What a Lovely Frickin' Day!

[Smazz]

Its not the first time we've seen Zigs when by rights there should have been a Zag,

 

The oil and its traders have never really given me a warm and fuzzy so Im going to get my popcorn and watch this one go.....

[biaggio]

I am starting to feel fearful, less confident, ... must be near the bottom soon.

 

[DCG]

There certainly are a lot of indications that we're heading into a recession and this is going to be more than just a correction.

 

The Philly fed survey and the consumer sentiment survey yesterday were real bad, as were some earnings reports. I expected bad results from HPQ (which has been a pretty awfully run company over the last few years) but I didn't see that report from NTAP coming.

[Myth465]

I dont understand the huge focus on recession. I always figured growth would be -1% - 2%, Very slow and anemic. I guess I should have correlated that with market expectations.

[biaggio]

Eventually we ll have a recession. They always happen.

 

I thought we  were beyond correction, feels that way. Dow down only 12.5% so far in last month?

 

Trying to keep to fundamentals + principals often discussed on this board.

 

Good to have dry powder-although this was by accident for me. Averaging in owner managers (BRK, FFH, L), some dividend paying companies

[rranjan]

If you buy cheap enough without short duration leverage then recession or no recession , you will come out well. I do have control over buying cheap so I will simply focus on that. If I have to make a guess then I would think we are not going to get recession but I am not guided by this while making purchases.

[bookie71]

In spite of the "economic definition" I personally don't feel like the recession ever ended.  Too many folks were still out of work.

[Myth465]

In spite of the "economic definition" I personally don't feel like the recession ever ended.  Too many folks were still out of work.

 

This is where I have been lol. It hasnt worked too well from an investing perspective.

[sswan11]

Morgan Stanley (MS) getting lots of insider buys (from Yahoo Finance). Still a buy?:

 

Insider Transactions Reported - Last Two Years

Date Insider Shares Type Transaction Value*

Aug 5, 2011 OLAYAN HUTHAM S

Director

5,000 Direct Purchase at $20 per share. 100,000

Aug 4, 2011 TAUBMAN PAUL J

Officer

50,000 Direct Purchase at $20.38 per share. 1,019,000

Aug 4, 2011 PORAT RUTH

Officer

25,000 Direct Purchase at $20.50 per share. 512,500

Aug 4, 2011 GORMAN JAMES P

Officer

100,000 Direct Purchase at $20.62 per share. 2,062,000

Aug 2, 2011 OWENS JAMES W

Director

5,000 Direct Purchase at $22.04 per share. 110,200

[original mungerville]

As an old poster on this board who hasn't posted in some time, I am stunned by the enthusiasm and even the title of this thread "What a lovely frickin' day". Its a joke these little declines, you ain't seen nothing yet - even if your base is in $US terms. However, I hope that is not your basis because they just keep printing more of them - those $US. Its like you think you are brave and wise to delve into the market when we have a little 15% drop. BIG DEAL. 15% is nothing. Going down to zero cash on a little 15% drop? What are you going to do if the stock market drops 40%?

 

Having said that, every day has been more lovely than the next IF you measure the value of the stock market relative to gold - your portfolio is dropping by more than 40%. It just keeps going down relative to gold and it should. As a value investor I am stunned by other value just blindly being led by some favorite quote of Warren Buffet regarding gold. You need to think for yourselves. Yes, gold can not be measured .... but nor can the value of money currently. So you need to reconcile this rather than just blindly base your investments on some quote by Buffet on gold.

 

We are in a building monetary crisis. Any idiot can figure that out - even a bottom-up value investor. Normally you say who cares, if I buy cheap and sell dear, I'll make money as a value investor. However, these are not normal times - this is a 1:100 year event as Prem has said. You need to position your portfolio based on these more important forces (normally you need not, just keep value investing - but this is not normal we are in a monetary crisis) on an exceptional basis. Listen to Seth Klarman, listen Jean-Marie Eveillard to get you going a bit - they too are both value investors but who understand we are in a monetary crisis that is a 1:100 year event.

 

I just don't think these have been lovely frickin' days. They will get much much more lovely.

 

 

 

 

 

 

[biaggio]

Original Mungergille,

 

How much cash are you holding?

 

On another thread, Rick Rule (interview) indicated that if you had tax losses to take, to take them now as he expects a lot of volatility + a lot of people to sell their losers in October + November. He will be buying in Oct Nov when he expects another downturn due to tax loss selling. Mr Rule advocates having Cash + courage when this occurs.

 

Personally I am not smart enough to know what is going to happen in the future. I have been pessimistic + wrong in the past. I hope to be prepared if + when severe market down turn . I have been slowly buying owner operators,

+ am lookimg at buying some undervalued dividend paying companies.

 

[ERICOPOLY]

However, these are not normal times - this is a 1:100 year event as Prem has said.

 

...

 

they too are both value investors but who understand we are in a monetary crisis that is a 1:100 year event.

 

I realize you were talking about the other two guys but...

 

Prem's 1:100 year event isn't a monetary crisis though.  He went more heavily into USD exposure when he took on more ORH, and has been more worried about deflation.

 

Plus he agreed with the policy actions in early 2009.

 

[sswan11]

Some pre-crisis comments on bank valuations by Thomas Brown of bankstocks.com:

 

http://www.bankstocks.com/ArticleViewer.aspx?ArticleID=6320&ArticleTypeID=2

[BargainValueHunter]

Remember...when you are absolutely positive about what is going on and what will happen next...then you think you are smarter than the market.

 

That can be VERY dangerous for an investor.

[stahleyp]

As an old poster on this board who hasn't posted in some time, I am stunned by the enthusiasm and even the title of this thread "What a lovely frickin' day". Its a joke these little declines, you ain't seen nothing yet - even if your base is in $US terms. However, I hope that is not your basis because they just keep printing more of them - those $US. Its like you think you are brave and wise to delve into the market when we have a little 15% drop. BIG DEAL. 15% is nothing. Going down to zero cash on a little 15% drop? What are you going to do if the stock market drops 40%?

 

Having said that, every day has been more lovely than the next IF you measure the value of the stock market relative to gold - your portfolio is dropping by more than 40%. It just keeps going down relative to gold and it should. As a value investor I am stunned by other value just blindly being led by some favorite quote of Warren Buffet regarding gold. You need to think for yourselves. Yes, gold can not be measured .... but nor can the value of money currently. So you need to reconcile this rather than just blindly base your investments on some quote by Buffet on gold.

 

We are in a building monetary crisis. Any idiot can figure that out - even a bottom-up value investor. Normally you say who cares, if I buy cheap and sell dear, I'll make money as a value investor. However, these are not normal times - this is a 1:100 year event as Prem has said. You need to position your portfolio based on these more important forces (normally you need not, just keep value investing - but this is not normal we are in a monetary crisis) on an exceptional basis. Listen to Seth Klarman, listen Jean-Marie Eveillard to get you going a bit - they too are both value investors but who understand we are in a monetary crisis that is a 1:100 year event.

 

I just don't think these have been lovely frickin' days. They will get much much more lovely.

 

What are you basing your 40% drop on?

 

Also, please refer a link to the comments from Klarman and Eveillard.

 

From what I read, Klarman only partially saw some of this current mess. He only had a small amount of his portfolio of buying  MBS (none until 2008). Klarman did talk about how he is not a fan of gold.  This was also said, "Mr. Klarman pointed out that his own ideas "on bottom-up opportunities in undervalued securities are more likely to be accurate than my top-down views on what's going to happen in the world at large."

 

 

Furthermore, the article stated: "You could have heard a pin drop as Mr. Klarman proclaimed, "I am more worried about the world, more broadly, than I ever have been in my career."

 

Well, yeah, his career started back in, what, 1978 or so. I know he founded Baupost in 1982. Of course this is scarier than anything in the past 30 or so years.

 

http://www.senseoncents.com/wp-content/uploads/2010/09/Seth-Klarmanm-Interview-Financial-Analyst-Journal.pdf

 

I have no idea if the market will go up a lot or down a lot. I would imagine over my investing career, it will probably go up quite a bit. I also believe it's really, really, really hard to try and time it. Buffett has said you can only time it a few times in one's investment career. By most valuation metrics, stocks are not all that expensive or cheap. Now, if we go through some period where earnings are crushed due to some macro stuff, then, yeah, maybe they are way too expensive. That timing stuff, in my limited experience, tends to happen when people are overly giddy about market prospects. They generally don't watch risks. There is a lot of risk aversion right now. Now, the big concern for me is the low rates. Many people are taking risks because cash is paying nothing. I certainly think that could cause some problems. It artificially alters risk outlooks.

[Liberty]

[...] As a value investor I am stunned by other value just blindly being led by some favorite quote of Warren Buffet regarding gold. You need to think for yourselves. Yes, gold can not be measured .... but nor can the value of money currently. So you need to reconcile this rather than just blindly base your investments on some quote by Buffet on gold.

 

We are in a building monetary crisis. Any idiot can figure that out - even a bottom-up value investor.

 

Ok, am I the only one who finds this very condescending? Please stop attacking strawmen and pretending that goldbugs are the only people who can think for themselves or whatever (anyhow, these days, the lemmings are in gold, not in value investing).

 

It is entirely possible to agree with Buffett and Munger without just following what they're saying blindly and unthinkingly.

[Uccmal]

Welcome back Mungerville, 

 

Mungerville is one of our early and better posters.

 

Sswan11,

 

Reread Tom Brown's posts leading up to the original credit crisis.  He is generally a little overly optimistic to say the least.  I stopped reading his blog shortly after the credit crisis started.  That being said they are right on BAC.

[original mungerville]

I was just trying to get people's attention, not be condescending (next time I’ll be more delicate). Thank you for the welcome back Uccmal its been a while since I have posted much of anything.

 

PART 1

 

The point I was trying to make is that as value investors, we seem to have 1) a blind-spot with regard to top-down macro issues (because bottom-up company-specific picks have worked so well over time we figure we should just put our heads down and just compound), and 2) we have a tendency to listen to Buffett (I know I do) who has dismissed gold (you dig it out of the ground, pay to store it, …whatever, etc.). Well, I dismiss paper money (you cut a tree, make some paper, doodle some number and persons on there with some ink, swap it around for years, then here’s the really good part, when you don’t manage your governmental affairs appropriately or the crucial components of your economy for a decade or two and the shit starts hitting the fan, you can just go cut more trees and repeat…).  In this environment the question is not only what are precious metals is worth, its what is a dollar worth.  One question leads to the other and vice-versa so precious metals should not be dismissed because “they are hard to value” because the alternative which is “cash” which is just as hard to value. This precious metal -to-dollar valuation thing needs to be reconciled by all investors including value investors in order to maximize real returns over the next 5 years.

 

I am not sure where to begin but let me begin with:

 

 

1) Stock Market Valuation

 

I am not as optimistic as my friend Uccmal whose views I respect very much. For example, I think the US stock market has been significantly over-valued for the last 14 years (roughly the entire period I have been investing), with only very brief periods of fair valuation (eg March 2009). There have been longer periods in those 14 years where stocks have not been outrageously /dangerously priced (just “high”), however, in no time in these 14 years have these “high” prices been accompanied with governments and central banks both “doing the right thing” at the same time from a long-term perspective in order to give me the confidence to fully take off the hedges. Rather, its been high prices accompanied by kicking the can down the road one more time.

 

The methods of other smarter people than me also indicate stocks are “high” (assuming price stability that is): Buffet’s Fortune articles in 2000/2001 go over how to value stocks to GDP (although he was being somewhat optimistic in those analyses so adjustments are necessary, and one can track Munger’s comments from the period to get a sense of the adjustments necessary), Grantham’s valuation methods for the S&P 500 have been very good over the last decade. 

 

My conviction on valuation leads me to continue my hedging …

 

 

2) Portfolio hedging and the kicking of the can

 

Watsa bet along with Buffett in late 2008 that the can would again get kicked, and kicked it was - big-time, and Watsa took off all the equity hedges. In no way had anything fundamental been fixed and he knew that when he did it (Watsa that is) – he bet on the stimulous having a huge effect (Grantham also called that – and exactly in March 2009 no less). Its one thing to bet on the can getting kicked and the effect – you have to be very wily to be sure the can will a) get kicked again, and b) of the effect of the kicking - however I would argue that that involves some degree of risk because the politics could somehow turn against you and then you get caught 100% in stocks in a depression. Both Buffett and Watsa – being wily enough though - took that calculated risk at the end 2008/2009 and were proved right.

 

Actually, although sometimes I thought I was nuts to do so, I have been hedged to at least some significant degree probably at almost every point since I started investing over a decade ago – because stocks have either been 1) way over-valued or 2) highly value accompanied by mismanagement of the economy at all points in that period (other than very brief points like March 2009 where we got to some level of fairish valuation). I was fully hedged going into the crisis, but I could only bring myself to take off 50% of my equity hedges at that same point Watsa took off 100% of his.  I have been 100% hedged through all of 2011 having fully transitioned up again from that 50% hedge.

 

If you contrast the last 4-5 years of my hedging with Watsa, he took off 100% of his hedges in 2009 … but they went back on in 2010 and he is again 100% hedged now – so he wasn’t long without them precisely because nothing has been fixed, the can keeps getting kicked and the stock market remains high.

 

But now what is changing is that they have kicked the can so damn far down the road, they got to the end of road, but that didn’t even stop them, they went out and got the dozers and built more road to kick it a couple more times.

 

So although I want to simply hedge 100% (ie basically 100% cash plus a value spread) like in 1997, I can’t be what is effectively 100% cash now (ie the financial system was going to collapse then and effectively 100% cash was great then, but now the threat has been shifting to the monetary system – and 100% cash is not good in that situation but nor do I want to be unhedged 100% long in stocks because nothing has changed on that front either - ergo Watsa is 100% hedged) …

 

 

3) The Right Dry Powder (precious metals versus cash?) and Optimal Hedging/Portfolio Construction in this Environment

 

As value investors, we have been content keeping our “powder dry” in cash in the past, or like Pabrai did before the financial crisis started, some have even kept it dry in Berkshire Hathaway. Like Pabrai questioned himself keeping his powder dry in Berkshire during the crisis, I question keeping powder dry in cash in these times.

 

Maybe this thinking came from my hedging, but I started thinking a couple years ago, if I am 100% hedged like Watsa, my net position is basically 100% cash with, hopefully, me earning my value investor stock picking spread. But its basically 100% cash plus a spread and do I want to be 100% cash now at this point. In the past decade that has been fine, stocks have gone nowhere overall so hedging 100% and being effectively 100% cash plus a spread has been fine, but not now because other forces are becoming increasingly prominent: one of the potential directions we are headed in seems to be towards a whole new monetary system (maybe the odds are 60% in my view). The others are a depression (maybe at 20%), and also the chance of just some sort of muddle through (20%) which eventually becomes inflationary/ stagflationary – this is what the central bankers are shooting for as it’s the most palatable option. I certainly don’t want to be 100% in cash if we go to a new monetary system, nor do I want to be 100% in highly valued stocks if we go into a depression, and I don’t think I want to be 100% stocks in stagflation. At a minimum, I want my “dry powder” to be “safe” in all situations and ready to deploy in undervalued stocks.  But forgetting the minimum, from an optimal portfolio perspective for the next 5 years, I want to make as much money as possible in a safe way without anyone robbing me of my value investor spread (that spread being the spread between the growth of the value of my portfolio measured against both i) the stock market performance, and ii) cash) by inflicting on my portfolio either 1) significantly higher price levels, or 2) a depression.

 

I need to stop here for tonight…but I will say that this is what started my thinking about precious metals about 18-24 months ago, and to start listening to other great value investors partial to either 1) hedging against these stock market risks and/or 2) precious metals (Klarman, Eveillard from First Eagle, Sprott) to try and understand where they where coming from - while also trying to reconcile those views with Watsa’s and Buffett’s to the degree I can read those tea leaves correctly.

 

I'll post a PART 2 soon.

[original mungerville]

stahleyp - a 40% drop is very possible in a normal recession. I think the average is mid 30s percentage wise or so - ie in terms of a drop when you head to recession. The problem here is 1) if we go into recession, with the backdrop we have today, the drop would arguably be more than mid 30s, however 2) printing money may offset this greater drop.

 

Basically though, in real terms, the drop could be mid 30s, 40 percent or more - given the backdrop. But if they print more money, in nominal terms, it could be less than 30%. If they print enough the stock market might even dislocate from the underlying economy as a hedge against inflation and go up.

 

At some point, the nominal drop is not what matters - oil has more than doubled in the last 7 years, other commodities including ag, as have precious metals - and this is really what I am getting at. Relative to all of these, the stock market has been dropping for years.

 

 

[original mungerville]

biaggio, I'm 0% cash and 100% hedge using deep in-the-money long-term Russell 2000 puts.

 

Ericopoly, I don't think Prem's thinking is that simple. In any case, if it was, it would seem Buffet disagrees with him, and I don't want to get in the middle of those two! So I think both views need to be reconciled. I think the investment environment is a lot more complicated like Klarman has said: something about now it takes three dimensional thinking or something along those lines.

 

 

[moore_capital54]

Mungerville, fantastic post and reconcilliation of Precious Metals (Gold) as it relates to the value investor.

 

In reality, when adjusting for the price of gold over the last decade, almost every manager has underperformed. That is why many intelligent managers are now using a gold-class for their fund.

 

 

[ERICOPOLY]

I think Watsa is making the straight supply/demand argument for pricing (and thus inflation).  I've never heard him discuss the idea of sudden hyperinflation from currency collapse -- except that in a 2007 quarterly conference call he answered a question on gold simply to say "We don't invest in gold".

 

http://www2.canada.com/business/fp/prem+watsa+what+comes+next/2287614/story.html?id=2287614&p=2

 

Q The market's corrected but is the worst over?

 

A 80% of the economy [the private sector] is de-leveraging. 20% is government stimulus. Companies are operating at 65% of capacity or utilization rate. Unemployment is rising. If in six to 12 months' time, the stimulus and bailouts don't work, and we are at zero interest rates, what then? We had 20 years of good, meaning no recession to speak of, and only one year of bad. We are not worried about inflation, just the opposite. If wages start to go up, there will be inflation. But there is lack of demand. That's the problem.

 

 

I did read earlier in 2009 his comments saying he'd be worried if the government pulled back it's spending.  And actually if you look at how the markets have performed ever since the big debate over raising the debt ceiling this summer, I think the markets are likely most worried about this very scenario -- the government gets new religion over austerity and balances the budget on spending cuts. 

 

[ERICOPOLY]

My thinking for myself on gold goes like this...

 

1)  There isn't much of it in absolute total value if you take the total known supply and price it in dollars at the current market price.  Thus, if we go back to a gold standard it will need to go sky-high in price (so that the total value of it will begin to make sense).  This will be a big win for gold owners, but to everyone else it really won't matter.  Prices of bread in dollars will be the same, it's just that those dollars will be backed by gold all of a sudden.  Life would go on.

 

My reasoning to support this ho-hum scenario is that the world was already flooded in dollars over the past 40 years since taken off the gold standard.  And so pricing already reflects the flood of printed money.  The thing that would need to catch up is gold prices.

 

Meanwhile there are other ways of finding value instead of betting on a rebasing in gold of the USD.  So I'm playing that game instead.

 

And I agree with Watsa on the idea that goods are priced by the amount of dollars chasing them.  A car for example is going to be priced (all other things being equal) on the wages of the person interested in buying one.  If a person doesn't get a raise, he can't bid up the price of that car.  So just because the Fed inflates reserves, it doesn't actually push up prices in the real world unless that money gets into the wages of ordinary people who buy things.  And why would it get into their hands if they are not in demand (wages stagnant)?

 

 

 

 

[ubuy2wron]

My thinking for myself on gold goes like this...

 

1)  There isn't much of it in absolute total value if you take the total known supply and price it in dollars at the current market price.  Thus, if we go back to a gold standard it will need to go sky-high in price (so that the total value of it will begin to make sense).  This will be a big win for gold owners, but to everyone else it really won't matter.  Prices of bread in dollars will be the same, it's just that those dollars will be backed by gold all of a sudden.  Life would go on.

 

My reasoning to support this ho-hum scenario is that the world was already flooded in dollars over the past 40 years since taken off the gold standard.  And so pricing already reflects the flood of printed money.  The thing that would need to catch up is gold prices.

 

Meanwhile there are other ways of finding value instead of betting on a rebasing in gold of the USD.  So I'm playing that game instead.

 

And I agree with Watsa on the idea that goods are priced by the amount of dollars chasing them.  A car for example is going to be priced (all other things being equal) on the wages of the person interested in buying one.  If a person doesn't get a raise, he can't bid up the price of that car.  So just because the Fed inflates reserves, it doesn't actually push up prices in the real world unless that money gets into the wages of ordinary people who buy things.  And why would it get into their hands if they are not in demand (wages stagnant)?

Ericopoly it is posts like this that make me think your success in the mkt has more to do with smarts than luck. By the way if we reverted to the gold standard the REAL gold bugs would not be any happier and they still would not sell their gold because they would not trust the govt would go of it at some point in the future.

[Parsad]

1) Stock Market Valuation

 

I am not as optimistic as my friend Uccmal whose views I respect very much. For example, I think the US stock market has been significantly over-valued for the last 14 years (roughly the entire period I have been investing), with only very brief periods of fair valuation (eg March 2009). There have been longer periods in those 14 years where stocks have not been outrageously /dangerously priced (just “high”), however, in no time in these 14 years have these “high” prices been accompanied with governments and central banks both “doing the right thing” at the same time from a long-term perspective in order to give me the confidence to fully take off the hedges. Rather, its been high prices accompanied by kicking the can down the road one more time.

 

The methods of other smarter people than me also indicate stocks are “high” (assuming price stability that is): Buffet’s Fortune articles in 2000/2001 go over how to value stocks to GDP (although he was being somewhat optimistic in those analyses so adjustments are necessary, and one can track Munger’s comments from the period to get a sense of the adjustments necessary), Grantham’s valuation methods for the S&P 500 have been very good over the last decade. 

 

My conviction on valuation leads me to continue my hedging …

 

You are assuming investors are only buying the market.  If the market has been overvalued for 14 years, then how did I manage to quintuple my initial investment capital in that time?  In fact, my initial investment in Corner Market Capital is up 4,000% over the last five years.  If you are searching for value, then you are buying individual investments...equities, bonds, entire private businesses, etc...not the market.

 

2) Portfolio hedging and the kicking of the can

 

Watsa bet along with Buffett in late 2008 that the can would again get kicked, and kicked it was - big-time, and Watsa took off all the equity hedges. In no way had anything fundamental been fixed and he knew that when he did it (Watsa that is) – he bet on the stimulous having a huge effect (Grantham also called that – and exactly in March 2009 no less). Its one thing to bet on the can getting kicked and the effect – you have to be very wily to be sure the can will a) get kicked again, and b) of the effect of the kicking - however I would argue that that involves some degree of risk because the politics could somehow turn against you and then you get caught 100% in stocks in a depression. Both Buffett and Watsa – being wily enough though - took that calculated risk at the end 2008/2009 and were proved right.

 

Actually, although sometimes I thought I was nuts to do so, I have been hedged to at least some significant degree probably at almost every point since I started investing over a decade ago – because stocks have either been 1) way over-valued or 2) highly value accompanied by mismanagement of the economy at all points in that period (other than very brief points like March 2009 where we got to some level of fairish valuation). I was fully hedged going into the crisis, but I could only bring myself to take off 50% of my equity hedges at that same point Watsa took off 100% of his.  I have been 100% hedged through all of 2011 having fully transitioned up again from that 50% hedge.

 

If you contrast the last 4-5 years of my hedging with Watsa, he took off 100% of his hedges in 2009 … but they went back on in 2010 and he is again 100% hedged now – so he wasn’t long without them precisely because nothing has been fixed, the can keeps getting kicked and the stock market remains high.

 

But now what is changing is that they have kicked the can so damn far down the road, they got to the end of road, but that didn’t even stop them, they went out and got the dozers and built more road to kick it a couple more times.

 

So although I want to simply hedge 100% (ie basically 100% cash plus a value spread) like in 1997, I can’t be what is effectively 100% cash now (ie the financial system was going to collapse then and effectively 100% cash was great then, but now the threat has been shifting to the monetary system – and 100% cash is not good in that situation but nor do I want to be unhedged 100% long in stocks because nothing has changed on that front either - ergo Watsa is 100% hedged) …

 

This argument doesn't wash with me, and I have no idea why individual investors always reflect back on what Prem is doing.  Fairfax is an insurance company.  One that carries asset to equity leverage of 4-1 and about $2B in consolidated debt.  Their business absolutely exists based upon their credit rating and levels of statutory surplus.  If either goes down, they could be out of business. 

 

It is very likely that Fairfax's credit rating would drop significantly if they lost 10% of their assets, which would be roughly 35% of their equity.  If somehow the credit rating stays intact, the amount of business they could write would shrink enormously in such circumstances.  He has responsibilities to his employees, shareholders and customers.  Especially the customers who bought policies that need to be paid out in the most dire of circumstances.  Like Berkshire, or any other insurance company, Fairfax's check cannot bounce.  That's why Prem hedges.

 

3) The Right Dry Powder (precious metals versus cash?) and Optimal Hedging/Portfolio Construction in this Environment

 

As value investors, we have been content keeping our “powder dry” in cash in the past, or like Pabrai did before the financial crisis started, some have even kept it dry in Berkshire Hathaway. Like Pabrai questioned himself keeping his powder dry in Berkshire during the crisis, I question keeping powder dry in cash in these times.

 

Maybe this thinking came from my hedging, but I started thinking a couple years ago, if I am 100% hedged like Watsa, my net position is basically 100% cash with, hopefully, me earning my value investor stock picking spread. But its basically 100% cash plus a spread and do I want to be 100% cash now at this point. In the past decade that has been fine, stocks have gone nowhere overall so hedging 100% and being effectively 100% cash plus a spread has been fine, but not now because other forces are becoming increasingly prominent: one of the potential directions we are headed in seems to be towards a whole new monetary system (maybe the odds are 60% in my view). The others are a depression (maybe at 20%), and also the chance of just some sort of muddle through (20%) which eventually becomes inflationary/ stagflationary – this is what the central bankers are shooting for as it’s the most palatable option. I certainly don’t want to be 100% in cash if we go to a new monetary system, nor do I want to be 100% in highly valued stocks if we go into a depression, and I don’t think I want to be 100% stocks in stagflation. At a minimum, I want my “dry powder” to be “safe” in all situations and ready to deploy in undervalued stocks.  But forgetting the minimum, from an optimal portfolio perspective for the next 5 years, I want to make as much money as possible in a safe way without anyone robbing me of my value investor spread (that spread being the spread between the growth of the value of my portfolio measured against both i) the stock market performance, and ii) cash) by inflicting on my portfolio either 1) significantly higher price levels, or 2) a depression.

 

And if we see deflation, which is also one of Prem's hedges?  What is gold's price going to do from where it is right now? 

 

Macroeconomic forecasting is a very dangerous thing for the average investor.  If the best economists in the world can never get it right, what advantage do we have?  The only advantage the value investor has is the intellectual framework that allows us to come to some estimate of an investment's intrinsic value, and then apply a margin of safety before buying.  That's the single greatest advantage we have.  I do not know of any other aspect of finance where we have such opportunity or probabilities.  Cheers!