Buffett Investment Lesson; Gold Capitulation Part 2


RISK: My grandfather invested his fortune in Russian bonds. This was before the Russian Revolution. At the time, he was told he couldn’t lose money. Because the bonds were pegged to gold. So there was no currency risk. And these were bonds of Russian railways, which were the most solid businesses in the world, and they were guaranteed by the Tsarist government. No currency risk. No default risk. No business risk. They were as close to risk-free as you can get. But when the Bolsheviks took over they seized the railways. They stopped paying the bonds. And they executed the Tsar and his family.”

It didn’t make any difference if the bonds were pegged to gold or not. They were worthless. It just reminds you of how things can go very bad in a way you don’t expect. Who would have imagined a communist revolution in Russia? (Could a Dictator take over the U.S.A.?)  www.acting-man.com

Buffett Image

The 1975 Buffett memo that saved WaPo’s pension

Found here:Warren-Buffett-Katharine-Graham-Letter on Pensions 1975

The letter alone is quite amazing. In it, Buffett identifies the pension problems that others would key in on only a decade or so later. But he also lays out perhaps for the first time — Buffett was 45 when he wrote it and years away from attaining the investment fame he has today — his philosophy behind what it takes to be a successful investor. His main pieces of advice: Think like an owner, look for a discount, and be patient. Full article: http://finance.fortune.cnn.com/2013/08/15/warren-buffett-katharine-graham-letter/?iid=EL


Gold and Gold Stock Capitulation (GLD represents gold while GDX represents an index of major gold producers and GDXJ represents junior gold miners). Note the date of the low prices in End June/Early July. We last mentioned capitulation here: http://wp.me/p2OaYY-25W


Paulson’s Investors help form a bottom in Gold: http://www.acting-man.com/?p=25354#more-25354 (a suggested read)

Paulson & Co. – a Victim of Redemptions?

Today news hit that John Paulson has finally sold a big chunk of his position in GLD. It is not terribly surprising that this happened in the quarter when gold made its low. After Paulson sold his holdings in bank stocks, the group soared, with many of the stocks he had sold at the lows rising by 200% and more thereafter. However, this time it has probably less to do with his bad timing, but very likely more with the bad timing of investors in his funds. As the Bloomberg article mentions:

“Paulson & Co., the largest investor in the SPDR Gold Trust, the biggest exchange-traded product for the metal, pared its stake to 10.2 million shares in the three months ended June 30 from 21.8 million at the end of the first quarter, according to a government filing yesterday. The New York-based firm, which manages $18 billion, cut its ownership for the first time since 2011 “due to a reduced need for hedging,”according to an e-mailed response to questions.”

CSInvesting Editor: As mentioned before, I have been unable to find attractively priced franchises so in the past four months I have bought “quality” miners and related companies like RGLD, SLW, FNV, AUY, AEM, NGD, EGO, etc.  I place the word, QUALITY in quotes because those companies are not franchises and each struggles with the cyclical risks of their product–metals. So beware, I am biased to seeking out information that bolsters my bullish outlook like Commercial Hedgers having a low short position:


and extremely negative speculative sentiment–a contrary signal.



  • A very seasoned mining executive I’ve known for years (www.grandich.com)  sent me the following email, along with the latest World Gold Council report. He made a very keen observation is his email. Here it is:

“As an aside FYI, attached is the WGC’s first ½ 2013 report  – skip to page 14 and look at the highlight yellow I put in. Of ~2000 supply and demand tonnes  , ~578 tonnes are sold by ETF’s. If ETF’s sales were zero there would be a 29% supply shortfall. Total mine production is 1377 tonnes, ETF’s sold 42% of all mine production first ½ this year.    My math is that if the ETF’s get cleaned up and go to 0 sales, we are looking at quite a gold supply problem. Old fashioned thinking I know, but alas, I am just a simple guy.”

We have a very serious mine production shortfall that has been masked during the gold raids and sell-offs. I think it will get exposed going forward.

I need evidence against my thesis, so please send any negative information against owning precious metals miners and gold. I am reading:

Gold Bubble Book

Next week, I will post a valuation on Royal Gold (RGLD) so get a head start and visit the websites of Franco-Nevada (FNV), Silver Wheaton (SLW) and Sandstrom Gold (SAND) to learn about this business.


10 responses to “Buffett Investment Lesson; Gold Capitulation Part 2

  1. Hi John,

    Thanks again for all the great articles. I am assuming you have read it, but ‘the power of gold, the history of an obsession’ by Bernstein is an excellent book (as are his other books). It does its best to be unbiased.

    A great quote from Benjamin D’isreali on the UK gold standard in 1895 “Our gold standard is not the cause but the consequence of our commercial prosperity”.

    I think this is essentially true, a gold standard does not result in a prosperous and stable economy, its essentially a by-product. What the book does attest to is the poor history of previous fiat currencies. Given the money printing going on currently and the large off/on balance sheet liabilities, history may just rhyme. If this scenario plays out, gold could be a decent store of value as it has been historically, but I doubt whether it will once again form the pillar of our monetary system.

    Just for the record I am long a few precious metal mines and related businesses, but I am very weary of being wrong.



    • Yes, Floris, I have the book, but I have not read it closely.

      The gold standard is not a panacea. Throughout history, govts have abandoned the gold standard (WWI) the US Civil War when governments were desperate to raise funds for war.

      I struggle with your argument of cause and effect. All a gold standard does is remove the power of the printing press from govt officials and it provides a stable store of value which makes for a great medium of exchange which helps in specialization which helps make a society more productive. The chicken and the egg. Certainly, our current financial system in the US is an absolute joke–a debt laden ponzi that is devastating the economy. Please, I will pay someone to teach/show me otherwise. Printing money has never created prosperity–Zimbabwe, Japan, The US.

      Miners are like burning matches–there is a time to buy and a time to sell. I don’t think that day is today, but buy and hold will not be a winning strategy.

      Gold is simply non fiat money. I don’t consider it an investment. The last thing you want is to see the gold price go through the roof, because your real rate of return on your other investments will not be pretty.

      Thanks for the rec.

      Pray for us.

    • It’s good that you’re seeking discomfirming evidence to your thesis.

      I think the biggest case against gold is that it’s hard to value. Farmland and property for example provides a yield which is fairly robust over time, but gold doesn’t have such an anchor. Cash cost doesn’t provide a floor since demand is fluid. Much of the demand since 2009 has been from ETF’s and China. ETF’s represents speculation to a large degree, which is sentiment-driven. China seems likely to be undergoing a deflationary credit bust given how growth in shadow banking assets are developing. so that leaves central banks. The only way essentially to value it is to look at historical prices and compound them with some sort of inflation metric. It’s a myth that it’s a store of value, except in the very long run. From the early 80’s to 90’s it wasn’t a good store of value, despite inflation, simply because inflation expectations came down. Today I’m not sure if gold investors have high inflation expectations but I suspect they do given the large focus on the metal in the media. Compared to the 70’s we haven’t had very serious inflation yet, although of course CPI numbers are understated for various reasons. I think that one thing that investors are missing is that this massive increase in the Fed balance sheet isn’t necessarily inflationary if the interest on reserves is higher than the Fed Funds Rate, which it has been since 2008 due to the IOER. That means excess reserves won’t be lent out and the money multiplier won’t work properly. So due to deflationary pressure and the IOER, the economy is not reacting as it normally would to today’s super-low interest rates. There is a risk that Fed won’t be able to shrink its balance sheet once we normalise policy (Grant’s make a case for this) as they won’t be able to afford the IOER if it rises. I’m not sure I would make such a bet though – the Fed can print money at will. So now we’re muddling through with M2 at 7-8%, which looks somewhat higher than ordinary but not extreme. Then you have savvy investors like Dan Loeb recently selling all their gold ETF holdings, you start wondering why. On the positive side for gold, in the short term it seems to be trading off the expectations of real interest rates, and if you look at the inflationary expectations implied by TIPS, inflationary expectations have started increasing again. And I think miners are so over-sold they might be a good buy even if gold doesn’t rebound or trends lower (Barrick is at 1992-lows!) Having said all this, I’m not an expert so appreciate any opinions contrary to mine.

      • Well Dr. Fritz:

        Thank you for your detailed thoughts.

        I don’t know where the price of gold will be in terms of U.S. dollars in a year or two ($500 or $1,500) but the trend has been up since 1971 after Nixon severed the US Dollar link to gold. I take a thirty-year view. I don’t think of gold as an investment. Gold is simply money. What is the cash flow of a dollar?

        Gold is simply non-fiat, non printable money. If not, then why do banks hold it as reserves? Gold has little use value compared to its medium of exchange value.

        I also view gold as “cheap” insurance against monetary mayhem–rising inflation or debt deflation. Gold does especially well in a deflation since it is money. I don’t think the central bankers have a clue as to what they are doing.. By the way can YOU tell me WHAT they ARE DOING? Bernanke, “Subprime is contained. The housing market is strong (2006).” That said, I don’t think they would purposely allow hyperinflation either since that would destroy their power.

        Gold at $12,000? Some think the dollar will once again be backed by gold. I don’t think the Central Bankers want to give up their powers. However, the market may take the printing press away from them eventually or tomorrow. Note the action of the US Bond market starting to act “Funky.” The economy is weakening while interest rates start to rise…

        The only thing I KNOW for a fact is that central planning doesn’t work. Current CB policies lead to weakening economies laden with debt. ………..So guess what might happen?. Debt default either implicitly or explicitly. The clock is ticking by 85 billion a month……….

        I don’t own much gold or silver bullion but certain mining stocks. Even if Gold drops to $600, some companies will thrive in the long run. What matters is the input/output spread for the miners. Expect a lot of volatility in the miners over the next year or two. But mining stocks are burning matches–there will be a time to sell.

        P.S. Dan Loeb and other investors selling their gold is a HUGE positive in my eyes. Who is on the other side of their trade? Is it Dan Loeb who is selling or his investors?

        I wanna own Coke from $30 dollars but instead I cower in my bunker with gold coins and cat food.

        Good luck,

  2. I have trouble understanding how to value most of these miners – it seems like any “profits” are all reinvested back into the same business no matter what, and those reinvested amounts grow during good times and shrink during bad times. This runs counter to what I would expect. I would expect them to find deals when things aren’t going well and to at least at some point, back off on growth when things are going better than they ought to go.

    If any of those miners let cash pile up during good times and then deploy it during bad times, that would get me excited. I would need to see a mix between Henry Singleton and Buffett when it comes to miners. I just don’t want someone who will dig a hole every time they have a dollar laying around.

  3. I think you might be better off looking at the royalty/streamer companies since you can value on assets/cash flows: FNV, RGLD, SLW.

    I will post a valuation soon on RGLD. The investors who do well outside of those companies know the managements who can manage properties from discovery to production. Not the standard valuations. Everything is forward looking–speculative.

  4. My long thesis for gold at current price.
    If Gold price goes down any further, all the unprofitable mines (all in cost at $1000/oz) will begin to cease production. At the same time if the Fed wants inflation they will get it. With the Indian rupee depreciating the price of gold has gone up in India, while the stock market is going down, confirming the ingrained belief that gold always goes up. India consumes roughly 1000 tonnes / year , so are the chinese. Where is this supply going to come from if current prices persist?

    • Dear Peer Mohamed:

      Some mining experts say (depending on how you calculate “All-in costs”) that costs are about $1,200 or higher. In Fact, this article and link discuss $1,600 and higher for free cash flow: Profitability for miners: http://news.goldseek.com/GoldSeek/1377277294.php

      But the question I have for you: How significant is gold production in terms of supply? If current supply is estimated at 170,000 to 180,000 tonnes (World Gold Council) but production is, say, 2,000 tonnes then you are talking about a difference of only 1% change in supply if ALL the gold producing mines were shut down.

      How can so slight a shift cause a reason for a price change?

      My bias is that the price is set by the reservation demand/supply. Google: http://www.acting-man.com and reservation demand.
      If U.S. govt debt keeps rising which means monetization of that debt, then the gold price should rise. Of course sudden spikes in price might discount that rise in debt, so remember the importance of price as a discounting mechanism.

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