It is always a delight to peruse Warren Buffet’s annual letter to the happy shareholders of Berkshire Hathaway (BRK/A), who I consider the greatest investment mind of our generation. Warren was pleased to report an increase in the book value of his holding company of 13%, versus a gain by the S&P 500 of 15.1%, including dividends. Since Berkshire started reporting results in this format in 1965, book value has risen by 490,409%, compared to only 6,262% for the S&P 500.

To show you how well Warren has performed, look at how the shares once owned by his son, Peter, have done. When Peter reached adulthood, dad gave him a small number of shares to do what he wanted with. Peter sold them immediately, and the proceeds were enough to buy some groovy sound equipment. Today, those shares are worth $86 million. Obviously, the apple does fall far from the tree.

Plowing through the 27 page opus, I found it chock full of great management insights and homespun homilies. They also include observations of the harsh realities of our world, like the fact that the big Wall Street Banks are nothing more than a school of hungry sharks. I’ll list the highlights below, and feed out the better quotes in my Quote of the Day section in future letters. For those interested in reading the full letter, as well as its predecessors going back to 1977, please click here for the letter.

• Berkshire’s $36 billion takeover of Burlington Northern Santa Fe a year ago has boosted is pretax earning power by an amazing 40%. The railroad has major cost and environmental advantages over trucking, consuming only a gallon of diesel fuel to move a ton of freight 500 miles. That is three times more efficient than trucking.
• The insurance “float”, the amount of money that it is holding on behalf of other companies, now totals $66 billion. The worst payout his companies ever had to endure was $3 billion in the wake of hurricane Katrina.
• Warren chronicles his 60 year relationship with insurance company GEICO, which began in 1951 when, as a 20 year old student at Columbia University, he pounded on the door at company headquarters after hours to obtain information. Some 25 years later, he bought a third of the company for $46 million, and the rest in 1996. Today, the good will alone is worth $14 billion. And here’s your free plug, Warren. I have been a happy user of GEICO’s services for decades and recommend them highly. For a free quote, call 1-800-847-7536.
• The breadth of Berkshire’s holdings is eye opening, cover 106 companies employing 250,000. They include See’s Candies, RV and boat building Forest River, shoemaker H.H. Brown, MidAmerican, the largest power utility in Iowa, fractional jet ownership company Netjets, and farm equipment maker CTB.
• Buffett expects a recovery in the housing market to begin in a year. He argues that home ownership makes sense for most Americans, particularly at today’s lower prices and bargain interest rates. In the meantime, his holdings in the area are suffering mightily, like John Manville, MiTek, Shaw, and Acme Brick. Earnings are a tiny fraction of their bubble peaks. I bet you didn’t know that Buffet control 47% of the US mobile home market through his investment in Clayton, and holds 200,804 of the mostly subprime mortgages on those structures.
• The best investment Buffet ever made was in two wedding rings. It is not clear if he is referring to their gold content, then pegged at $34/ounce, or the relationships that came with them.
• Warren favors stable, high dividend payers among his publicly listed holdings. They include household names like American Express (AXP), Coca-Cola (KO), Johnson & Johnson (JJ), Wal-Mart (WMT), and one of my favorites, Chinese electric car maker, BYD (BYDDF). He thinks his 6.8% holding of Wells Fargo (WFC) will restore its dividend once it gets Treasury permission to do so.
• Berkshire is holding $38 billion in cash earning money market yields close to zero which he does not expect to end soon. This is eating into returns, but he prefers to keep a large amount of dry powder to take advantage of future opportunities. This philosophy enabled Warren to put to work $15.6 billion during the 25 days the followed the Lehman Brothers bankruptcy in 2008. Preferred stock yielding 10% Buffet bought from Goldman Sachs (GS) and General Electric (GE) are prime examples.
• Buffet is still maintaining a massive short volatility position. During 2004-2008, he took in $4.8 billion in premium shorting naked 15 year puts on the S&P 500, believed to cluster around the 500 level. While Berkshire shareholders sweat bullets as we approached this strike during the crash, Warren was never worried. He is convinced that the Black-Scholes option pricing formula leads to “wildly inappropriate vales” when applied to long dated options. He’ll know for sure when these contracts expire in 2019, when he is 89.

Warren ends his letter by inviting all to his shareholders’ meeting in Omaha, Nebraska on April 30, which he characterizes as “the Woodstock of Capitalism.”

To read Warren Buffet’s fascinating autobiography, buy The Snowball by Alice Schroeder at a discounted price from Amazon by clicking here.

“Money will always flow towards opportunity, and there is an abundance of that in America….America’s best days lie ahead” said “Oracle of Omaha”, Warren Buffet, CEO and the largest shareholder in Berkshire Hathaway.

Entering 2011 as the currency that everyone loved to hate, the Euro has staged a dramatic comeback, much to the chagrin of hedge fund managers and traders alike. Since January, the troubled currency has rallied ten cents from $1.28 to $1.38. Is this the beginning of something big? Or has it shot its wad and headed for a spill?

I vote for the later. The euro is essentially winning the best deck chair on the Titanic contest, the fastest horse at the glue factory, and the prettiest girl at the ugly ball. It’s really all about interest rate differentials. At the end of last year, the US economy was growing gangbusters, while Europe was in intensive care. That sent medium and long term American interest rates skyward, while those in Europe languished.

Now the tables have turned. High oil prices are starting to act as a drag on the US, causing economists to rapidly pare back forecasts. Treasury bonds have come back from the dead, bringing the yield on the ten year from 4.70% down to 4.4%. In the meantime, European Central Bank officials have been jawboning the Euro up, threatening interest rate hikes to deal with imagined inflation, no matter that such a policy would be insane to pursue. Hence, we are seeing Euro strength and dollar weakness.

There is another wrinkle to the Euro story here. You would think that high oil prices would be Euro negative, as the continent is a massive importer from that troubled part of the world. But what do Arabs do with the dollars they get for this oil? They buy Euros in order to keep their reserves in a diversified spread. That is why the lurch in crude to $112 in Europe was accompanied by the Euro move to $1.38. This is why the traditional flight to safety bid for the dollar failed to show this time, as it has in all previous oil crises. Some of this spill over buying also explains why the Japanese yen has recently been strong, holding on to the ¥81 handle, despite its dismal fundamentals.

How does this party end? US stocks rally once again, US bonds tank, and oil takes a rest, falling well back into the nineties. That could then take the Euro back down to the bottom of its ten dent trading range. A put on the Euro has become a de facto call on US stocks. That’s when we test the lower end of the European currency’s recent trading range.

This Party Will Not End Well for the Euro

“He who lives upon hope will die fasting,” said Benjamin Franklin.

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Having started using the services of The Mad Hedge Fund Trader in 2009, I went from having a -6% return in 2008 to a +17% return in 2009, much of which I put down to your specific recommendations.

Your insights and analysis are often way ahead of the pack, and it is clear that you have an extensive network of invaluable contacts from a career spanning many years across various fields. I have found your calls on commodities and currencies to have been the most accurate. Thankfully your ego does not prevent you from admitting when on the odd occasion you have got it wrong, a rarity in this era.

Your style of writing is easy to understand, cleverly expressed and often full of wit and irony. The addition of Hedge Fund Radio has also been a welcome bonus to your website. Your newsletter is always the first I read out of a select few.

John
Tokyo, Japan

“It’s “both-and”, it’s not “either-or” when it comes to energy sources in the United States….We should give both the Democrats and the Republicans everything they want when it comes to energy supplies…. High energy prices stifle economic creation,” said John Hofmeister, former president and CEO of the US operations of Shell Oil, and author of Why We Hate the Oil Companies.

EconomistS are furiously downsizing their economic growth forecasts for 2011 in the wake of the oil price spike, both for the US and for the world at large. Since last week, West Texas crude prices have soared $12 from $86 to $98. Each $1 increase in the price of oil jumps gasoline prices by 2.5 cents. Each one cent rise in the cost of gasoline takes $1 billion out of the pockets of consumers.

If oil stays at this price, it removes $30 billion from the pockets of consumers. At $110/barrel, it short changes them by $60 billion, or 4.1% of GDP. Subtract this out from even the most optimistic GDP forecasts for this year, and you end up with negative numbers. That, my friends, is what they call a recession. If you wonder why hedge fund managers have lurched into an aggressive ‘RISK OFF’ mode, are throwing their babies out with the bathwater, and why the volatility index is spiking to three month highs, this is why.