petec

As far as I know, the US government has no direct control on the US oil production unlike the OPEC countries. The government could control the production indirectly only by the permit and export laws. Is that a correct assumption? How is the government control in other countries like Canada and Australia? Yes, that's correct. US oil and gas production used to be directly regulated I believe but are no longer. It's a free market, so long as producers operate within the law (getting the right permits etc). There is therefore no 'official purpose' of rising US oil production, only the impact of finding a new technology (fracking) and lowering its cost. Five years ago a lot of people believed US (and possibly world) oil production had peaked and that psychology helped oil prices to very high levels, almost certainly above the marginal cost of production. Today there is a possibility that fracking technology will go global and the world will be awash in oil, so there has been a huge shift in thinking. People have also realised that OPEC won't hold the price up to the benefit of their competitors. This is, therefore, a normal market reaction except for its suddenness. But then even that might be normal: as we all know, in economics things can last longer than you can imagine and then change faster than you can imagine.

Funnily enough I found Prem's slide on interest rates after the Wall St crash and in Japan today. Average trough for long term rates 2%, average time taken to get there after the panic, 14 years, average rates 20 years after the panic 2.5%! I know these are different times, but I do wonder whether we are in for a much longer period of low rates than anyone thinks. Maybe, maybe not. First thing that comes to mind though is that the US is pretty different from Japan on many levels. Absolutely, and different from itself in 1930.

Funnily enough I found Prem's slide on interest rates after the Wall St crash and in Japan today. Average trough for long term rates 2%, average time taken to get there after the panic, 14 years, average rates 20 years after the panic 2.5%! I know these are different times, but I do wonder whether we are in for a much longer period of low rates than anyone thinks.

I don't think #4 is right. OPEC gained pricing power in 1971 when the Texas Railroad Commission instructed US producers to produce at 100% (meaning there was no spare capacity in the US, which had been the swing producer). OPEC abused that power in the 1970's and the high prices thus created allowed the development of new, high cost resources in the North Sea and Alaska (in particular). Users also got more efficient. By the early 1980s the market was heading for oversupply and so OPEC started cutting to keep the price up. Except most of them didn't, because it pays an individual country to overproduce vs. quota so long as the whole cartel is cutting. So basically Saudi cut. And cut. And cut. And then thought: why are we doing this? All that's happening is everyone else is getting rich and more high priced supply is being developed. So in 1986 they flooded the market, and we got 15 years of cheap oil. The Saudis who are in charge now are old. They remember. And today OPEC is a much smaller percentage of world oil supply so their influence is smaller. If they cut, all that would happen is efficiency would continue to rise, supply would continue to rise, and OPEC would eventually end up producing very little of their incredible asset. (And in time, when we move to other technologies to supply our energy, they'd look at all that now-useless oil still in the ground and think: bugger. As Al Naimi has said, the stone age did not end for a lack of stones and the oil age will not end for a lack of oil.) The only sane thing a low cost producer can do is produce flat out, keeping prices fair and demand high and other producers out of the market. Ask Potash Corp how the other strategy works out ;) That's not to say OPEC won't occasionally cut if politics briefly rules over common sense. But they won't, in the long term, hold the price of oil above the market price because they know it's stupid and won't work.

Relatively being the operative word. That's a hell of a book, and puts things in perspective.

You say that, but what's the alternative? When you're young and working for someone else, it seems that the only differentiating factor that you can control is your availability and dedication. Quite. And if the alternative is not saving so much, and having to work weekends and evenings when you're older...

Has anyone compiled Prem's letters into one document? I plan to but if someone else has done the work for me...! Just re-read the last couple and I do think they are excellent on thinking and culture. Pete

What was first, deflation or lower oil prices? Well in Japan they had deflation even with rising commodity prices. We're not seeing deflation here yet, but we are seeing lower commodities. Real purchasing power is rising as is employment. So far anyway :-X I have been thinking about it a lot lately and I'm still not sure about it. Why did we have high(er) oil prices in the face of the whole shale gas revolution only a few months ago? To me, it seems more probable that the prices are reacting to deflationary pressures from all around the world (but the US). I'm really curious whether we will see this working out as economic stimulus for the US economy or more as importing deflation. Gundlach talked about this lately: http://video.cnbc.com/gallery/?video=3000333313 He is using oil as a leading indicator for the CPI. I recall going to a dinner arranged on this board before the 2009 annual dinner and someone asked Sam Mitchell: inflation or deflation? He said: both, and what really matters is when one turns into the other. I'm inclined to think he's right, and I think commodity prices coming down are deflationary at first, and that is so good for the economy that Eric's thesis plays out and we get wage growth and a little inflation. But the third order effect is that, with those elements of the economy normalised, CBanks can and might have to raise rates, and it is quite possible that that will cause havoc. Now, by the time you get to third order events your chance of making a correct prediction is so small as to make the exercise pointless! But I can see how Prem's 2011 forecast of a possible decade of flattish nominal GDP with bouts of deflation might come true. But then I suppose any forecast *might* come true ;)

My take would be that none of these passes the quality sniff test. IBM might, but there are clear problems. PBR is a corrupt government ministry with a cash flow problem. Conn-well you said it yourself. My view is if you buy quality cheap and it doesn't go up for a while it doesn't matter, especially if it pays a good dividend. If you buy crap cheap and it's doesn't go up, you're left with...well...crap ;) Edit: I should add that for me a quality stock needs most of the following characteristics: it'll probably last forever, it'll probably grow a bit, it has and can sustain high returns on capital, it doesn't need to spend much capital, and management are good at allocating capital. Clearly if it can allocate a lot of capital to growth at high returns that's great, but I'll take longevity of cash flows over growth of cash flows any day, ceteris paribus.

P24, Well, that's an interesting point to ponder. I want to say that it was roughly 2007 that Markel was selling for 2X book and, at that time, I contemplated selling a good-sized chunk of my holdings. I think they also got pretty close to 2x BV in 1999 as well. Ultimately I never did and it cost me dearly as I could have, a couple of years later, purchased some MKL for dramatically less. I promised myself that, even though I think MKL is a great company to own (and I know you do as well), that I'd sell half or so of my holdings if it was selling at 2x BV. I think that it is a reasonable conclusion that 2X book for MKL is a result of price getting ahead of value. As we are currently sitting at about 1.3x BV, we've got a ways to go. The same concept would seemingly apply to FFH but the specifics are not as clear to me. I cannot argue with your assertion that 1.7x BV being a selling point, but I cannot endorse it either. Do you have any specific calculation that says 1/7x BV is overvalued? Not trying to challenge you on this, just looking to understand. -Crip I agree. Gut says that somewhere between 1.5x and 2x it becomes very fully priced, but with the deflation swaps it's hard to know what happens to bv.

Absolutely agree. I think the management of the company has been exemplary over the last few years. I realise some consider the equity hedges to be a mistake; I don't, and I think they have bought some great operating businesses in the meantime.

so you are talking about USD$700/share now. Way to go! I'd probably do the same. Or consider it.

Good luck. It's a tough exam, probably the nest-designed one I've ever taken, and you are doing exactly the right thing focussing on answering as many questions as you can. P

Gio, Your original post here was a pretty epic call. What are you thinking now? Pete

Funnily enough I'm reading a history of Waterloo at the moment. Amazing how easily it could have gone the other way but as a Brit, I can't help but feel a little smug reading Napoleon's dismissal of British infantry and Wellington on the eve of the battle. I didn't realise he hadn't faced either directly before, but he misjudged both. More importantly perhaps, he misjudged Blucher. Unfortunately the book does not help me know what will happen to stocks, but I'm not sure I'd have wanted Napoleon as my fund manager!

Certainly isn't mine ;) I think it's on a mid-teens look-through PE which given the quality of the businesses and the capital allocation is absolutely fine by me. So what is your estimate of FV? To be completely blunt, I don't make one. My main point (poorly expressed perhaps) was more that I find it easy to believe that a company like Berkshire might be worth a substantial premium to BV. My subsidiary point is that 15x 2014 doesn't strike me as expensive when you look at the quality of the underlying businesses, the multiples that peers trade on (railcos for example), and the quality of the capital allocation which should have a huge impact on multiples. Now clearly if I don't have a specific FV estimate I don't know where I'd sell. That's true. As long as I don't think it looks overvalued on a basic metric such as lookthrough PE, I won't think much more about it. If it gets to the point where the basic metrics make me twitchy, I'll have a more serious dig into how fast IV might grow. E.g., I might start thinking seriously at 2x bv, or 20x 1y fwd lookthrough earnings. A big part of my investment philosophy is to ask if I'd like to own this operating business forever, get in at the right price, and then apply "lethargy bordering on sloth", as WB would put it. P

Certainly isn't mine ;) I think it's on a mid-teens look-through PE which given the quality of the businesses and the capital allocation is absolutely fine by me.

I don't disagree with any of this - I suspect that your posts are merely the tip of the iceberg in terms of your knowledge and that gave me the impression of oversimplification. In a way I have a similar method, in that I have a long list of stocks that pass two or three key criteria (have been around for decades, have decades of slow growth potential, generate high roic and fcf) and I add to these when the market and the stocks look cheap. I guess I'm kind of making my own etf, while becoming more or less aggressive depending on mean reversion in margins and valuations. So, in a way, quite similar. Once I have decided the stocks meet my criteria I barely analyse them again. What I would add is that if you're a mean reversion man, now's not the time to be investing ;) The data seems to show a -ve correlation between gdp growth and stock market returns which is interesting (though I suspect the data is at least mildly flawed). However, in a broad ETF like VT, the consistent underperformers are by definition small components given that the indices are market cap weighted. VT is very US-dominated.

I believe the swaps are on the main CPI index (i.e. including fuel and food) in which case low oil price will be a deflationary factor.

My approach would be to choose a broad market etf (e.g. VT) and invest 90% of whatever you save in it on a monthly or quarterly basis, without fail. I would leave the remainder in cash and have a rule that you use it to buy more whenever the market has fallen xx%. You'd need to do some research and decide where you are comfortable setting this rule. E.g. if you are trying to take advantage of corrections every couple of years then -15% might work for you, but if you're trying to take advantage of crashes every 10 years then you might choose -40% or whatever. That allows you to be passive and value oriented without spending a lot of time on research. Frankly, and don't take this as rude because it is just an observation from your posts, everything else you've suggested here looks more like oversimplification than value investing to me. You can't tell if an etf is cheap without analysing every component of it, so you're better off analysing stocks. The other option would be to choose an active value fund run by someone with an epic record. P

I can't find it now but someone on here has previously commented that the swaps appear to be valued as Level 3 assets by FFH, meaning they have considerable flexibility in how they value them. IIRC the poster felt they valued them using a very conservative internal model because they often seemed to get market down very shortly after they were purchased. In other words, you might not be able to predict the carrying value even if you can get a price quote.

I think one has to look why oil is cheap to decide whether this is good or bad. When its just caused by overproduction its a good thing, but when i recall it correctly we have a demand contraction, too. And this is a bad sympton, because that means that the economy is losing steam. You just have to look at chinese house prices to have an idea of whats possibly coming. You need to have a look at why you have a demand contraction. It might be because the economy is losing steam, or it might be because we get better at using it when it is expensive. Cars get more efficient, and we invest in innovation to make outer sources of energy cheaper. All this is happening.

Hmm. This is an interesting one for someone battling a relapse into depression! I'm grateful for fantastic parents and the continued support of the one who is still here; for great friends; for the opportunities I have had to see amazing parts of the world (Jordan and South Africa especially); for COBF, which I find fascinating; and for the future.

The CAPE article is really interesting, both in that it exposes serious flaws but also in that it doesn't say the idea is bad, just that there are errors in the calculations used at certain key points in time. That said, it's not a timing tool but a returns-forecasting tool. I'm not sure I agree with him on energy though - he's basically arguing that past earnings have no predictive value but that's the case for many companies, and where it is extreme the PE is just lower (as for energy) so CAPE vs CAPE history still makes some sense.

Absolutely agree. Selling slowly into increasingly extreme valuations can't be bad, nor buying when things are silly cheap.