I have long been nauseated by the hagiography surrounding Warren Buffett. The veneration of St. Warren has reached a peak of late, as he is Obama’s go to guru, providing protection against accusations that the president is anti-business, and giving cover to Obama’s plans to jack up taxes on the wealthy. After all, if a man richer than God is on your side, how can you possibly be a class warrior?
My cynicism about the saintly Buffett dates from almost exactly 14 years ago. There is substantial evidence that in February, 1998, Buffett cornered the silver market.
I repeat: there is substantial evidence that Warren Buffett cornered the silver market. Cornered, as in manipulated.
Yes, Saint Warren was almost certainly a manipulator.
The story in a broad outline. Beginning on 25 July, 1997, Buffett began to accumulate large quantities of silver via Phibro, a subsidiary of Salomon Brothers, an investment bank in which Buffett had a big stake, and which he had saved from extinction when Salomon traders cornered the Two Year Treasury note market in 1991. He eventually acquired nearly 130 million ounces of silver.
He stood for big deliveries in February, 1998. The market went nuts. All of the inidicia of a corner were present. Nearby prices skyrocketed relative to prices for delivery in the spring. The following chart depicts the spread between the March, 1998 COMEX silver price, and the prices for May and July.
Note that the spread blows out when Buffett stood for delivery, during the first week of February, with the March-July spread going from -.2 cents/oz on 1/29/98 to 20 cents/oz on 2/5/98. The March 98 price went up a dizzying $1.25/oz (about 20 percent) during that week.
The loco London lease market for silver also showed acute signs of a squeeze. (The lease rate is the cost of borrowing metal. If you need silver in a hurry to make delivery, you are willing to pay a big premium for nearby delivery, that is, you are willing to pay a lot to borrow/lease silver. Formally, the forward price of silver is the spot price times one plus the interest rate minus the lease rate. If the lease rate is very high, the forward price will be below the spot price: that is, the market is in backwardation.)
This depicts the one month lease rate for silver. Note it skyrocketing right around the time of the deliveries. In early February, the lease rate was quoted as much as 75 percent annualized (some press reports say 80 percent).
There were physical distortions characteristic of a squeeze. People around the world scrambled to get silver and transport it to London–often by plane. The silver market in India, a major consumer, almost shut down:
But in the past two months, work at the refinery has slowed–because of one man half a world away. Until a few days ago, most Indians had never heard of Warren Buffett. They even say his name wrong, confusing it with buffet. No matter. Since last October, when Buffett began buying silver, imports into India have nearly stalled as Indians decided that the metal costs too much. Today, more and more Indians are selling their dishes and jewelry made of silver, which now fetches $7.25 an ounce, 20% above the normal $6. That makes for an interesting match-up: 960 million Indian sellers vs. one billionaire buyer from Omaha. “Tell [Buffett] he can’t last,” thunders dealer and refiner Mukul Sonawala. “Indians say the price is too high. They’re saying: `Mr. Buffett, have your buffet, we’ll wait till the price drops. Good-bye.”‘
There were backlogs processing the silver flooding into London: the official weighers couldn’t keep up. The London Bullion Market Association responded to the bottleneck by extending the normal 5 day delivery period to 15 days.
There was plenty of silver in New York, but Buffett didn’t buy it there, even though it was cheaper there (more on this below). Instead, silver was shipped from NY to London, by airfreight(!) mainly, where it had to be re-assayed because the assay marks were from a firm no longer in existence. This created yet another bottleneck.
As soon as the deliveries were completed, prices, spreads and lease rates collapsed: by 27 February, the London price had fallen 22.5 percent off its peak, and lease rates were down to where they’d been before the frenzy began in the immediate aftermath of a Buffett press release (see below). These price and price relation changes are also symptomatic of a corner. They are the manifestations of what is often referred to as “burying the corpse”–a phrase I’ve been accused of coining.*
What did Buffett have to say? This (on February 3, 1998):
During 1998, Berkshire has accepted delivery of 87,510,000 ounces in accordance with the terms of the purchase contracts and the remaining contracts for 42,200,000 ounces call for delivery at varied dates until March 6, 1998. To date, all deliveries have been made on schedule. 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.
Over 30 years ago, Warren Buffett, CEO of Berkshire Hathaway, made his first purchase of silver in anticipation of the metal’s demonetization by the U.S. Government. Since that time he has followed silver’s fundamentals but no entity he manages has owned it. In recent years, widely-published reports have shown that bullion inventories have fallen very materially, because of an excess of user-demand over mine production and reclamation. Therefore, last summer Mr. Buffett and Mr. Munger, Vice Chairman of Berkshire, concluded that equilibrium between supply and demand was only likely to be established by a somewhat higher price.
On which I call Bull!
If it was a long term investment, why did Buffett take delivery at a huge premium over deferred prices? If he was betting on the long term fundamentals, why not sell nearby silver at its huge premium, and buy silver at a much lower price for delivery in July, say? If he was right about the fundamentals, the July price would rise as the “equilibrium [was] established.”
Taking delivery at a premium price was actually foolish, if long term investment was the actual goal. Buffett paid a premium of about 45 cents/oz to get silver in early-February. He was buying high and selling low. If he wasn’t manipulating, and his trading wasn’t causing the price distortions, he could have sold spot silver, bought silver for delivery in a month, and picked up 45 cents/oz by doing so (instead of standing for delivery). Warren Buffett did not get that rich by being that stupid. No, the evidence clearly shows he had another, very short-term objective in mind.
Put differently, if Buffett had been acting purely as a long term investor, why would he have needed people around the world–as far away as India–to scrape up all the silver they could find, put it on planes, fly it to London to get in the customs queue to be delivered in a five day window (later extended to 15 days)? Why did Mr. Long Term need silver on those 5 (15) days? What was the big hurry, if he was taking the long view?
And why did he need it in London? This chart depicts the difference between the London silver fix and the COMEX March futures price. Note the spike when Buffet was taking deliveries in early February. At the margin, he paid a premium of 56 cents/oz–representing almost 8 percent of the NY price–to get silver in London in early February rather than getting it in NY. Note too that the premium crashed after the bottleneck cleared.
The answer to these questions: demanding delivery in a short time window in a single location had nothing to do with a long term view on silver. It was a corner, pure and simple, exploiting the frictions involved in bringing large quantities of silver to London on short notice. That made it very costly to deliver, allowing Buffett to loan out silver very profitably at the inflated lease rate. He created an artificial shortage, and likely profited accordingly. An investor acquiring silver based on a long-term view would attempt to minimize cost by purchasing in the cheapest locations and dates. Buffett bought a lot of silver at the most expensive location and the most expensive date.
And note well the little insult that Buffett added to economic injury:
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.
A reasonable period. A modest fee. How saintly. Note well again: the market rate for deferring delivery by as little a month was as high as 75 percent on an annualized basis. In dollar terms, about 45 cents/oz (6 percent of the price) to defer delivery by one month. Does that sound “modest” to you? Not to me. Does it sound like the actions of a purely long term investor, who shouldn’t need to get the silver RIGHT NOW? Couldn’t a long term investor wait a month? Wouldn’t a long term investor want to buy at the cheapest location, not the most expensive?
The lease rate tells you exactly what that “modest fee” was. Deferring delivery for one month cost 75 percent annualized–over 6 percent per month. That’s not even that modest for loan sharks.
No, the market showed acute signs of shortage, and that shortage had one cause: Buffett standing for huge deliveries.
So keep this in mind when you hear Buffett praised to the heavens. He is more than willing to play smash mouth to add to his fortune. He is also very willing to lie about it, and to claim sanctimoniously that he is doing those he is smashing a favor.
That doesn’t sound too saintly to me.
* I wish. Actually, the phrase originates with P. D. Armour, a famous Chicago grain and meat magnate in the 19th and early-20th centuries. (You might have had Armour chili–same company.) He was asked whether it was easy to corner the market. He responded that it was like a murder: ” to commit murder is very simple, the trouble is to bury the corpse”, the corpse being the excessive quantities of the commodity delivered to the market, that the cornerer had to unload later at a loss.