On Mistakes Admitted

“Expensively purchased knowledge should help us avoid future errors.”

Bruce Berkowitz, Fairholme Funds

Something special happened in the last Markel conference call. Something that rarely happens in a corporate sponsored conference call: humor. Not just humor, but humor on mistakes.

In the first quarter, Markel’s total investment return was negative .3% (+.9% on fixed income and -5.4% for equity). That’s not very bad considering most other insurance investment returns were disappointing. Even more interesting, the Current allocation to equities stood at lower than normal 66% of stockholders equity. Typical exposure is 80%. Lowest ever? In 2000, at 50%.

This is a number I will be paying a great deal of attention to going forward. After about 3 years of getting to know the company, it’s finally on my radar. At times, it felt like an opportunity lost. It was always on the watch-list and I always admired the company. In fact, I would say they are in the top 5% at doing what they do.

Here’s what Mr. Berkowitz had to say about Markel, “The company’s accounting is conservative and management has a record of generating excellent returns for owners…compensation to employees is fair and management spends significant time discussing past mistakes and future risks when communicating to shareholders.”

Here’s what Markel has to say about themselves. In every annual report, at the very beginning you will see the “Corporate Profile” it states:

“Markel Corporation markets and underwrites specialty insurance products and programs to a variety of niche markets. In each of these markets , we seek to provide quality products and excellent customer service so that we can be a market leader. Our financial goals are to earn consistent underwriting profits and superior investment returns to build shareholder value.”

Sure seems to satisfy the Fairholme insurance investment checklist.

After the “Corporate Profile” you will see a section titled “The Markel Style.” After reading it, you want to own a piece of this wonderful business, immediately. It states:

“Market has a commitment to Success. We believe in hard work and a zealous pursuit of excellence while keeping a sense of humor. Our creed is honesty and fairness in all our dealings”

“The Market was is to seek to be a market leader in each of our pursuits. We seek to know our customers’ needs and to provide our customers with quality products and service.”

“Our pledge to our shareholders is that we will build the financial value of our Company. We respect our relationship with our suppliers and have a commitment to our communities.”

“We are encouraged to look for a better way to do things…to challenge management. We have the ability to make decisions or alter a course quickly. The Markel approach is one of spontaneity and flexibility. This requires a respect for authority but a disdain of bureaucracy.”

“At Markel, we hold the individual’s right to self-determination in the highest light, providing an atmosphere in which people can reach their personal potential . Being results oriented, we are willing to put aside individual concerns in the spirit of teamwork to achieve success.”

“Above all, we enjoy what we are doing. There is excitement at Markel, one that comes from innovating, creating, striving for a better way, sharing success with others…winning.”

If Markel was a brand of toothpaste, Dentist would be out of business, If it was an engine, you would never need an oil change. And if it was a significant other, you’d be marrying up no matter what your financial situation was.

If you don’t believe in owning a business with a partner who has a commitment to success, a sense of humor, who is honest and fair, respecting of customers and always looking to improve. You have problems, and I can help, send me an e-mail and I will find the closest mental institute.

Rewinding back to the beginning of this post, regarding the conference call and why it was special.

Mr. Tom Gayner, the Chief Investment Office at Markel found humor, in a good way.

Here are a couple of quotes:

-“We are in a number of wonderful businesses at attractive prices.”

-“We have chosen to participate in this worldwide growth through companies with intangible brand values, manufacturing networks, and intellectual expertise.”

-“Our goal is always to have reserves established at a level that is more likely to prove to be redundant and deficient”

-On Reserves “Imprecise science.”

-Meyer Shields, Stifel Niicolaus “I guess, Tom, I know verly little about analyzing banks, but I would think…”

-Tom Gayner, “It turns out so do I, but go ahead with your question.”

-“Well clearly, when you make mistakes, you need to admit it, recognized it, and figure out what you can learn from it and move on.”

-“We are at an unusual time in the markets where the highest quality things that you have the highest degree of confidence in are also selling at bargain prices.”

-“There’s more capital in the P-C industry than there are premium opportunities.”

-“We are managing the business as if they are not going to change quickly.”

-“Our underwriters, with the help of our actuaries, have a keen understanding of where we drive that line in the sand and we just simply don’t go past that point. And consequently we’ve lost some premium volume because of it.”

I mentioned last week that I had written this weeks post already, because I don't think I will get a chance to purchase Markel at book, I had talked myself into 1.25X. I have not yet purchased the equity in question, but it is getting close...

Here are a couple links worth looking at:

-On Moral Hazard

-Anyone that attended the Berkshire Annual should recognize this lighthearted British humor that was shown to shareholders before the meeting started.

-Finally, a person in the blogosphere is in the process of painting the value worlds Sistine Chapel. I will be paying very close attention to this over the coming weeks and months as well as take part in the discussion.

-Lastly the obituary of Mr. Templeton. While your presence will be lost, your ideas and thoughts will not.

In the meantime, take care. Not sure what I will write about next week and that's where the fun begins. If you have any ideas, I'm all ears.

Regards,

S.K.

Worse Than Ours

“At least 95% of the insurance business in the world are worse than ours.”
Charlie Munger, Wesco Annual 2008

That is a remarkable statement coming from a person with an even more remarkable reputation. Whether it is or isn’t true, the statement stands on it’s own for the sheer reason of bluntness. Not to suggest it isn’t true, in fact it may very well be an accurate assessment.

Sure would be great to be invested alongside the top 5%, or even the top 10%.

If you haven’t had the time or chance to read the Fairholme annual letters, you should. They are short and to the point. You could read all within a 2-hour time period and in the end, you will feel smarter. Mr. Berkowitz’ record is astounding in relative and absolute terms. Further, their intimate knowledge of the insurance business allows the ambitious Intelligent Investor to understand in layman terms what to look for.

For example: “Property and Casualty companies have three ways to make money: 1) Underwriting Profit, 2) Investment income (Equities and Bonds-but mostly bonds), and 3) Investment Appreciation (Mostly Equities).” (Parenthesis mine)

Because with “The right management, these streams can generate a torrent of free cash flow.”

Part of a great investment thesis is not the stream of information from one direction, but from multiple sources. Relying on what makes sense (to you!), and making a purchase at prices you feel comfortable based on your appraised value of the business. In the value investment world, relying on different models is attributed to Mr. Munger.

In 2000, 50% of Fairholme fund was in Property and Casualty businesses. Why? Because “Such company have earned 20% returns on Book, and we paid near book.” (Emphasis mine)

During Fairholme funds existence, they have purchased Markel, Alleghany, Berkshire, and a couple of others. With insurance, the triple waterfall that comes from: “1) Improving underwriting results, 2) Growing Float, and 3) the Redeployment of capital from low to high return investments” makes for a great investment model.

Putting 2 and 2 together, and searching for the 5% of insurance businesses that have the same model as Berkshire, the focus on underwriting profit, investment income and capital appreciation is pretty hard. This insurance industry and the three factors mentioned by the folks at Fairholme doesn’t happen in syllogism fashion in the insurance industry. You can find an insurance company that underwrites profitably, but doesn’t have the investment acumen to find solace in the latter two. In which case, you are with the other 95% of insurance business worse than Berkshire.

So be careful. Be strict with these guidelines. They are only qualitative factors and with the right checklist, you can easily scratch off a potential insurance investment in less than 24 hours.

Comment on Comment

I devoting a new section to comments posted on specific posts for two reasons:

1. Sometimes very good points are made that other readers may be interested to know, and
2. If a reader dedicates a portion of his time to read something of interest to me, the least I could do is make note of it.

Last week, a reader asked if I have made any recent purchases in ORH. I have not, most recently I’ve been a consistent Fairfax buyer. All in all, about three months ago ORH was 3X more than FFH, within the last 2 months, FFH is now 1.5X ORH position. At the same time, not one share of ORH has been sold. The decision to sell other positions to raise cash to subsequently purchase FFH was all too simple.

I’ve already penned next weeks post and with lower market appraisals, it may be perfectly timed.

Until then, take care.

Buyers Delight

Good to be back and dusting off the keypad to write again feels pretty good. My grammar may be a little off, but writing a post is the equivalent of a grammar jog.

I have to say, my Seven-One Insurance Cherry was popped recently and with increased work assignments, blogging became "Cleaning out the Garage" type of work. For that, I sincerely apologize.

Now onto more topics of substance and less self-sorrow.

Insurance businesses are Cheap. Not just cheap, but utterly cheap. From a long-term perspective, you have to love the prices offered for certain insurance businesses. And make no mistake, this is not an endorsement for the plain-vanilla shops like XL or AIG, readers of this blog can use the search function to understand my distaste on the two.

As we look back 3-years ago, XL had a market cap of 10.4B and at 1.34 P/Book and AIG has a market cap of 142B and a P/Book of 1.77- my have the mighty fallen.

Today, AIG has a market cap of 65B and .84 P/Book, making comparisons worse, XL has a market cap of 3.56B and .41 P/Book.

Some vulture buyers in the insurance industry are about to go on a feast soon. The best part is some of these blood-smelling sharks are flush with cash and are trading at book. Cost of capital is the oxygen to an insurance business, with swift credit rating downgrades, cost of capital has the same type of damage as pulling a boat on a Miata. Even better, it's not insurance losses that is destroying the cost of capital structure, it is their investment portfolios. Which means, most insurance company's with valuable franchises are very much profitable as stand-alone shops.

Usually, the vulture buyers buy an under performing insurance franchise/sub because of their belief that having the right management could turnaround the operations. With the most recent investment portfolio problems of certain company's, some profitable insurance franchises look rather unprofitable.

Take for example, Alleghany Corp. (Y), last Monday a purchase was made in the unknown-untold-unreported section, Allied made a purchase for Darwin Professional. Alleghany owns 55% equity position in Darwin worth approximately 300million based on the Allied purchase price. The terms were fair (P/Book 2) and in a market where a bird in a hand is worth two in the bushes, I was pleased to see Alleghany with extra bullets.

These guys were purchasing Burlington Northern in the teen's and have started to sell their position in the last two years. The chances of Alleghany making an imprudent capital allocation decision are low. Not zero, just low. They were already well capitalized and based on the Darwin sell, now over-capitalized in a market full of purchase potential. Needless to say, the 55% Darwin position at the beginning of the year was a little more that 45% less than the 300million Alleghany will receive once the deal closes.

Another reason why I have a favorable view of Alleghany is the tax/shareholder friendly dividend. For every 50 shares you own, you get 1 share. Wall Street doesn't know anything about Alleghany conference calls, management doesn't like them. And our other friend Uncle Sam, the worst capital allocating pseudo hedge fund doesn't need to know.

With that in mind, I think you have to evaluate and make your own decisions based on what works best for you. Alleghany makes a lot of sense to me and most recently I've increased my position. There's a funny story actually, a few weeks ago, I was talking to a friend about how I missed a fat-pitch. Earlier this year, I purchased a 1/10th position at 340. For four months, I wasn't willing to pay a higher price than my estimated book value (345) at the time. Why?

Simply because valuable insurance franchises with equity centered investment portfolios and outstanding qualified management at book is a damn good deal.

Take for example the paragraph you see when you go to the company website:

"Alleghany's objective is to create stockholder value through the ownership and management of a small group of operating businesses and investments, anchored by a core position in property and casualty insurance. Alleghany is managed by a select company staff which seeks out attractive investment opportunities, delegates responsibilities to competent and motivated managers, defines risk parameters, sets management goals for its operating businesses, ensures that managers are provided with incentives to meet these goals, and monitors their progress.

The operating businesses function in an entrepreneurial climate as quasi-autonomous enterprises.

Conservatism dominates Alleghany's management philosophy. Alleghany's philosophy shuns investment fads and fashions in favor of acquiring relatively few interests in basic financial and industrial enterprises that offer the potential to deliver long-term value to the investor."
(Emphasis mine)

If that statement doesn't peak your interest in any way, I'm sorry to have disappointed you.

I don't think there is a 50% margin of safety here, however I also don't think there is zero margin of safety. Once they report their latest results, I'm all ears.

That's it for today. Next week, I'll take a shot at looking over some highlighting/underlining marks I made for the most recently reported numbers by insurance company's (of interest).

Until then, hopefully everyone had a safe 4th of July weekend. We live in a great country. Although I'm not the owner of patriotic boxers, I share with you a story that rings loud to the great tradition of this country.

I moved to the states at the age of 7 from overseas. My first language was Farsi, some now confuse Farsi being my second language. In fifth-grade, one morning, after saying the Pledge, my teacher asked me to stand up.

When I did, I was asked: "Are you a citizen?"
The answer at the time: "No"
Next question was: "Do you have a green card?"
Again, the answer was: "No"

My teacher then proceeded onto making a comment I have come to love and respect throughout the years: "Well Shahin, every morning you are the first one stand up for the pledge, and I respect that very much."

Fast forward to now, and I share a great affection for this country and the people whom have greeted me with open arms.


And so it goes, we live in a great country. Happy 4th.


S.K.

Back Soon!

Evening,

I am still alive and well. Thank you for your e-mails! Unfortunately, this is the time of the year when our business unit is busy for the 7/1 renewals, too much insurance! Worst part is this is also the time of the year for new annual reports, and quarterly cc's from company's of interest. Never thought a blog would take a life of it's own, I was wrong.

During this time, I did attend the Berkshire Annual and a weekend trip to Lost Wages. All in all, it has been eventful to say the least.

Hopefully I can find time for some posts starting next weekend.

Thank you,

S.K.

Three Wise Guys, Making Money from Desperate Crack-heads

“Too much of a good thing can be Wonderful.”

-Mae West

Depends who you are, if you are a crack head, too much of a good thing (crack) can be wonderful in the short-term, and if you are a business partner of the three wise guys (FFH, ORH, NB.TO), too much of a good thing (increased position) can be wonderful in the long term.

The reference to crack-heads is actually to the whole financial institution spectrum that the Three Wise Guys profit from through their CDS portfolio. Why so harsh? Not a day goes by where so and so institution doesn’t get capital infusion from foreigners, and they don’t do it because they are sincere, they do it at the cost of massive dilution. So just as how crack-heads and druggies need one last high before they are “sobered up or quit” (so they say!) and willing to sell valuables (family jewels) to pawn shops (foreigners) at dirt cheap prices, which the pawn shop will gladly buy and resell at a higher price later on in the future, the Three Wise Guys profit.

So go to your local bar and order the drink Three Wise Guys to start the night, it is composed of:

Johnnie Walker® Scotch whisky (Fairfax)
Jim Beam® bourbon whiskey (Northbridge)
Jack Daniel's® Tennessee whiskey (Odyssey)

Just a rundown on FFH, NB.TO, and ORH, I have been meaning to do this for a while, thanks to a rolled ankle from playing basketball, I can afford to now…

Fairfax 2007 Results were the best in 22 year history, 1.1 billion after tax, Book value increased by 49% to 230 (Currently I think it’s at least in the 260-270 range. 2007 Combined Ratio was 94%, 2006 CR was 95.5%. No CDO’s, or ABS, 80% hedge of equity portfolio.

-Refinanced common debt to 2017 maturity, resulting in lower interest rate. Consolidated debt to capital ratio to 27%, net-debt to net capital to 17%.

-Counterparty include 3 large international banks. For year 2007, sold 1 billion notional value for 199 million, cost of 25 million, profit of 174 million. In accounting terms, realized 185 million!

-From January 1- February 15, sold an additional 2.7 billion notional value for 651 million, realized gain of 591 million, cost of 60 million.

-Purchased an additional 2.2 bilion notional value for 51 million. Now totals 18 billion notional value. Value had increased by 596 million since the end of 2007.

-If Q1 ended Feb. 15, total gain of 747 million (150 on contracts sold, 596 increase in market value.) As of February 15^th, maket value of 18 billion notional was 1.3 billion. In summary, sold 3.7 billion for 850 million approximately 10 times original cost of 85 million and more than two times total cost of all CDS contracts ever bought.

-Not only has Mr. Watsa recouped total cost of the CDS portfolio, in effect he has a total 100% gain, even if all the remaining contracts expire. Further, they continue to be protected from a 1 in 50, and 1 in 100 storm in financial markets. I’m not a historian, but if now is a 1 in 50 storm, rest assured; Mr. Watsa has 10 people carrying bags to the right side of the balance sheet. Cumulative investment gain of over 5.5 billion since 1986.

-Fourth quarter earnings of 563 million were outstanding, but that’s more attributable to a relatively disaster-free year. 4Q07 underwriting profit was down 39% YOY, and that’s fine, if business is not profitable why be the village idiot, let AIG play their role.

-Fairfax also noted, “Deterioration in rates and pricing, intense competition for accounts, renewals and new business.” Again, this isn’t a surprise, astute readers of the Utterly Unknowable have noted this price deterioration when we chronicled the reports of 15 or so PnC insurers.

Now for the Subs:

For Odyssey,

-“Underwriting pricing is dropping, costs are going up. Property Cat- pricing continues to subside, remains relatively attractive…Primary level is more severe, Surety continues to perform very well.”

-“Picked up several new accounts in Europe.”

“In London, reinsurance for 1/1 is competitive, rate down 5%.”

-“Medical malpractice at Asian marketplace and Asian marketplace have been growing.”

-“May see net premium in 2008 decline up-to 10%. Competition on renewal will increase, margins will compress.”

-Net income, 4Q07 243 million (3.48 per share), 4Q06 84 million (1.16 per share)

-Operating Income, 4Q07 59 million (.85 per share), 4Q06 65 million (.91 per share)

-Combined Ratio (Quarterly), 4Q07 93.7%, 4Q06 94.8%

-Combined Ratio (Annual), FY07 95.5%, FY06 94.4%

-2007 underwriting profit of 94.7 million, versus 2006 underwriting profit of 77 million.

-Gross Written Premium was down 2%, In America down 10%, London up 3%

-Premium Composition 52% U.S., 48% international

-Business Composition, Casualty 53%, Reinsurance 68% of total.

Regional

-Euro-Asia, Gross Premium Written up 3%, CR of 81.5%

-London, Gross Premium Written up 26%, CR of 38.5% (49.2% of favorable development)

Losses?

-30 million- Flood in Tabasco

-10 million for potential D&O subprime losses

-Asbestos survival ratio reserving 10.7 years

AM Best estimate for Combined Ratio for the reinsurance line was 95%, ORH notched a spectacular 95.5%

Why spectacular? Because rating bureaus always underestimate true market vibes.

Investments

- Investment Result of 595 million in 2007, 507 million in 2006.

-CDS, rise in value when credit spreads widen

-As of Dec 31^st, carrying value was 308 million, up from 130 million as of Sep. 30, 2007

-Notional Value of 5 billion, term to maturity 3.6 years.

-In 1Q08 up to Feb 15^th, sold an additional 670 million notional for 161 million

-Remaining- total earnings thus far have benefited by 179,4 million, carrying value of CDS portfolio was 327 million.

Finances

-Debt to Capital 16%

-Purchased 770,000 shares or 1.1% of outstanding for 28 million, since Sep. 30^th

-Full Year- 2.6 million (3.7% of outstanding) for 94 million

-Since Dec. 31, 2007 to February 21, 2008- Purchased an additional 329,000 shares

-Total 3 million at cost of 109 million (36.33 average)

-91 million dollars remaining,

Economic Interest

-26% economic interest in Fairfax Asia

-6.5% share of ICICI Lombard

Book value of 36.78, up 31% for the year, in the 4^th quarter 12% or 3.87 per share

Since 2001, grown book value at 20%

For Crum & Forester,

Best’s estimate was 94% and C & F bested that with 93.5%. 2007 underwriting profit of 77 million, 86 million in 2006. Gross written premium was down 7%, and net premium written down 8%. Net Earnings of 293 million in 2007, 312 million in 2006.

For Northbridge, Canada’s leading Commercial insurance group

-Underwriting profit of 78 million in 2007, 20.5 million in 2006. There was some “Frequency and some severity in its Commonwealth and its Markel books.”

-2007 combined ratio of 92.3.

-Net earnings grew to 295 million in 2007, 167 million in 2006

-1.7 billion of premiums written across the four company’s (Lombard, Markel, Federated, and Commonwealth)

-Net investment income was 89.9 million

-Shareholder equity rose to 1.42 billion

Across 4 company’s:

-Lombards- CR 93.7% for 2007, 90.1% in 2006

-Growth in specialty

-YOY decline in underwriting profit because of increased frequency

-Favorable reserve development contributed to about 18 million underwriting profit

-Markel- CR 95.2 % in 2007, 91.2 in 2006

-Net premium written down 15% YOY

-Competition in mid to large accounts

-15.5 million benefit from favorable exchange movement on U.S. Claims

-Long haul trucking, “returing to the darker days of the last stock markets.”

-Federated- CR 94.1% in 2007

-Premiums written flat

-Common Wealth- CR of 77% in 2007, 153.7% in 2007

-Underwriting profit favorable development of 31.3 million

-Book value of 28.59 (22.89 in 2006), up 25% for the year.

-Investments

-Carrying value of investments of 3.3 billion, 2.9 billion in 2006

-Includes (+136 million in CDS gains, +100 million in Hub Gain, +12 million improvement on short sales of S&P, -23 million write down, -21 million in foreign exchange loss)

-Already 85 million in gains on CDS in 2008

-26% in cash and shore term, 54% in government

-Buybacks

-30 million for 840,000 (35.71 average)

-Allow repurchase of 2.5 million shares before Nov. 5 2008 (watch this date! Why? Well because Northbridge averages a little over 92k shares a day, if they wanted to take advantage of the full 2.5 million share buyback, that would take 27 full days of NB.TO being the only buyer of stock, obviously that’s not going to happen…here’s the perfect scenario, for the stock to go down, average 100k volume, and NB.TO to take advantage of the full 2.5 million share buyback).

-Future

-“We think there is going to be considerable consolidation in this industry over the coming decade as markets soften and who knows how much of the foreign owned parents will get into capital problems over the coming years.”

For Fairfax Asia,

-Underwriting profit of 20 million, up 40%, Combined ratio of 70.4%. Gross written premium of 171 million, up 27%, net premium written 70 million, up 16%.

-Growth in Singapore, introduced Falcon Thailand.

-For India (26% owned ICICI Lombard), the largest general insurer by market share in India.

-Group Re had an underwriting profit of 11.3 million, with combined ratio of 95.6

For Runoff,

-187 million pre-tax income due to investment of 291 million, 241 attributable to CDS. Year to date gains on CDS of 160 million pre-tax.

Cash is over 1 billion, paid down 100 million in debt, debt to capital ratio declined from 35.7% in 2006 to 27.1% in 2007.

They have a 19 billion dollar investment portfolio:

-Bonds represent 10.5 billion, duration of 7.5, last year was 8.5

-cash and Short term securities represent 4 billion

-Equities represent 3.3 billion, we now know that 10% of their equity portfolio is in JNJ.

-Derivatives represent 1.2 billion

They have no intention of selling any run-off business. New CDS positions have exposure to “Auto, Credit Card, Private Equity, Bank loans, all sorts of things.”

Why?

Because, “The idea of tranching loans, be it mortgage loans, credit card loans, the structure was applied all across the credit markets, and that has led to moral hazard.”

Who?

If you somehow come across a guy with the last name “Bradstreet” congratulate him, even if his first name isn’t Brian. The guy will forever be remembered as the brains behind the very profitable CDS portfolio. Rest assured, Mr. Watsa says “We like where we are.” And who wouldn’t?

Just to conclude: I hold positions the three wise guys (FFH, ORH, NB.TO) and I actually treat it as one position. Why? Well management philosophy is pretty much the same, investment portfolio is the same, and if I like those two qualities and want to be a part owner in Fairfax Asia, and the largest Canadian insurance company, would it make sense to just hold ORH? It does to some people and I don’t want to step on any toes, but I think too many people own one and not the other based purely on metrics. I own all three because I want specific exposure to certain business operations that I wouldn’t get with only ORH, or only NB.TO. I believe that treating all three as one investment position will allow you to hold an outstanding insurance business portfolio. For example, if you only hold ORH, you are not getting any of the Runoff business or Crum and Forester business, your best bet is to buy FFH, then add ORH and NB.TO.

Anyways, those who hold one, likely hold two, and if they hold two they probably do own all three. So I am probably preaching to the choir.

Enjoy your week, I will be heading off to Houston, TX this weekend. A friend that works in the insurance industry as an underwriter has an annual meeting should be fun. I’ve been trying to convince him to write for the Utterly Unknowable for some time now, don’t hold your breath!

As always, until next time,

Take care,

S.K.

I'm Not Selling

Good evening, just thought I should write since a couple of family members and few friends have asked me if I am selling my long held gold position. In short, obviously by the title of this post, the answer is no. I first shed light on this position in the post Random Rants:

I remember when I made my first purchase. It was 2004, I held an internship at J.P. Morgan Chase, the Credit Card Division, not the I-Bank. It was late in the afternoon and my mentor, Mr. Hancock, 15 year veteran instant messaged me saying, "Kudlow & Cramer just said they would short gold at 394." This of course was music to my ears only for the fact that my father spent 20 years as a jeweler in Iran. Much of the West doesn't understand the importance of Gold in Asia. The majority of the Middle East only trusts the yellow metal as a true store of value. In fact, to this day, anytime there is a wedding, there is a transaction of Gold between the two parties. Further, 80-90% of the gifts received are gold! With one of the more youthful demographics, Gold will continue to be in circulation.

Now to India, same story as above. There is just massive amounts of Gold that is treated as a currency. Men wear Gold as a symbol of wealth and it's not the 14 K material! I just find it hard to believe that anytime Gold is talked about in the media it is talk of inflation. And don't get me started on that, as inflation is the most wrongly used word today. Inflation is not rising prices, rising prices are the result of inflation. Inflation is just the increase in money supply/credit.

So within a week of Kudlow and Cramers great investment idea of shorting an asset class that I personally have "inside info" through my father, I made my first purchase of the yellow metal. Physical gold of course, at the price of $396 an ounce. I still hold it. In addition the next year I purchased premium gold coins, the Saint Gaudens, MS-63 and the MS-65. Consequently, late 2005 I purchased physical silver, at around $7.15 an ounce. I saw a cheap asset class and my reasoning is 100% fundamental and there will be a time to sell. Call it a liquidity crisis, solvency, whatever you want, but as Mr. Coxe says, "Gold is the only asset that is no one else's liability."

Buying gold at $396 an ounce and silver at $7.15 an ounce wasn't always the easiest or most popular statement back in 2004-2005. In fact, I remember a guest who came to our house for dinner one night, MBA background. He asked what I was buying and my response wasn't met extreme ridicule. Shortly after, I excused myself from the table because my mannerisms and attitude had become slightly immature relative to my age. I remember vividly that one night.

Nowadays, most people don't believe that I hold these precious metals. So either way I'm at a loss of words. And I'm not selling, I can wake up tomorrow and gold can be down 200 and silver down 4 and it wouldn't bother me. People don't understand these commodities nor their respective mining process. Quite frankly, I don't care.

Often times, I save an article here and there just for memory. Relating to gold, earlier this year I saved this one, dated January 3, 2008, titled: "India housewives rush to sell trinkets as gold soars." This was at $868 an ounce and while I'm not the genius who will sell the gold at the exact top, my sign to sell will be when India's housewives buy their gold trinkets back at much higher prices. What will gold do tomorrow? that is Utterly Unknowable.

Thank you,

S.K.

The Genius of Watsa/Buffett/Simpson

"Seize the moment of excited curiosity on any subject to solve your doubts; for if you let it pass, the desire may never return, and you may remain in ignorance."

-William Wirt

Quick one tonight.

I was curious about recent positions taken by Berkshire/Fairfax, more specifically the one's in the pharmaceutical area. It actually drove me nuts, because we have heard numerous times about Sir Buffett's lack of understanding of the pharmaceutical industry. Now we know he is being humble. And we don't know for sure whether if the Glaxo/Sanofi purchase was Mr. Simpsons, but we can at least assume the JNJ purchase could have been Sir Buffet's. It really doesn't matter who purchased it and for a man (Lou Simpson) who never receives any credit, well he is a genius in his own right.

Fairfax of course also has made some recent purchases in pharmaceuticals, namely Pfizer and Abbott Labs.

Doing what little reading I could do this weekend considering my younger brother was in and out of the hospital, I had a chance to look over the W.R. Berkley Corp. conference call. In it, there is a nugget that had somewhat of a "hmmm, I sorta 'get' it if indeed it is true."

The quote:
"In general medical costs overall in the whole industry have been the real risk for cost inflation...medical inflation has been 6%, 8%, 10% depending on where and what."

Take it for what it's worth, because for clarification purposes, Mr. Berkley was talking about California workers compensation medical trends. However, I figured that for most liability lines, especially in auto for PIP (personal injury protection), the medical inflation wouldn't necessarily just apply to WC, it would apply to almost every other line.

Later on, Joshua Shanker of Citi stated in a wordy question, "You [Mr. Berkley] made an assumption on claim inflation but clearly one goes back one, two or three years on the liability side and the claims inflation has been much more modest than what you talked about."

It's indeed claim inflation as a whole that's increasing, and what the "Genius" at the head of Fairfax and Berkshire are doing is hedging claim inflation. Again, I don't know if this is their true intention and I'm very curious about these purchases in the pharmaceuticals. What do you think?

Until next time,

Take care,

S.K.