Portfolio ManagementShareholder Letters & ReportsWarren Buffett

Unconventional Investments

I was glancing through the Berkshire letters from the late 1990’s because I recall Buffett briefly mentioning his large silver position he acquired and I was trying to see if Buffett referenced the specific cash cost of production. He didn’t in the letter—only mentioning that Berkshire acquired 111 million ounces. He has mentioned in other interviews that silver was in fact below the cost of production—a supply/demand imbalance that can persist for a while, but not forever.

Buffett felt comfortable loading up on silver (he took down roughly 25% of the world’s available inventory), and then just storing it in the vault until this supply/demand dynamic normalized. He didn’t have to wait long, as silver appreciated modestly back above the cost of production later that year, and Berkshire booked a nearly $100 million gain on Buffett’s unconventional investment.

Today, the cost of production of silver has fallen to around $8 per oz, and the price is around $14, so for anyone hoping that silver might be a bargain after a 3 year bear market, it is still nearly 100% above the relative level where it was when Buffett backed up the truck to load up… (note: this is the so-called “cash cost” of production, which excludes company overhead expenses, exploration costs, and capex–it’s just the actual cost to pull the metal out of the ground, which is the metric I believe Buffett used in his decision to buy it in the late 90’s).

Speaking of unconventional investments—these are ideas that I think Buffett really loves, although he talks far more in the recent letters about the great businesses (and for good reason, those are the businesses that provide the “sure” money).

Of course, in his partnership years, Buffett talks a lot about both “generals” (stocks that are purchased simply because they are undervalued) and “workouts” (stocks with some corporate catalyst or event that will help realize the valuation gap). The workouts tend to be more “unconventional”, but can provide profits that are often uncorrelated to what the general stock market is doing. In Buffett’s early days, this involved things like oil company mergers, cocoa bean arbitrage, closed end fund liquidations, special dividends, spinoffs, activist positions, and many others. These situations provided significant profits to Buffett personally in the early years, and then later for his partners.

Buffett even bought silver in the late 1960’s—although he wasn’t a gold (silver) bug, like so many today.

Anyhow, here is Buffett in the 1997 letter discussing a few unconventional investments that Berkshire participated in. These are quite small relative to Berkshire’s equity, but it still describes his affinity for making profits out of unconventional special situations:

Unconventional Investments 1 Unconventional Investments 2 Unconventional Investments 3

The other interesting takeaway from this clip is that Buffett said he followed the fundamentals of silver for 3 decades without investing in it. Reminds me of how he talked about reading Bank of America annual reports and IBM annual reports for 50 years before ever buying a single share.

Patience—all knowledge is cumulative…

11 thoughts on “Unconventional Investments

  1. Thanks for this article. Very enlightening.

    I’ve recently got caught in a buzzsaw from a couple of special situation investments where commodity based closed end funds are converting to open-end funds or into etfs. I was a tourist in this realm and didn’t realize the drastic commodity moves could wide out a good 5% spread. Though probably under normal circumstances these investments would have worked out.

    John has probably read this already but for the benefit of other readers: http://www.leucadia.com/toc_c-p_letters.html reading the 2006 letter under the section entitled Goober Drilling will be of interest to those who wish to know more about investing in “supply and demand” situations or commodity situations.

    Leucadia used to, under former management, invest in a wide variety of commodity based companies not unlike Loews but with perhaps quite a deal more success and quite a bit more investments. So Leucadia’s letters are probably of interest to investors who have interest in supply and demand based investments.

  2. I don’t understand the Clinton reference. Is Buffett referencing Clinton’s having been blown by Monica, or is there some other reason that the president would feel their pain?

    1. I think it was just an extra layer of margin of safety for him. The “all-in” cost probably varies significantly from company to company, and so the cash cost is a) lower and b) more stable across the industry. So a commodity that is used in industry like silver cannot stay below cash cost for very long.

  3. Hey John,

    Great post, thanks for writing!

    While most of your points regarding the coal industry are spot on, I do believe some of the thermal coal players offer some value at current prices. ARLP for instance. Basic thesis is it remains low cost provider and even if you throw in a few lean years it’s available at a substantial discount to intrinsic value. Check it out or drop me a line.

    Anyway, thanks for the site; a lot of great, insightful articles on here!

  4. Thanks for that clarification of how Buffett invested in silver. I didn’t previously understand how he calculated that silver’s market price was below its “private market value,” as would be required for a value investment.

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