Everyone has an opinion on the record-high oil prices these days.  Half the experts thinks hedge funds and speculators have driven the prices up, whereas the other half thinks it's all supply and demand.  Interestingly enough, Warren Buffett is the latest to weigh in on his opinions -- he is in the supply/demand camp:

Becky:  You mentioned oil prices, and there's been a huge debate we've been having on our show, and throughout the day, where people are trying to figure out, is this supply and demand picture or to the idea that there's speculation going on in these markets.  That there's a lot more money in these markets than there used to be, say three years ago.

Buffett:  It's supply and demand.  I mean, if somebody buys a thousand forward oil contracts and somebody sells a thousand forward oil contracts, somebody's speculating on the downside and somebody's speculating on the upside.  The only way you could have speculators having a big impact is if you had a huge amount of storage where they started actually withdrawing actual, physical oil from the system.  But it's not speculation, it's supply and demand and the situation is that in my adult lifetime, up until the last year or two, there's always been a huge amount of excess supply available.  There's been reserve capacity.  And that goes back 30 years ago, in this country we produced way more oil than we needed here and we had something called the Texas Railroad Commission that shut down wells.  And a matter of fact, we got down to where they would only let wells operate in Texas for eight days, we had so much extra capacity.  We don't have excess capacity in the world anymore, and that's what you're seeing in oil prices.

Becky:  Except we had a series of people who came to Capitol Hill, to Congress on Monday, who said, the analysts, if you tamp down on speculation, you could cut 50 percent, as much as 50 percent, out of oil prices immediately.  Do you think that's just hogwash?

Buffett:  (Laughs.)  I think if they closed the oil futures trading, I don't think it would make much difference.  Incidentally, the five-year oil price, you can buy oil for delivery in 2012 now, or 2013, that price is very close to this price.  Now if anyone thinks that short-term speculation is entering into oil prices,  where are they paying 130 dollars a barrel for delivery in 2013.

This is the best transcript I have read on the 2008 Berkshire Hathaway Annual Meeting.  My favourite question/answers:

Q5: Would you use stock options to enter a position in a public company?

WB: If you want to buy or sell a stock, you should buy or sell a stock. We sold puts on Coca-Cola once, but usually it is best to just buy stock. Using option technique is an idea where you get to buy a stock cheap. Four out of five times you may get it right and one time you may miss the opportunity to buy. We virtually have never used options to enter or exit a position. We have sold long-term equity put options described in our press release. We don't get involved in fancy techniques.

CM: If I remember right, a public authority was wondering if they should set up an option exchange market. Warren was alone in the opinion of opposing it. You wrote a letter saying it wouldn't do any good to throw out margin rules in this fashion. It doesn't serve the country. I always thought Warren was totally right. Turning financial markets into gambling markets to enrich the croupiers doesn't make sense.

WB: A University of Chicago Graduate student asked me once, what are we being taught that is wrong? In business school the amount of time spent teaching option pricing is total nonsense. You only need two courses, (1) how to value a business, and (2) how to think about stock market fluctuations. The thing is that instructors know the formulas and you don't, so they have something to fill the time. It has nothing to do with investment success-what matters is buying businesses at the right price. If you were teaching Biblical studies and you could read the Bible forward, backward, and in four different languages, you would find it hard to tell everyone that it comes down to the Ten Commandments. The priests want to spend a lot of time preaching. You must have an attitude where you aren't influenced by the market. You need a mindset, and you need to have the attitude to divorce yourself from letting the market influence you.


Q23: New York. With small sums of money, what strategies would you pursue?

WB: If I were working with small sums of money, it would open up thousands of possibilities. We have found very mispriced bonds. We found them in Korea a few years ago. You could make big returns but had to be of small size. I wouldn't be in currencies with a small amount of money. I had a friend who used to buy tax liens. I'd look in small stocks or specialized bonds. Wouldn't you say that, Charlie?

CM: Sure.


Q26: New York City. American Express and Washington Post were big positions for you. How do you get confident enough with that [smaller] level of diversification?

WB: If we were running only our own money, putting 75% of our net worth in a single position is not a problem if it is something we really have high confidence in. Putting 500% or more of your net worth in a position is a problem. Several times I have had 75% of my non-Berkshire net worth in a situation. You will see things where it would be a mistake not to act. You won't see them often, and the press and your friends won't be talking about them. Wouldn't you say, Charlie? 75% is not a real significant amount?

CM: Sometimes, I have had more than 100% in an individual investment.

WB: You just had a good banker. Look at LTCM- they put 25x their money in things that had to converge- but couldn't play out the hand. There are people in this room with more than 90% of their worth in Berkshire. I saw things in 2002 in junk bonds that would have been worth going heavily into. You could have bought Cap Cities in 1974-selling for one-third the property value, with the best manager, and in a good business. You could have put 100% in Coca-Cola when we bought it and that wouldn't have been a dangerous position.

CM: Students learn corporate finance at business schools. They are taught that the whole secret is diversification. But the exact rule is the opposite. The ‘know-nothing' investor should practice diversification, but it is crazy if you are an expert. The goal of investment is to find situations where it is safe not to diversify. If you only put 20% into the opportunity of a lifetime, you are not being rational. Very seldom do we get to buy as much of any good idea as we would like to.


Q35: San Francisco. In 2002, you invested in Petro-China and all you did was read the annual report. Most professional investors have more resources at hand. Wouldn't you want to do more research? What do you look for in an annual like that? How could you make the investment only on a report?

WB: I read it in the spring of 2002, and I never asked anyone else their opinion. I thought it was worth $100 billion after reading the report. I then checked the price, and it was selling for $35 billion. What is the sense of talking to management? It doesn't make any difference. If the market value was $40 billion, you would need to refine the analysis. We don't like things you have to carry out to 3 decimal places. If someone weighed somewhere between 300-350 pounds, I wouldn't need precision-I would know they were fat. If you can't make a decision on PetroChina off the figures, you go on to the next one. You weren't going to learn more if you thought their big [oil] field was going to decline out slightly faster, etc.

CM: We have lower due diligence expenses than anyone in America. I know of a place that pays over $200 million to its accountants every year, and I know we are safer because we think like engineers-we want margins of reliability. It is a very dicey process.

WB: If you think the auditors know more about an acquisition, then they should run the business and you should take up auditing. When we got the call on Mars-Wrigley-I wasn't going to look at labor costs or leases. The value of Wrigley does not depend on the value of the lease or an environmental problem. There is a whole lot of trivia that doesn't mean anything. I never made an investment that would have been avoided due to conventional due diligence. We would have lost deals. On big deals, people rely more and more on process. When people want a deal, they will come to us. Mars only wanted to deal with Berkshire- there were no lawyers involved and no Directors involved. I got a call, it made sense, and I said yes. There was no material adverse change clause. Our $6.5 billion will be available regardless, even if Ben Bernanke runs off to South America with Paris Hilton. [eruption of laughter] That assurance is worth something. If you say, ‘I'll do it, but I need X, Y, Z, etc.'- that is costly.


Q61: Pharma? How do you value the pipeline of drug companies?

WB: Unlike many businesses, when we invest in pharma, we don't know the answer on the pipeline, and it'll be a different pipeline 5 years from now anyway. We don't know whether Pfizer or Merck, etc, have a better chance, or which of those will come out with a blockbuster. But we do feel we have a group of companies bought at a fair price that, overall, will do well and should offer chances for decent profits. These companies
are doing very important things. I could not tell you the potential in the pipeline. A group approach makes sense. It is not the way we would go at banks. If you buy pharma at a reasonable multiple, you will probably do okay 5-10 years from now.

CM: You now have a monopoly on our joint knowledge of pharmacology.

WB: He gets cranky at the end of the day. [laughter]

From CNN:

"You should be able to write down on a yellow sheet of paper, 'I'm buying General Motors at $22, and GM has [566] million shares for a total market value of $13 billion, and GM is worth a lot more than $13 billion because _______________." And if you can't finish that sentence, then you don't buy the stock. [Note: Buffett mentioned GM for illustrative purposes only.] All this requires some temperamental detachment from other people's behavior. Both Charlie and I have a natural instinct in that direction. We value our opinions more than others' -- perhaps to an extreme!"

...

Then Buffet said one of the most remarkable things I've ever heard him say: "There's no reason we should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month."

From Bloomberg:

Warren Buffett, chief executive officer of Berkshire Hathaway Inc., said the global credit crunch has eased for bankers and the Federal Reserve probably averted more failures by helping to rescue Bear Stearns Cos.

"The worst of the crisis in Wall Street is over," Buffett said today on Bloomberg Television. "In terms of people with individual mortgages, there's a lot of pain left to come." Buffett was interviewed before the Omaha, Nebraska-based company's annual meeting, attended by about 31,000 people.

Buffett, the world's richest man according to Forbes magazine, said the Fed acted properly when it arranged a $2.4 billion bailout in March of New York-based Bear Stearns by JPMorgan Chase & Co. The billionaire said he turned down the opportunity because he lacked enough capital and time to grasp the situation. More failures and wider panic may have resulted if the regulators didn't halt the run on Bear Stearns, he said.

"The worry was that there would be contagion; it was a very real worry," Buffett said. "If Bear Stearns had gone, the next day, somebody else would have gone. It could've been a very, very, very chaotic situation."

Buffett, 77, said he was contacted in March before JPMorgan, the third-biggest U.S. bank by assets, agreed to buy Bear Stearns. The person calling him, whom he wouldn't identify, was "someone responsible" and wasn't from the Federal Reserve or the Treasury. The call lasted about half an hour, Buffett said.

Too Big for Buffett

"As I understand it, Bear Stearns had $65 billion due on Monday and I didn't have $65 billion," Buffett said. "I couldn't get my mind around that situation in the required time." New York-based JPMorgan was the right buyer for Bear Stearns, he added.

Buffett’s comments about the dollar at his annual meeting today:

Warren Buffett said on Saturday he expects the euro and the sterling to hold their own against the U.S. dollar, in part because of U.S. fiscal and trade policies that weigh on the value of the greenback.

"I do not have a feeling that those currencies are likely to depreciate in a big way against the U.S. dollar," Buffett said at the annual meeting of Berkshire Hathaway Inc (BRKa.N: Quote, Profile, Research) (BRKb.N: Quote, Profile, Research), his insurance and investment company. "Overall, the U.S. is going to continue to follow policies that have made the dollar weaker over the years."

Buffett said he plans to go to Europe later this month to visit businesses, to be more on the continent's "radar screen," and perhaps lay the groundwork for future acquisitions. Berkshire owns about 76 businesses, and plans to add more in the coming years, he said.

"We are happy to invest in businesses that earn their money in euros in Germany, or France or Italy, or earn their money in sterling in the UK," Buffett said. "I feel no need to try and hedge those purchases."

I love this Buffett article from 1974 when he was 44 years old.  A must read to see how cheap the market was and how Buffett knew it and made a killing.

How do you contemplate the current stock market, we asked Warren Buffett, the sage of Omaha, Neb.

"Like an oversexed guy in a harem," he shot back. "This is the time to start investing."

The Dow was below 600 when he said that. Before we could get Buffett's words in print, it was up almost 15% in one of the fastest rallies ever.

We called him back and asked if he found the market as sexy at 660 as he did at 580. "I don't know what the averages are going to do next," he replied, "but there are still plenty of bargains around." He remarked that the situation reminded him of the early '50s.

Warren Buffett doesn't talk much, but when he does it's well worth listening to. His sense of timing has been remarkable. Five years ago, late in 1969, when he was 39, he called it quits on the market. He liquidated his money management pool, Buffett Partnership, Ltd., and gave his clients their money back. Before that, in good years and bad, he had been beating the averages, making the partnership grow at a compounded annual rate of 30% before fees between 1957 and 1969. (That works out to a $10,000 investment growing to $300,000 and change.)

He quit essentially because he found the game no longer worth playing. Multiples on good stocks were sky-high, the go-go boys were "performing" and the list was so picked over that the kind of solid bargains that Buffett likes were not to be had. He told his clients that they might do better in tax-exempt bonds than in playing the market. "When I got started," he says, "the bargains were flowing like the Johnstown flood; by 1969 it was like a leaky toilet in Altoona." Pretty cagey, this Buffett. When all the sharp MBAs were crowding into the investment business, Buffett was quietly walking away.

Buffett settled back to manage the business interests he had acquired, including Diversified Retailing, a chain of women's apparel stores; Blue Chip Stamps, a western states trading stamp operation; and Berkshire Hathaway, a diversified banking and insurance company that owned, among other things, a weekly newspaper, The Omaha Sun. The businesses did well. Under Buffett's management, the Sun won a Pulitzer prize for its exposé of how Boys Town, despite pleas of poverty, had been turned into a "moneymaking machine."

Swing, You Bum!

Buffett is like the legendary guy who sold his stocks in 1928 and went fishing until 1933. That guy probably didn't exist. The stock market is habit-forming: You can always persuade yourself that there are bargains around. Even in 1929. Or in 1970. But Buffett did kick the habit. He did "go fishing" from 1969 to 1974. If he had stuck around, he concedes, he would have had mediocre results.

"I call investing the greatest business in the world," he says, "because you never have to swing." You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it."

But pity the pros at the investment institutions. They're the victims of impossible "performance" measurements. Says Buffett, continuing his baseball imagery, "It's like Babe Ruth at bat with 50,000 fans and the club owner yelling, 'Swing, you bum!' and some guy is trying to pitch him an intentional walk. They know if they don't take a swing at the next pitch, the guy will say, 'Turn in your uniform.'" Buffett claims he set up his partnership to avoid these pressures.

Stay dispassionate and be patient is Buffett's message. "You're dealing with a lot of silly people in the marketplace; it's like a great big casino and everyone else is boozing. If you can stick with Pepsi, you should be OK." First the crowd is boozy on optimism and buying every new issue in sight. The next moment it is boozy on pessimism, buying gold bars and predicting another Great Depression.

Fine, we said, if you're so bullish, what are you buying? His answer: "I don't want to tout my own stocks."

Any general suggestions, we asked?

Just common sense ones. Buy stocks that sell at ridiculously low prices. Low by what standards? By the conventional ones of net worth, book value, the value of the business as a going concern. Above all, stick with what you know; don't get too fancy. "Draw a circle around the businesses you understand and then eliminate those that fail to qualify on the basis of value, good management and limited exposure to hard times." No high technology. No multicompanies. "I don't understand them," says Buffett. "Buy into a company because you want to own it, not because you want the stock to go up."

"A water company is pretty simple," he says, adding that Blue Chip Stamps has a 5% interest in the San Jose Water Works. "So is a newspaper. Or a major retailer." He'll even buy a Street favorite if he isn't paying a big premium for things that haven't happened yet. He mentions Polaroid. "At some price, you don't pay anything for the future, and you even discount the present. Then, if Dr. Land has some surprises up his sleeve, you get them for nothing."

Have faith in your own judgment or your adviser's, Buffett advises. Don't be swayed by every opinion you hear and every suggestion you read. Buffett recalls a favorite saying of Professor Benjamin Graham, the father of modern security analysis and Buffett's teacher at Columbia Business School: "You are neither right nor wrong because people agree with you." Another way of saying that wisdom, truth, lies elsewhere than in the moment's moods.

All Alone?

What good, though, is a bargain if the market never recognizes it as a bargain? What if the stock market never comes back? Buffett replies: "When I worked for Graham-Newman, I asked Ben Graham, who then was my boss, about that. He just shrugged and replied that the market always eventually does. He was right--in the short run, it's a voting machine; in the long run, it's a weighing machine. Today on Wall Street they say, 'Yes, it's cheap, but it's not going to go up.' That's silly. People have been successful investors because they've stuck with successful companies. Sooner or later the market mirrors the business." Such classic advice is likely to remain sound in the future when they write musical comedies about the go-go boys.

We reminded Buffett of the old play on the Kipling lines: "If you can keep your head when all about you are losing theirs … maybe they know something you don't."

Buffett responded that, yes, he was well aware that the world is in a mess. "What the DeBeers did with diamonds, the Arabs are doing with oil; the trouble is we need oil more than diamonds." And there is the population explosion, resource scarcity, nuclear proliferation. But, he went on, you can't invest in the anticipation of calamity; gold coins and art collections can't protect you against Doomsday. If the world really is burning up, "you might as well be like Nero and say, 'It's only burning on the south side.'"

"Look, I can't construct a disaster-proof portfolio. But if you're only worried about corporate profits, panic or depression, these things don't bother me at these prices."

Buffett's final word: "Now is the time to invest and get rich."

With the Berkshire annual meeting this weekend, I thought I would post this recent interview with Buffett.

How do you get your ideas?

I just read. I read all day. I mean, we put $500 million in PetroChina. All I did was read the annual report. [Editor's note: Berkshire purchased the shares five years ago and sold them in 2007 for $4 billion.]

What advice would you give to someone who is not a professional investor? Where should they put their money?

Well, if they're not going to be an active investor - and very few should try to do that - then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They're not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don't buy all at one time.

How does the current turmoil stack up against past crises?

Well, that's hard to say. Every one has so many variables in it. But there's no question that this time there's extreme leveraging and in some cases the extreme prices of residential housing or buyouts. You've got $20 trillion of residential real estate and you've got $11 trillion of mortgages, and a lot of that does not have a problem, but a lot of it does. In 2006 you had $330 billion of cash taken out in mortgage refinancings in the United States. That's a hell of a lot - I mean, we talk about having $150 billion of stimulus now, but that was $330 billion of stimulus. And that's just from prime mortgages. That's not from subprime mortgages. So leveraging up was one hell of a stimulus for the economy.

If that was one hell of a stimulus, do you think the $150 billion government stimulus plan will make an impact?

Well, it's $150 billion more than we'd have otherwise. But it's not like we haven't had stimulus. And then the simultaneous, more or less, LBO boom, which was called private equity this time. The abuses keep coming back - and the terms got terrible and all that. You've got a banking system that's hung up with lots of that. You've got a mortgage industry that's deleveraging, and it's going to be painful.

The scenario you're describing suggests we're a long way from turning a corner.

I think so. I mean, it seems everybody says it'll be short and shallow, but it looks like it's just the opposite. You know, deleveraging by its nature takes a lot of time, a lot of pain. And the consequences kind of roll through in different ways. Now, I don't invest a dime based on macro forecasts, so I don't think people should sell stocks because of that. I also don't think they should buy stocks because of that.

Your OFHEO example implies you're not too optimistic about regulation.

Finance has gotten so complex, with so much interdependency. I argued with Alan Greenspan some about this at [Washington Post chairman] Don Graham's dinner. He would say that you've spread risk throughout the world by all these instruments, and now you didn't have it all concentrated in your banks. But what you've done is you've interconnected the solvency of institutions to a degree that probably nobody anticipated. And it's very hard to evaluate. If Bear Stearns had not had a derivatives book, my guess is the Fed wouldn't have had to do what it did.

Do you find it striking that banks keep looking into their investments and not knowing what they have?

I read a few prospectuses for residential-mortgage-backed securities - mortgages, thousands of mortgages backing them, and then those all tranched into maybe 30 slices. You create a CDO by taking one of the lower tranches of that one and 50 others like it. Now if you're going to understand that CDO, you've got 50-times-300 pages to read, it's 15,000. If you take one of the lower tranches of the CDO and take 50 of those and create a CDO squared, you're now up to 750,000 pages to read to understand one security. I mean, it can't be done. When you start buying tranches of other instruments, nobody knows what the hell they're doing. It's ridiculous. And of course, you took a lower tranche of a mortgage-backed security and did 100 of those and thought you were diversifying risk. Hell, they're all subject to the same thing. I mean, it may be a little different whether they're in California or Nebraska, but the idea that this is uncorrelated risk and therefore you can take the CDO and call the top 50% of it super-senior - it isn't super-senior or anything. It's a bunch of juniors all put together. And the juniors all correlate.

If big financial institutions don't seem to know what's in their portfolios, how will investors ever know when it's safe?

They can't, they can't. They've got to, in effect, try to read the DNA of the people running the companies. But I say that in any large financial organization, the CEO has to be the chief risk officer. I'm the chief risk officer at Berkshire. I think I know my limits in terms of how much I can sort of process. And the worst thing you can have is models and spreadsheets. I mean, at Salomon, they had all these models, and you know, they fell apart.

What should we say to investors now?

The answer is you don't want investors to think that what they read today is important in terms of their investment strategy. Their investment strategy should factor in that (a) if you knew what was going to happen in the economy, you still wouldn't necessarily know what was going to happen in the stock market. And (b) they can't pick stocks that are better than average. Stocks are a good thing to own over time. There's only two things you can do wrong: You can buy the wrong ones, and you can buy or sell them at the wrong time. And the truth is you never need to sell them, basically. But they could buy a cross section of American industry, and if a cross section of American industry doesn't work, certainly trying to pick the little beauties here and there isn't going to work either. Then they just have to worry about getting greedy. You know, I always say you should get greedy when others are fearful and fearful when others are greedy. But that's too much to expect. Of course, you shouldn't get greedy when others get greedy and fearful when others get fearful. At a minimum, try to stay away from that.

By your rule, now seems like a good time to be greedy. People are pretty fearful.

You're right. They are going in that direction. That's why stocks are cheaper. Stocks are a better buy today than they were a year ago. Or three years ago.

From The New York Sun:

Mr. Eveillard's conservatism continues to serve him well. At the end of March, the global fund had 5.28% of total assets invested in gold bullion. Adding in related stocks, the fund's total exposure to gold is 9%. Why?

"Gold is our insurance against extreme outcomes," Mr. Eveillard says. "We have to worry about the unexpected. Under most circumstances, when equity markets go down, gold rises."

Spending some of his youth in postwar Germany, with its runaway inflation and consequent currency destruction, may have colored Mr. Eveillard's view.

"Gold has no real value," he says. "It does not provide income, but it is a substitute currency. Some people worry about deflation, but I think the risk of that is zero. With Mr. Bernanke at the Fed, deflation can always be avoided."

A hefty 12% of the fund is invested in cash today. After gold, the next largest holding is Berkshire Hathaway.

"Warren Buffett is the world's richest man, and I am not," Mr. Eveillard says, explaining his confidence in the company. Based on various valuation approaches, he thinks Berkshire Hathaway should sell between $125,000 and $130,000, or about where it is now. He bought the stock in 2002 at around $55,000.

Despite his cautionary holdings of cash and gold, Mr. Eveillard is on the lookout for bargains. In fact, the company recently reopened both the First Eagle Global and Overseas funds, which had been "soft-closed" since 2005 and 2004, respectively. "We don't see that many opportunities today," he says. "But the markets have been chaotic, and we want to have some cash." In other words, something could turn up.

The WSJ is reporting that Warren Buffett and Mars Inc. are going to bid over $22 billion for Wrigley (WWY) tomorrow.

Warren Buffett did a Q&A with college students at the University of Missouri recently.  Here are some highlights:

"Develop your own talents," Buffett said via satellite from a television station in his hometown of Omaha, Neb. He added that oral and written communication skills are the most important tools a person can have coming out of college.

"If you have those abilities when you're young, you jump out," the 77-year-old business giant said.
...

Of the Federal Reserve's recent bailout of Bear Stearns, the nation's fifth-largest investment banking firm, Buffet said it was a wise decision that prevented a potential economic disaster.

"I think the Fed did the right thing," he said. "It would have been a much more sad situation for the American economy ... if the government hadn't acted the way they did."

But if he were leading the Fed, Buffet said, he would work to stimulate the economy while remaining a little bit more cautious. "I wouldn't try to shower money on the public," he said.