Why Buffett failed...

The best way to own platinum today...

On a recent trip to Africa, S&A Global Contrarian editor Kim Iskyan saw firsthand the political instability and hotly debated race discussions.

He also learned about the continent's unbelievable opportunity in platinum. In today's Digest Premium, Kim reveals his favorite way to invest in the precious metal...

To subscribe to Digest Premium and receive a free hardback copy of Jim Rogers' latest book, click here.

Why Buffett failed... Two key lessons for commodity investors... The investment mania that bagged Charlie Munger...

In today's Digest, I (Porter) would like to share with you part of a larger research project I've been working on for the last six months or so. Caution... this Friday Digest is almost completely an exercise in teaching. Thus, it is almost surely a waste of time…

As you know, I completely disclaim the ability to teach anyone anything. Or as I prefer to explain: There is no teaching; there is only learning. So if you feel like learning something important about how to invest in commodities, please continue reading.

One of the best educations that you can give yourself in investing is simply reading the annual letters Warren Buffett writes to the shareholders of his holding company, Berkshire Hathaway. You can read them for free at www.berkshirehathaway.com. Also, a new book compiles all of his letters and can be read on devices like Amazon's Kindle. It's well-worth the price, as it makes his writing searchable.

To better understand Buffett's methods, I've been studying his mistakes. You always learn more by studying when something doesn't work. That's the main reason I spend so much time every year thinking about and personally writing our company's Report Cards. (You can see the most recent ones here and here.)

It's like Buffett's business partner, Berkshire Hathaway vice chairman Charlie Munger, says: Just tell me where I'm going to die, so that I won't go there. What he's really saying is, tell me how and why an investment approach fails, and I will learn how to improve upon it.

Improving upon Buffett? You might think that sounds like hubris or idiocy. But the truth is... since the late 1990s, Buffett's performance (as a stock picker) hasn't been special. After averaging annual gains in the mid-20% range for most of his career, Buffett's portfolio of publicly traded equities has only averaged about 6% a year since 2000.

And for the first time in his entire career, Buffett will announce sometime later this year that Berkshire's book value did not increase faster than the S&P 500 over the last five years. Buffett has beaten the S&P 500 over every other five-year period since the mid-1950s. The reason Buffett did not beat the S&P 500 over the last five years was because of poor stock picking. Berkshire's wholly owned businesses have performed well.

Buffett (and many others) will likely attribute this declining performance in stocks to Berkshire's portfolio size. Don't believe it. The two other managers who work with Buffett on Berkshire's portfolio both beat the market easily. But Buffett still manages the lion's share of capital. And he made one big, uncharacteristic mistake in the last five years... He chased a commodity boom.

During 2007 and 2008 – as oil prices soared to $150 per barrel on talk of "Peak Oil" – Buffett invested $7 billion in major oil firm ConocoPhillips. It was the single largest investment Buffett had ever made at the time. Within 12 months, he would sell most of the stock at a huge loss to free up capital for other investments. By then, the damage was done: ConocoPhillips cost Buffett several billion dollars. It was, by far, the worst investment he has ever made and probably his only genuine "blow up."

Buffett, who has always been completely honest with his shareholders about his mistakes, explained what happened in his 2009 letter:

Buffett started buying ConocoPhillips in 2007. He bought a little more than $1 billion worth of the stock and paid an average of $59.34 per share. It was a peculiar investment for Buffett to make.

First… the stock wasn't cheap. Over the previous five years, ConocoPhillips' share price had risen from a split-adjusted $13 to $60. Even more uncharacteristically, Buffett kept buying even as the stock went much, much higher. By the end of 2008, Berkshire documents show the company held a little less than 85 million shares of ConocoPhillips, purchased at an average price of $85.35. As I mentioned earlier, the size of Buffett's investment made ConocoPhillips the largest publicly traded investment of Buffett's entire career at that time. The stock represented almost 19% of the total cost of Berkshire's existing portfolio and almost 15% of the portfolio's total value.

The same year that Buffett began buying ConocoPhillips shares, he described his overall strategy as an investor this way:

You don't have to be a cynic or a Buffett critic (and we're neither) to wonder about how a massive investment in ConocoPhillips could qualify as an investment for him. ConocoPhillips is a vertically integrated energy company, meaning it controls every step in the process from exploring and producing oil to selling refined gasoline. It produces and refines gasoline and other commoditized fuels and competes in global markets with virtually no barriers to competition.

And why, we wondered, would Buffett make such a business his largest-ever commitment to a publicly traded stock? And why... why... would he ignore the inevitable commodity price cycle and continue to buy an oil company even as petroleum prices soared?

I think I know… I believe that for the first and only time in his career, Buffett got caught up in an investment mania – the "Peak Oil" bubble.

Besides the totally out-of-character moves Buffett made buying ConocoPhillips (chasing the price way higher), Buffett made a number of public statements that indicated he believed in the theory of Peak Oil – which argued that petroleum production had entered an inevitable and irreversible decline.

For example, on CNBC in early 2008, Buffett was specifically asked about why oil prices were soaring. Here's what he said on live television:

Another clue: During the 2009 annual meeting of Wesco (the small holding company that was run by Munger and is now fully integrated into Berkshire), Munger spoke at length about Peak Oil. "Whether the peak is five years from now or last year I don't know, but we are somewhere near peak oil production," he said. "Oil, I think, will get more and more expensive."

These comments were similar to ones Munger made before. For example, during a mid-2000s conference with Chinese business leaders, he said:

Looking at these comments and what happened with the stock, Buffett and Munger clearly believed in Peak Oil. They thought the world was literally running out of oil. That's the only explanation for Buffett's ConocoPhillips investment. The losses he took on this investment are the real reason Buffett isn't going to beat the S&P 500 over the most recent five-year period – his self-imposed key management goal.

There's a huge lesson here for investors. Rick Rule, who has spent his entire career investment in commodities, is fond of saying that in commodities, "You're either a contrarian or a victim." As a long-term investor, you almost never make money chasing commodity prices higher. Instead, to buy commodities (and commodity stocks) safely, you should always wait until their prices have collapsed.

Another of Rule's key laws to success in commodities is to remember that markets work. Sooner or later, higher prices will create new supplies. Extremely high prices – record-high prices – will create record new supplies.

And to the surprise of the disciples of 19th-century economist Thomas Malthus... it turned out that we aren't really out of oil at all. Nope. Instead, record cash flows from oilfields enabled huge investments in new technologies, like horizontal drilling. Those technologies unlocked new supplies of oil that dwarfed all previous discoveries combined.

Today, just five years later, the U.S. government is taking steps to allow our trading partners to tap our oilfields. These moves will strengthen the U.S. dollar and generate massive trading profits and hundreds of billions of dollars in new revenue in taxes and royalties for the government.

Two important takeaways from Buffett's biggest-ever mistake: Never, ever get caught up in any kind of Malthusian, limited-supply investment story.

Don't forget: Markets work. As prices move higher, new supplies are bound to be discovered and flood the market. It's only a matter of time. And second, never chase commodity prices higher. Always wait until they've fallen 80% or more to make a major commitment.

If you've been reading our research lately, you know many of our analysts believe one sector of the commodity world offers a huge opportunity today... gold stocks.

The Gold Bugs Index (the "HUI"), a basket of gold-mining stocks, is down more than 65% from its 2011 peak. And that's after the recent recovery we've experienced. As we mentioned in yesterday's Digest, gold stocks would have to double from today's levels just to get back to their average historical ratio versus the price of physical gold.

People are disgusted with gold stocks... The shares have gone straight down for years, to the point where several mining stocks are trading for less than the value of their gold in the ground. Lots of junior mining stocks are down 80%-90%. It has been brutal.

But we think the tide has turned... And the buyers are coming back to the market.

Here's the thing... When bull markets in gold stocks get ripping, these stocks absolutely soar...

I'm not the only guy on our team who thinks the bull market in gold stocks is on the way... Steve Sjuggerud, Frank Curzio, and Jeff Clark all agree. Jeff just recommended a trade to his S&A Short Report readers that he thinks could return more than 300%.

The gold stock in question is down 50% from its highs... And Jeff says it's on the verge of a breakout.

You can learn more about subscribing to the S&A Short Report and start trading along with Jeff by clicking here...

New 52-week highs (as of 2/6/14): EnerSys (ENS), Fluidigm (FLDM), and Targa Resources (TRGP).

"I bought [CVS] when Doc recommended it to Retirement Millionaire subscribers. I got into the trade shortly after the date of this issue... I am up 41% which is a far cry from 80%. I find that you routinely overestimate the returns, and I'm sure it is to make you look better than you are. Just tell the truth. That is all your subscribers want." – Paid-up subscriber Lorraine Ryff

Goldsmith comment: Naturally, we cannot reflect each subscriber's individual experience when reporting our track records. The best we can do is be consistent and base our calculations on when the editor makes his recommendations.

Doc recommended CVS on May 11, 2011 at $38.19 a share. It trades at $66.39 a share today. It has also paid out $1.80 in dividends since then… That brings you to a 79% gain (at today's price). Thanks for your faith in us, Lorraine.

"I had a question about trailing stop loss, say I bought company XYZ at $10 a share, my trailing stop is 25% so if it goes down to $7.50 I sell. If it goes up 100% to $20.00 do I then sell it if it goes down 25% from there?

"You've helped me become more educated about the markets and how to make decision on my own and not just follow you or any of the so called 'experts' we see on CNBC!" – Paid-up subscriber David Watts

Goldsmith comment: As the stock you're holding rises in price, you should adjust your stops upward… It's called a trailing stop loss because it trails your position higher. So in your example, should the stock go to $20, you'd sell if it fell to $15 a share.

Regards,

Porter Stansberry
Baltimore, Maryland
February 7, 2014

The best way to own platinum today...

Editor's note: Yesterday, S&A Global Contrarian editor Kim Iskyan shared his "boots on the ground" experience in South Africa and Zimbabwe. While he was there, he saw firsthand the political instability and hotly debated race discussions. But he also discovered his favorite way to invest in platinum. In today's Digest Premium, Kim continues the discussion... and shares that platinum investment...

I (Kim Iskyan) believe there is a way to profit from the political instability in South Africa... And it has to do with platinum and palladium...

South Africa produces nearly three-quarters of the world's platinum and more than one-third of the world's palladium.

Most platinum and palladium production is mined. And getting a mine up and running requires enormous investment in infrastructure. You have to build roads to the mine and wire it for power. Miners also need a place to live while they're working the mine. Since setting up a mine is time-consuming and costly, once it's up and running, mining companies need a really good reason to shut it down.

That helps explain why today, the entire South African platinum and palladium mining industry is operating below its cost of capital. You see, the price of platinum and palladium has been too low for a long time... and costs have been rising, to the tune of 18% per year over the past five years.

And some mines are getting old, which means that miners have to go deeper into the earth... which is more costly and more dangerous. Meanwhile, labor unions in South Africa are getting more demanding... They want more money, and they're not about to let mining companies fire thousands of workers to cut costs. All of this means that a lot of mines are losing money.

And in an effort to cut costs, producers have been putting off making big capital investments into equipment and upkeep. Lonmin, for example, cut its capital-expenditures budget by around half, to $210 million a year. For the platinum industry in South Africa overall, deferred capital expenditures might be more than $5 billion.

Imagine if you put off replacing the roof of your house, fixing the broken bathroom faucet, upgrading the '70s-era furnace, and only had money to replace the microwave in your house. The value of your house would decline... and eventually, your house would be falling apart around you. That's what's happening to platinum and palladium mines in South Africa.

This can only continue for so long. Either the price of platinum and palladium has to rise, so that producers can cover their cost of capital... or production will be shut down because producers can no longer stand to lose money. These mining companies might also go bankrupt, as many smaller miners already have. If this happens, lower supply – particularly when demand is higher than supply – should spur the price upward.

And it's likely the recent decline in platinum and palladium production in South Africa will accelerate... creating an even bigger supply deficit. As we've seen, politics of race is eating away at South Africa's economy... and the mining sector is at the forefront of efforts to redistribute wealth. Platinum and palladium producers are hurting, and they're not going to be cut any slack by labor unions. But demand for platinum and palladium is continuing to grow. So at some point, decreased supply and strong demand will result in higher prices.

As the legendary resource investor Rick Rule told me, "If the price of something can go up and should go up... it probably will."

It could take a while for the prices of platinum and palladium to catch up with this dynamic... timing a sector bottom is always a tricky business. But I think a sharp rally in the two metals isn't far away.

One way to profit from the upcoming rally would be to go out and buy platinum and palladium bullion (or bars). It's not as easy as buying gold, but it's one option.

Personally, I prefer something easier to buy and hold... like the Sprott Physical Platinum & Palladium Trust (SPPP). It's a closed-end fund that holds physical platinum and palladium bullion (split 50/50 in dollar terms at inception).

Unlike an open-end fund, which issues new shares to investors, SPPP has a fixed number of shares... so the market price of the fund moves according to demand for the shares.

– Kim Iskyan

Editor's note: As regular Digest readers know, there aren't many bargains in U.S. stocks right now. That's why we're sending Kim across the world, relying on his extensive network of global contacts to discover the best international investing opportunities.

And today is the first day we're allowing people to subscribe to Kim's newsletter, the S&A Global Contrarian. To learn more about a subscription – and gain access to Kim's latest issue – click here. (You won't have to watch a long promotional video.)

The best way to own platinum today...

On a recent trip to Africa, S&A Global Contrarian editor Kim Iskyan saw firsthand the political instability and hotly debated race discussions.

He also learned about the continent's unbelievable opportunity in platinum. In today's Digest Premium, Kim reveals his favorite way to invest in the precious metal...

To continue reading, scroll down or click here.

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