India holds key to Buffett gamble
Friday, February 6, 1998
By Eric Reguly
HAS superinvestor Warren Buffett, the latest convert to silver, met his match in India?
India has had a love affair with silver for centuries. Indian farmers use it as a store of value and jewelry makers buy it by the truck load. In 1996, Indian demand accounted for about 16 per cent of global demand and the 1997 figure (the final tally is not yet available) should be somewhat higher, according to the Gold and Silver Institute in Washington.
But Indian demand has been on the wane in recent months for the simple reason that the price has been climbing. A year ago, it traded on the spot market at about $5 (U.S.) an ounce. By yesterday, it had soared to about $7.50, putting it at the highest level since mid-1988. The driving force behind the rally was Mr. Buffett's disclosure on Tuesday that Berkshire Hathaway , his investment company, had made an estimated $700-million investment in silver. Berkshire controls almost 130 million ounces, a figure roughly equivalent to India's total annual consumption.
Mr. Buffett rarely gets things wrong and has a personal fortune worth more than $21-billion to prove it. His silver foray has paid off so far; the price has jumped by more than 50 per cent since he started buying in July. But some commodities experts believe he took an enormous risk by making such a big investment in a metal famous for its volatility.
In the short term, at least, it appears that prices are more likely to fall than rise. "The serious money is not buying now," said Doug Upton, head of commodities research at HSBC James Capel in London. "I think the price will come down pretty quickly."
India is the wild card. The country's silver purchases declined substantially in the fall, when the price began to rise. In effect, price shock made the Indian jewelry industry swap silver for gold, whose value was going in the opposite direction. "The Indian market is especially price-sensitive because they use silver for solid jewelry and the like as opposed to industrial uses," said Stewart Murray, managing director of Gold Fields Mineral Services, a consultancy in London.
By most accounts, Indian demand has fallen by half, to about five million ounces a month, since November. The question is whether demand will keep falling and, if so, at what point will the market reach a balance between supply and demand. Since 1990, global silver stocks have been diminishing, partly because Indian demand has been so robust.
The questions are not easy to answer because jewelry makers, for example, could shift their allegiances back to silver if the price of gold starts to climb sharply. The stream of silver extracted from scrap sources such as discarded photographic film also affects prices. Recycled supplies are notoriously hard to predict.
Nonetheless, it is hard to make a case for higher prices when Indian demand is collapsing. Mr. Buffett's exit strategy is not clear. He may be gambling that India's waning enthusiasm for silver will be short-lived and that the current price, although high by 1990s' standards, is still not strong enough to trigger a flurry of mine openings in Mexico, Peru and the United States, the three main silver producers. In the meantime, Berkshire can cover its silver financing costs by lending its holdings. Manufacturers often borrow silver with the expectation that prices will drop, allowing them to return it to the lender at a lower price.
Mr. Buffett is a long-term investor and there is no indication that he will change his strategy on the silver front. Berkshire said this week that it is neither a buyer nor seller of silver. Although stocks remain at record lows, some analysts believe high prices cannot be sustained in the long term.
One silver bear is Wiktor Bielski, the commodities analyst in the London office of Deutsche Morgan Grenfell. He believes that digital technology will eventually destroy the market for photographic film, which accounts for about one-third of the global demand for silver. Digital cameras dispense with film, allowing photographers to see pictures instantly and load them into computers, where they can be edited and sent across the Internet. (Consultant Mr. Murray disagrees, saying that digital cameras are expensive novelty items that show little sign of gaining broad appeal.)
In spite of all the uncertainty surrounding silver prices, Berkshire investors have remained loyal. The shares yesterday climbed to a high of $53,100 apiece, for a one-year total return of 50 per cent. To them, Mr. Buffett is infallible.
Investors, though, would be foolish to follow his lead by loading up on silver shares and bullion at current prices. The sage of Omaha himself would not recommend breaking his own tenet: "What the wise do in the beginning, fools do in the end." |
