original mungerville

I think everybody's comments are right on this thread so far: could be defaults in Europe, US dollar strong, etc...but I don't think I would short precious metals here, I still think they should outperform other asset classes in this kind of environment and should begin to strengthen relative to the stock market. "When gold goes up, it's because everyone is increasingly realizing that it's the only true money. When gold goes down, it's because everyone is increasingly realizing that dollars are the only true money. There, I explained it for you." This is exactly it, and the question is which one will it be in the end? A strong dollar or high gold prices? I don't know the answer to that one. If someone knows for sure, let me in on the secret. In the meantime, I am betting both ways. Silver had its biggest 2 day drop since 1983 and biggest one day drop apparently since 1979 today according to a Bloomberg article. I decided that I should buy a bit more silver. Ultimately, I think governments are probably going to have to triple the price level to cut the debt by 2/3rds and gold and silver will triple fundamentally and then there will be a pile on effect and they may go up 4 to 5 fold. This may unfold in a very short period of time - say 12 months. Until then, its going to look like we are heading into deflation and debt destruction with increasing amounts of volatility in the markets and this could last for some time - years? I think one thing we can count on is significant volatility as this system seeks to work its way through to stability (ie stability meaning lower debt relative to GDP whether via debt destruction or massive inflation).

I use LEAPS like Uccmal and also try and roll them forward at this time of the year. Sell the 2013s and buy the 2014s. In-the-money LEAP calls can provide leverage while limiting your downside if the market drops in half. I like using them because I take big notional positions in individual stocks (eg 100% of the value of my portfolio, so if I pay 15 cents for every 100 cents notional for deep in-the-money LEAP calls 2 years out and keep rolling I can take a big position while limiting my downside to less than 15% due to continual residual time-value...say 10% max downside). I do this with my own money. If I run other people's money, I cut that in half or so depending. I plan on trying to make a killing again at some point over the year or two using LEAPS.

I did not buy anything with this little extra 6-7% drop over 2 days. Tightened up my puts to provide some cash so I am positioned to buy now but other than that... If we go down another 4 to 8%, that'll get me out of bed and I'll start thinking about adding something. I just don't see much of an advantage adding without at least a 10% drop in the market, or when the stocks you want to own don't drop at least 15% individually. Are you really going to double down when the stocks you own drop 6-7%? or even 10%? Are you even going to add 50% to your current position? If not, why waste your time? Its not going to make a huge difference... other than for the feel-good psychological benefits of knowing you bought a bit on a down day.

Liberty, "The Dow went from 66 to 11,000 or 12,000 during the last century, and you got paid a lot of dividends along the way. Gold went from $20 in 1900 to $400 in 2000, plus you’d have to pay insurance and storage costs, so it’s not a good store of value." Well, that's an excellent time period for Buffet to choose not adjusting for the inflated valuations of common equities. In 2000, stocks were over-priced by about 50% so cut that 12,000 to 6,000 for a fair price on equities. Also unaccounted for were everyone's full 200% confidence in Greenspan - double gold to $800 for that. (we can argue about both adjustments, but my point is directional and that the comparison is weak given the time period chosen which just coincided with the annual report, so I am not blaming Buffett rather I am saying its not applicable to what we are going through today - see below) For 2000, on that adjusted basis, equities went up 100, and gold went up 40 times (I would say that that is pretty close - only a 100% difference over 100 years or less than 1% compounded per year); If you don't like my adjustments, currently, the Dow is at 11,000 and Grantham says its worth something like no more than 9,000. Gold is at 1,900. But lets just go with 11,000 - that's about 160-170 times from 66; gold is up about 100 times from 20 - damn close over a 110 years - now much less than a 1% annual difference compounded. People still think the authorities can save the day and prevent deflation - otherwise stocks would not be at 11,000. If you take the gold bubble to be the inverse of the authority bubble, gold is not in a bubble because people still think the authorities can save the day. But let's just stick with the numbers - I'll even give Buffett the less than 1% slippage a year (not that I am certain that that is the case). So you know, let me agree with him that in normal times, take the candy - take the productive asset, take the stocks, farm, etc and over time that is better than gold at the end of the century. But I would say this: I am not concerned about who has slippage of 1% compounded over the next 100 years and who doesn't. I agree with Buffett there, either the other stuff is better than gold in this regard, OR its a wash - I would guess its a wash but maybe he is right. What I am concerned with is keeping my powder dry over THIS PARTICULAR TRANSITION period where I am not smart enough to know if we get deflation (like Watsa thinks) or inflation (like Buffet thinks) and whether the latter is accompanied or not by a new monetary system and a one-time significant adjustment of the price level upwards. I am not smart enough to know that my Russell hedges are the right thing to do over these next 1 to 4 years anymore (I was certain they were the right thing over significant periods in the last 12 years though) but I am certain that "safe" is the way to go. And I am pretty sure that in the Buffett and/or new monetary scenarios, precious metals, after accounting for this less than 1-4% slippage (over the next 1 to 4 years, ie. I'll give that measly less than 4% away no problem) should outperform stocks dramatically. Actually for the record, I have been in this stuff for close to 1.5 years already, so make that from 2010 to 2015 inclusively, precious metals should outperform stocks as the financial crisis compounds the sovereign fiscal crises if we get significant inflation and/or a new monetary system. Buffett and Munger in that quote are talking very long term, and saying stay focussed on the candy because in the END, the candy is just as good as precious metals. And I agree but I am talking in THIS TRANSITION PERIOD which could be brutal, add in-the-money calls (ie don't put your whole portfolio in) on precious metals to the mix with an equity hedge to ensure your dry powder doesn't get wet. This is the only way I can think of of being "safe" with my "dry powder" dry in all scenarios. Having said all that, what sucks about thinking about this crap, is arguably that it may detract from you developing your stock-picking skills further while you focus on this stuff for this particular transition period. (But if worse comes to worse, after this is all over sometime in the next 4 years, I can give my money to one of the capable board members to invest purely bottom-up. But I guess even I can find three good stocks to hold at any one time.) I actually can't wait 'till the day comes when I will feed that the optimal portfolio strategy includes no equity hedges - and no currency/precious metal hedges - because its a real pain in the ass frankly.

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.

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.

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.

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.