CHAPTER 21
BUFFETT’S MANIPULATION?*
ON WEDNESDAY, JANUARY 14, 1998, ALMOST TEN YEARS AFTER THE Hunt case went to trial, the Wall Street Journal reported that the Commodity Futures Trading Commission had “increased surveillance in the silver futures market following allegations that several market participants were manipulating prices.”1 A price increase of almost 30% during November and December 1997, bringing the white metal to an 8½-year high of almost $6 an ounce, triggered the inquiry according to the Journal.2 A CFTC spokesperson said, “The Commission intensifies its surveillance efforts when unusual events or activities occur such as we’ve seen lately in silver markets.”3
The CFTC had good reason to suspect foul play. Unlike 1979 and 1980, when investors took refuge in gold and silver to protect against rising inflation and political unrest, the near-30% jump in silver during the last half of 1997 came with global stability and a decline in gold prices of more than 13%, making manipulation the prime suspect in silver’s resurgence.4 Chase Manhattan Bank’s head of commodity risk analysis, Dinsa Mehta, said, “One has to treat with suspicion an overt attempt to muscle the commodity higher.”5
A report in the Wall Street Journal that “silver stockpiles at Comex Warehouses dipped to … the lowest level since 1985” and rumors that “a lot of that silver has left the country” sounded like the Hunts were back in business.6 New York attorney Christopher Lovell revived names from that era by filing a lawsuit charging Phibro, the commodities trading arm of Travelers Insurance Company and originally the Philipp Brothers division of Engelhard In dustries, with moving silver from Comex warehouses to “non-reporting black hole locations” in England and elsewhere.7 The U.K. Guardian spiced the international scene with the headline, “Booming Silver Market ‘Rigged,’ ”8 and quoted a London bullion market trader, “It seems to us someone is doing something.” The Guardian reported that “both the Bank of England … and the London Bullion Market Association … are watching developments.”9
The mysterious “someone” emerged from behind the curtain on Tuesday, February 3, 1998, in a press release from Warren Buffett’s Berkshire Hathaway Company: “Because of recent price movements in the silver market and because Berkshire Hathaway has received inquiries about its ownership of the metal, the company is releasing certain information that it would normally have published next month in its annual report. The company owns 129,710,000 ounces of silver. Its first purchase was made on July 25, 1997, and its most recent purchase was made on January 12, 1998.”10
Buffett, at the time a spry sixty-eight-year-old with a white-hair comb-over, the most successful American investor in the second half of the twentieth century, suggested in the press release that he had completed accumulating the white metal: “Berkshire has no present plans for purchase or sale of silver.”11 The disclaimer failed to discourage speculators, who drove up silver prices by a significant 16% in two days following the Berkshire Hathaway announcement, reaching $7.59 per ounce, the highest in almost ten years.12 They had every reason to jump on the bandwagon. In less than six months Buffett had bought 25% of the world’s annual production of the white metal, a performance worthy of Nelson Bunker Hunt.13
Silver did not belong among Warren Buffett’s investments. He had led Berkshire Hathaway for more than thirty years, priding himself on picking companies that are “understandable, possess excellent economics, and are run by outstanding people,” qualities he examined as though he were considering a lifelong commitment.14 His investments lasted longer than most modern marriages. When Robert Goizueta, the CEO of Coca Cola, Berkshire’s largest holding in 1997, died in October, Buffett commented, “After his death, I read every one of the 100 letters and notes he had written me during the past nine years. Those messages could well serve as a guidebook for success in both business and life.”15 In discussing his acquisition of International Dairy Queen in 1997, he first gave some general information, “There are 5,792 Dairy Queen stores operating in 23 countries—all but a handful run by franchisees,” and then added a personal touch, saying that he and his partner Charlie Munger, vice-chairman of Berkshire Hathaway, “bring a modicum of product expertise to this transaction. [Charlie] has been patronizing the Dairy Queens in Cass Lake and Bemidji, Minnesota, for decades and I have been a regular in Omaha. We have put our money where our mouth is.”16 But Buffett would dismiss owning assets like precious metals that “will never produce anything, but that are purchased in the buyer’s hope that someone else … will pay more for them in the future.”17 His least favorite was gold, which he said would “remain lifeless forever.”18
FIGURE 20. Warren Buffett gives investments the taste test.
The CEO of Berkshire Hathaway gave silver a reprieve because the metal is a cross between precious and industrial, a store of wealth for millions, and productive in photography and electronics. It was also good to him early in his career, making his commitment personal as with Dairy Queen: “Thirty years ago [1967], I bought silver because I anticipated its demonetization … [and] ever since I have followed the metal’s fundamentals but not owned it.”19 He had been watching silver longer than Bunker Hunt and made it sound like a homecoming when disclosing this “non-traditional investment” in his 1997 letter to Berkshire Hathaway shareholders: “In a way, this is a return to the past for me.”
Buffett’s return began on Friday, July 25, 1997, when silver was $4.33 an ounce, and he proudly reported that by the end of the year the “position produced a pre-tax gain of $97.4 million.”20 He explained his reasons for the investment, which totaled about 2% of Berkshire Hathaway’s portfolio: “Charlie and I concluded that a higher price would be needed to establish equilibrium between supply and demand.” Buffett liked silver because annual consumption by industry outpaced mine production, the same fundamentals attracting the Hunts to silver rather than gold, but he quickly distanced himself from the fallen billionaires: “Inflation expectations … play no part in our calculation of silver’s value.” To just about everyone else, however, the price jump in the white metal brought back memories of a squeeze and inevitable comparisons to Bunker Hunt.
The day after Berkshire Hathaway disclosed its purchases the Washington Post told its readers that “Buffett has amassed the biggest silver position any single individual has accumulated since the Hunt brothers were accused of trying to corner the silver market in 1980.”21 The New York Times drew a distinction:22 “When the Hunts were accumulating their position, they and many investors believed that there was no way that rampant inflation could be checked. … Now, the opposite consensus prevails, with inflation deemed to be quiet and likely to stay that way.” But the Times then turned Warren Buffett into a Bunker Hunt look-alike by making the technical observation that “silver has recently traded in what is called backwardation.” The word “backwardation” means that silver for immediate delivery sells for a higher price than silver for delivery in the future, which is very unusual for a precious metal that incurs storage costs. The Times then explained that this strange phenomenon “reflects concerns about a possible squeeze on current supplies, and is an indication … that huge quantities of silver have been accumulated.” The Times should have reminded readers that the CFTC had used backwardation and related concepts to charge the Hunts with manipulation.23
Buffett tried to soften the squeeze by saying in the original press release: “If any seller should have trouble making timely delivery, Berkshire is willing to defer delivery for a reasonable period upon payment of a modest fee.”24 Looking back he claims that Berkshire Hathaway “intentionally avoided buying an amount beyond what was easily available for delivery” but the contemporaneous backwardation in silver indicates otherwise.25 Buffett owned a large stake in the Travelers Insurance Company and had used its commodities trading subsidiary, Phibro, to accumulate the white metal in London, draining Comex warehouses and adding to the perceived shortage.26 The Guardian explained:27 “Silver was heading for London to meet Mr. Buffett’s order and once there, it disappeared behind a veil of secrecy because London publishes no figures for the bullion in its vaults.” Switzerland had been the silent refuge for Hunt silver.
The Berkshire Hathaway press release of February 3, 1998, ended the CFTC’s investigation almost before it began, a testament to Buffett’s reputation for integrity and the slippery definition of manipulation.28 The commission’s annual report never mentioned Warren Buffett by name and summarized the incident like the weather bureau on a tropical disturbance: “Silver prices rose sharply from $4 to over $7 per ounce between July 1997 and February 1998. … The most significant concern was the demand for silver by the holder of a sizable position in London. … Subsequently, prices fell and spreads loosened as the market was able to provide sufficient supplies.”29 Christopher Lovell, the New York attorney who had sued Phibro for carrying out the manipulation, joined the CFTC on the sidelines and withdrew the complaint.30
The subjective nature of manipulation, which requires the intent to distort prices, eased Buffett’s treatment. Dennis A. Klejna, a lawyer who ran the CFTC’s Division of Enforcement when the agency prosecuted the Hunts, said, ‘‘It is very difficult to establish manipulation under the law, because there are very legitimate reasons for people to purchase large amounts of commodity futures contracts or large amounts of physical commodities.’’31 Buffett’s accumulation squeezed the silver market but proving manipulation by an individual investor requires testimony by a mind reader. The jury convicted the Hunts because they conspired with other traders, a violation of the antitrust laws, while Warren Buffett’s approach to investment abhors collusion. His success comes from being a contrarian, buying when everyone is selling, as explained in his 1997 letter to Berkshire Hathaway shareholders:32 “You pay a very high price … for a cheery consensus … pessimism drives down prices to truly attractive levels.” Buffett’s investment in silver fits this profile.
Berkshire Hathaway never disclosed the average cost per ounce of its white metal but the pretax profit of $97.4 million reported for 1997 permits an estimate of $5.05 for 111.2 million ounces bought in 1997.33 The remaining 18.5 million cost about $5.50.34 Buffett had bought a bargain and paid cash, so he could have held forever, as with his Coca Cola stock.35 But he became impatient and would scold himself: “I bought it very early and sold it very early.”36 Buffett missed the explosive advance that would soon challenge the Hunt era record of $50 an ounce.
*Warren Buffett refused to be interviewed for this discussion. He responded to one question by e-mail through his administrative assistant, as described in an endnote below.