index says it all.

The major uptrend in the Dollar Index has broken, and this important measure of the dollar’s health relative to the other major currencies of the world is now in a severe and protracted downtrend. The dollar is losing purchasing against the world’s major currencies. But the Dollar Index is not the only indicator giving us a warning signal.

I include below the chart of the Fear Index. Based on the preliminary calculations as of the end of October the Fear Index climbed last month from 1.13% to 1.14%.

Fear is still rising, but the important part of this chart is the 23-year downtrend line. That downtrend is about to be broken. We are moving from a 23-year period in which confidence in the dollar and the US banking system has generally been rising to its extreme opposite. Rising fear means that confidence in the dollar and the banking system are falling, and when that downtrend line is finally broken, a new era begins. It will be one more like the 1970’s than what we experienced in the 1980’s or 1990’s.

The Fear Index is basically confirming what prescient investors like Warren Buffett are now telling us. There are severe problems with the dollar. These problems are likely to get worse before they get better. The trend for the dollar is turning, and its outlook is getting increasingly worse. Consequently, it is necessary to diversify out of the dollar, or as Buffett puts it, ‘to build an ark’.

Buffett does not say in the Fortune article precisely what his ark looks like. However, one can assume that he has the euro and perhaps the currencies of the commodity producing countries like Canada and Australia. And when you read between the lines of what he is saying, one has to wonder if he is not buying gold too?

This question is not outrageous, given that he probably still owns the silver he purchased back in 1997 and 1998. It also makes sense when you consider that Warren Buffett’s father was a goldbug.

More importantly, the gold market acts as if someone big is buying. Bill Murphy of www.lemetropolecafe.com, who calls this buyer the ‘stalker’, has repeatedly made this observation in recent weeks. Bill suspects that the ‘stalker’ is a group of Asian businessman, and that they are acquiring about $1.6 billion of gold. And Bill may be right. But it is also possible that the ‘stalker’ could be Warren Buffett. Given that Berkshire has about $24 billion of cash, a $1.6 billion purchase would represent a 6.5% diversification into gold, which is a reasonable percentage.

In summary, it is not outrageous to think that Warren Buffett is building his ark with some gold. I recommend that everyone else use some gold too, and 6.5% of your cash assets is as good a percentage as any in order to get more diversification out of the US dollar.