Buffett's Silver Streak

By Dan Kadlec With Reporting By Helen Gibson /London

Being a genius investor has its rewards besides making one filthy rich. Chief among them is knowing that hordes of people will follow your every move once you disclose what you have most recently bought. All the genius wannabes, you can be sure, will pile in and drive up the price of what you already own. Great work if you can find it.

So it was last week in the silver market, where prices spiked to a nine-year high after Warren Buffett, the Oracle of Omaha, disclosed that he had taken a major shine to the metal and bought up 129.7 million oz. of the stuff. That amounts to 37% of the world's aboveground stock of raw silver, according to the CPM group, a commodities and precious-metals consulting firm.

Buffett made his gleaming presence felt. The price for an ounce of silver to be delivered in March hit $7.28, up 16% in the two days after Buffett's disclosure and up nearly 70% since he started buying the precious metal six months ago. Despite the surge, veteran--and thus oft-pummeled--silver traders will note that a price just north of $7 is nothing next to silver's peak in 1980, when it hit $50 amid an infamous attempt by the brothers Herbert and Nelson Hunt to corner the market.

Still, the jump in price spread chaos across the market as Buffett called for delivery of more than 42 million oz. of the silver he had bought--after already having some 87 million oz. in tow. Panicky short sellers, who had borrowed silver and sold it in the expectation that the price would fall, had to swallow huge losses to complete the deals. Major buyers of silver like Eastman Kodak, which processes millions of ounces a year into film, faced big increases in raw-material costs. And everywhere families began eyeing grandma's precious flatware as a possible source of cash. "We think we may see the spike reach double digits--maybe $10 an ounce--but one doesn't really know in this rarefied territory," says Nick Moore, director of Flemings Global Mining Group in London.

Buffett's purchases shifted vast amounts of silver from U.S. warehouses, where stocks of the metal were publicly listed, to warehouses in London that are not required to disclose how much they hold. That helped to keep the purchases under wraps. The disappearance caused a Canadian investor to sue the giant commodities-trading firm Phibro for deliberately hiding supplies of silver to push prices up. Phibro, a unit of the Travelers Group--whose shareholders include Buffett's Berkshire Hathaway holding company--denied the charge.

Buffett's silver spree caught almost everyone off guard. After all, the man made his personal billions--$25 billion at last count--by buying and holding undervalued stocks. But silver doesn't even pay a dividend and, worse, costs money to store. So why on earth did Buffett use Berkshire to acquire 4,000 tons of silver--a cache weighing more than 10 Boeing 747s--at a cost of $650 million between July 25 and Jan. 12? Until then, Buffett hadn't owned an ounce in 30 years.

For starters, silver prices were down last summer. That made the metal a value play, something Buffett is good at. In fact, Buffett says in a statement that he saw a huge imbalance between the amount of silver available and the demand for it to make things like jewelry, photographic supplies, electronic components, mirrors and batteries. So he began buying because "equilibrium between supply and demand was only likely to be established by a somewhat higher price." Translation: It looked like a good deal.

More than most tycoons, Buffett is forthcoming, and there is no reason to doubt his word. But there's also a bigger picture that's worth a look. At Berkshire's annual meeting last year, Buffett warned that the stock market was presenting few bargains and that investors should expect dramatically lower returns. Just last fall he bought $2 billion of--gasp!--long-term Treasury bonds, an investment that betrays some concern about stocks. Now he turns around and buys enough silver to make the Hunts jealous. Could it be that Buffett has soured on the stock market?

Not a chance, says Robert Hagstrom, author of The Warren Buffett Way and manager of the Focus Trust, a stock fund that tries to mimic Buffett's style. "You shouldn't take this as a cue to be seduced into commodities, and don't misunderstand this as a big move out of stocks," Hagstrom says. Indeed, the silver and T-bonds, even after recent run-ups in price, account for less than 10% of Berkshire's $34 billion portfolio.

But another Buffett watcher, Stephen Leeb, editor of the newsletter Personal Finance, notes that Buffett may feel vulnerable. The stock market has roared ahead in the past three years on the power of a "perfect-world" economy, one where inflation was low but earnings were robust. Buffett's stocks, more than most, have been big winners. Coca-Cola, his largest holding, has shown an average annual gain of 36.2% since the end of 1994, vs. 30.6% for the Standard & Poor's 500. Coke now trades at about $67 a share, more than 40 times last year's earnings and close to double the earnings multiple for the average stock.

"Perfect worlds don't last forever, and Buffett knows that," Leeb says. What Buffett doesn't know is how, or when, this one will unravel. But he's not alone in planning for problems. Some other high-profile investors, including Loews Corp. chairman Lawrence Tisch and international investor George Soros, have big stakes in metals-mining operations. And Federal Reserve Chairman Alan Greenspan has been talking about either inflation or deflation at various times in the past few months. Either one could knock the stock market for a loop, and Buffett's highfliers probably would be among the hardest hit.

So Buffett has been moving to protect against both risks. The T-bonds he bought last fall give him a hedge against deflation. Their value would soar if the economy soured and knocked down interest rates. The silver he just picked up gives him a hedge on the other side. The metal would gain value along with other commodities in a heated economy that raised inflation and interest rates. But small investors should be wary of following Buffett into silver lest he decide to take his profits and run. "How long will this last?" asks Moore of Flemings Global. "Buffett has to exit at some stage, and how he does that will determine whether it is a buffet or a banquet."

But that's your concern, not Buffett's. Assuming he hasn't already sold, which we probably wouldn't know until the selling was over, he's hedged in all directions at once. In uncertain times, that may be the ultimate sign of genius.

--With reporting by Helen Gibson/London