He believes the housing sector and associated industries remain in a depression and that this is the reason employment has barely improved while most aspects of the US economy have seen strong gains recently.
However, he also firmly expects the housing market to recover "before long", simply due to demographics and the market system. When that day comes, Buffett thinks many people will be surprised just how far and how quickly unemployment drops.
Leading up to 2008, America simply built too many houses, but Buffett suggests this imbalance has already begun to reverse. He believes that many couples postpone marriage and children during uncertain times, which leads to fewer new households, but quips that eventually "hormones take over". He also points out that recessions see households "doubling up" to reduce costs. On this point, he notes that living with in-laws can quickly lose its allure.
Buffett is renowned for paying more attention to how much an investment earns for him, rather than what its share price is doing, and he has some interesting comments regarding one of Berkshire's newer holdings, IBM. Buffett is hoping the IBM share price languishes over the next few years. Although this seems counter-intuitive, his logic is simple. He believes that if you plan to buy shares in a company in the future, either with your own money or indirectly (as when a company you own is conducting a share buyback, as IBM is), you will benefit more if prices remain low.
His point is that periods of share price weakness are the long-term investor's friend, and that many companies continue to have very strong prospects over these weak periods, making them an even better investment during these times. Clearly, it is easier for a multi-billionaire to take this view, but perhaps six decades of investing experience makes it easier to see times of extreme volatility as great opportunities, rather than times to sit on the sidelines.
The thoughts and comments I find most interesting come at the end of the letter. Buffett breaks down the three basic investment choices people have and outlines his view on each.
The first is currency or money-based investments, including bonds, fixed interest and bank deposits. Generally considered the safest, Buffett believes these can be among the most dangerous of assets.
Although investors receive timely payments of interest and the repayment of their principal, the purchasing power of these investments often falls significantly over the long-term. Since 1965, when he took over management of Berkshire, the US dollar has fallen by a staggering 86 per cent in terms of its purchasing power. An investor would have needed to earn a 4.3 per cent annual return simply to maintain spending power.
He explains that over this period, US Treasury bills have returned 5.7 per cent a year, which sounds reasonable at first glance. However, when tax is deducted this return falls to 4.3 per cent, and this is quickly reduced to zero by the "invisible inflation tax".
Buffet admits that, at times, high interest rates compensate investors for this inflation risk. But at present, he believes interest rates do not even come close to offsetting these risks to purchasing power. He believes that "right now bonds should come with a warning label".
The second category contains those assets that will never actually produce anything, but are purchased in the hope that someone else will be willing to buy them in the future, such as gold. Gold is the investment of choice for people who fear other assets, especially traditional currency, which can be undermined by money printing and inflation.
Although Buffett clearly agrees that investors should be cautious of currency-based investments, he doesn't think gold is the solution. He believes that although it has some industrial and decorative use, this is limited and it will remain forever unproductive.
In his view, most gold buyers are motivated by the belief that more people will become fearful, increasing the pool of potential buyers and this additional buying enthusiasm will further validate the investment thesis for the believers. He cautions that as more investors join the bandwagon, they will create their own truth, but only "for a while".
He notes that the world's gold stock is about 170,000 tonnes, at current prices worth about US$9.6 trillion. He suggests that for this amount of money, he could own all of the farmland in the United States, as well as 16 Exxon Mobils (one of the world's largest and most profitable companies) and still have US$1 trillion leftover.
The third option, and unsurprisingly his clear preference, is to invest in productive assets. In selecting these, the key attribute he looks for is the ability to produce or deliver an output that will retain its purchasing power. He believes farms, property and good-quality companies like Coca-Cola and IBM meet this requirement.
Buffett argues that it doesn't matter whether a currency is based on the paper money we use today, gold or something else. If investments produce something useful, people will be forever willing to exchange what they themselves produce or earn for it. Because of this, investments in this third category will always be superior to non-productive or currency-based assets. He notes that more importantly, he believes that over any extended period of time it will be by far the safest.
Warren Buffett certainly has strong opinions and is very open about communicating them. Some would argue that he's too subjective, but when you're one of the top five richest people in the world you can probably be as opinionated and subjective as you like. Then again, he's much wealthier, more successful and more experienced than the rest of us, so maybe he does know a thing or two about investing.
Mark Lister is head of private wealth research at Craigs Investment Partners. His disclosure statement is available free of charge under his profile on www.craigsip.com. This column is general in nature and should not be regarded as specific investment advice.
