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The Daily Reckoning | Monday, April 9, 2012 Warren Buffett vs. Midas Metal...the showdown continues... Readers weigh in on buying real estate within US fences, Plus, Patrick Cox on monopoly expiration and the generic drug boom ahead... ------------------------------------------------------ World oil production is about to be shaken to its core... You won’t believe which nation analysts at Wall Street’s biggest banks expect to become the world’s biggest energy producer by 2017 — or the effect it will have on America... our economy... our future... Click here to see who is set to become the new king of oil — and how you can use the news to go for big profits as early as this MAY!   To Buy or Not to Buy Readers Weigh in on the Homebuyers’ Dilemma   Joel Bowman Checking in today from Buenos Aires, Argentina... Ouchie! Traders had their fingers hard on the button again this morning. The “sell” button, that is. After resting their phalanges over the long weekend, they were poised at the open to whack the Dow for 140 points, sending it below the 13,000 point mark and erasing all the gains of the last month (and then some). The thirty bluest chips have since recovered about one third of their morning losses. Who knows, by the end of the day, we could be back in the black...or back below the morning’s lows. In fact, neither would surprise us. In many ways, the stock market has become somewhat of a casino in recent years, rigged to favor the politically connected at the expense of those on the verge of becoming the very economically disconnected. Increasingly, therefore, those without a bevy of K Street lobbyists’ and D.C. insiders on their speed dial are finding they must resort to alternative asset classes in order to, at best, grow their savings and, at worst, protect them from the ravages of inflation. Who could have known that today, in the year 2012, one of those alternative asset classes would include residential real estate? “If you think we’re crazy, you’re not alone,” mused Addison Wiggin and Samantha Buker in their recent, unambiguously-titled Daily Reckoning column, Buy A House. “The housing market is a complete bust right now,” the pair continued. “The following chart shows the median home price in terms of per capita disposable income. Based on this calculation, home prices are lower than they have been in 40 years!” Addison and Samantha went on to site a slew of data — from historical average monthly mortgage payments to the number of national housing starts to inexorable population growth and more — to make their case. But not everyone is convinced. Here we offer a handful of reader responses to our “Buy a House” message. Contrarians, take note. First up, here’s Reckoner Don with a “fight or flight” conundrum all too familiar to millions of Americans across the country... I agree that “all things being equal” — i.e., without any major political/social changes — real estate is a good investment. Buying real estate is an investment in the future of America. My question is, does the US have a bright future? Will the money creation stop after 100 years? Will it even slow down? The authors of your piece don’t think so. They kept sighting the certain increase in inflation as a good reason to put our dollars into real estate. And that has worked in the past because of inflation. But will it continue? Can any country inflate forever? Does it really work? Or does it always end in economic/social collapse? And if it does, how close to the end are we? These are questions not asked, let alone answered. Probably because no one, not even the Austrian economists, know for sure. The economy may collapse slowly over the next fifty years, Or it may crash in five. Either way, the political situation is a nightmare. We live in a police state much like many third world countries. Why would I choose to live here if I could expatriate and live freer and cheaper? I turned all my assets into gold coins in 2007 and am mobile. I don’t want to bale, but I won’t be a victim either. I will stay to fight for America, but I am prepared for a hasty retreat to avoid destruction. If I bought a house, I would be tying up half of my wealth in an illiquid asset. Is that wise, given the world is awash in fiat currency? And here we have an unsustainable warfare/welfare state? No, I don’t think so, and I can’t believe you do either. So why publish such a one-sided piece? It could turn out to be very bad advice. DR: Good points, Don. We’ve actually run a ton of pieces on “Gettin’ Outta Dodge” in these pages before [see here and here for starters]. And we are certainly sympathetic to your concerns. Undoubtedly, the flight option is more to the liking of some readers. In fact, this excellent article by fellow Agora Financial editor, Gary Gibson, makes the case that America is on the precipice of becoming a full- blown debtor’s prison...if, indeed, it is already not. For those who are inclined to stay within the gates, however, we do encourage you tocheck out Addison’s “American Oases” report, free for subscribers of his Apogee Advisory service. The situation stateside is heating up. Quickly. So if you do intend to stay, please, at least be prepared. Here’s a slightly different take from A Reckoner, writing in from the Sunshine State... Prices here in Florida are quite cheap and I agree that if you carefully seek out properties in good neighborhoods, do a lot of research on being a landlord/investor, there is money to be made. Of course, I would never have a real estate company rent out my apartments for me. It is something I prefer to do myself since it can be quite costly to rent out to the wrong person... These days there are bargains to be had. Some owners have had their property on the market 1 or 2 years and are desperate to unload it, especially if it is a cash deal. The only problem I see is that after the election [spring 2013] I do believe that the market will once again crash and there will even be fewer buyers and therefore there will be even more bargains to be had. Rents will keep up with inflation, there is money to be made with rental properties especially with these low mortgage rates. And finally, a few readers were more philosophical about the whole subject. What does owning a house really mean, anyway? Here’s one from Reckoner B. Williams... Maybe it’s just a merry-go-round... In the beginning there was real estate...and there were kings who owned it and peasants who were allowed to live on the land for work in the fields and the roads. Sometimes the peasants even thought they owned the land, but those thoughts usually evaporated when the kings’ interests came first. Now we have papers, which say we own the home and land — unless you borrow to obtain it in which case the kings still own it. And now you will ask — “Ok how do I get a home without borrowing?” And the merry-go-round goes around again... DR: To which we would only add...try not paying your property taxes, or doing some renovation without the state’s approval. Now who is the owner, and by whose benevolent graces you may be allowed to live in your “own” home? Plenty more on the Buy A House question in future installments, dear readers. And please, feel free to keep those emails coming. For now, though, let us return to another Daily Reckoning topic du jour: Bashing (or at least, questioning) the cult of Warren Buffett. Eric Fry has more...   External Advertisement The China Catastrophe China is about to make an announcement that will shake the world to its foundations — and that will destroy everything you’ve ever worked for. So says a renowned financial journalist on assignment in Asia — and the crazy thing is,he’s famous for being right.  He was one of the few to warn of the great tech stock meltdown of 2000...the housing and banking bust of 2007...and the recent boom in gold and commodity prices. Is he right again? Watch this shocking video and judge for yourself. The Daily Reckoning Presents A Case of Cult Envy   Eric J. Fry Today, we examine two cults — one with a charismatic leader and millions of disciples; and one with no leader whatsoever, but billions of disciples. Neither cult engages in fringy activities like polygamy, sacrificing goats or building armed compounds in the desert. Nevertheless, both cults attract a very fanatical following. Today, we examine the cult of Berkshire Hathaway and the cult of gold-buying. The former pays homage to Warren Buffett; the latter genuflects at the altar of Hard Money. [To disclose your editor’s biases in advance of making them obvious to all, he is far more sympathetic to the gold-buying cultists than he is to the Berkshire cultists. In fact, he owns gold, but has no position of any kind in Berkshire Hathaway.] If you always wanted to belong to a cult, but didn’t want to deal with the threat of a federal raid or the hassle of raising dozens of children who may or may not possess your DNA, Berkshire Hathaway may be your ticket. In fact, Berkshire may be the most “cultish” cult since the Branch Davidians. Let’s pull back the sacred shroud to examine the evidence... Once a year, you get to join your fellow cultists in Omaha for Berkshire’s annual shareholder meeting — the “Woodstock for Capitalists.” Additionally, you get to quote the utterances of your leader as if they were holy writ. Best of all, you don’t have to surrender your possessions to the community of believers. Instead, you get to make even more money for yourself. Unfortunately, like most cults, the early adopters have fared better than the late converts. (You may have noticed, for example, how the leaders of a cult often partake of the identical earthly pleasures that they instruct their followers to renounce. Similarly, the early adopters of the Berkshire Hathaway cult have enjoyed much greater earthly pleasure than the latter-day converts.) A buyer of Berkshire Hathaway common stock at the end of 1988, for example, would have received a robust 31% annualized return on that investment over the ensuing decade. By contrast, a buyer of Berkshire Hathaway common stock at the end of 1998, would have received a dismal 3.3% annualized return over the ensuing decade — or less than half the return of simply buying a 10-year Treasury. Curiously, the worse Berkshire’s investment performance becomes, the greater the frenzy to attend the company’s annual love-in... and the higher the price to break bread with the cult leader. As the chart above illustrates, the attendance at Berkshire’s annual meeting in Omaha has exploded from a mere 15 individuals in 1981 to about 40,000 last year. And as the chart below illustrates, the winning bid to purchase a lunch for eight with Warren Buffett has skyrocketed from $25,000 in 2000 to $2.6 million last year. If this “lunch with Warren” were a stock, its value would have increased at a compound annualized growth rate of more than 50%! Still not convinced Berkshire is a cult? Here’s the clincher: The Berkshire cultists hold the members of other cults in contempt...especially members of the gold-buying cult.  In this year’s letter to the Berkshire faithful, Warren Buffett derides gold as an asset that is “forever unproductive.” “[Gold] will never produce anything,” the Grand Pooh-Bah of Berkshire Hathaway declares, “Gold has two significant shortcomings, being neither of much use nor procreative. “This type of investment,” says Buffett, “requires an expanding pool of buyers who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future.” Of course Buffett scorns gold! It represents the opposite of everything that enabled him to become a billionaire. He amassed most of his billions betting on anti-gold investments in an anti-gold era. He acquired most of his über-wealth during the disinflationary decades of the 1980s and 1990s. He became an investment genius, thanks largely to a mighty US economy that featured low inflation, low taxation, a reliable rule of law and a stable dollar. But gold’s steady climb since the 1990s suggests that the foundations underlying Berkshire’s success are rotting a bit. The current generation of American capitalists faces a much more hostile environment than did Warren Buffett at the dawn of his legendary career. Berkshire Hathaway is a leveraged play on the American enterprise. It always has been...and so it remains. As the American enterprise flourished throughout the last 50 years, so did Berkshire Hathaway. But now that the great American economy has started sputtering a bit, Berkshire’s spectacular long-term track record is becoming less and less spectacular. In other words, the world is changing before our eyes, but Buffett seems to have little desire to change with it. Perhaps he is incapable of doing so. He knows what has worked for him and assumes that it always will. Gold has never been a part of Berkshire Hathaway’s secret sauce...and it still isn’t. Buffett’s contempt for gold, therefore, feels more like a wish then an investment insight. But so far, he appears to have tossed his shiny pennies into the wrong wishing well. Despite gold’s “significant shortcomings,” it has delivered a much higher return during the last 15 years than the “useful” and “procreative” Berkshire Hathaway. By any quantitative measure, gold has kicked Berkshire’s rear-end from wherever you happen to be reading this column all the way back to Omaha. And as James Grant, editor of Grant’s Interest Rate Observer, points out, gold is not the only non-procreative asset to have embarrassed the Berkshire Empire during the last decade and a half. “In 1996,” Grant relates, “a pound of raw cane sugar cost eleven cents. Fifteen years on, at year-end 2011, the same non-procreative pound was quoted at 23 cents. The fact is, that from year-end 1996 through year-end 2011, the hypothetical continuous holder of the generic sugar futures contract earned a compound annual return of 5.13%, while a stockholder in the utterly non-generic Coca-Cola Co. (NYSE:KO) had to settle for a compound annual return of 3.99%.” “Sixteen years ago,” Grant recalls, “we characterized Coke, only half-facetiously, as the ‘corporate equivalent of Mount Rushmore, the hot dog, the Bureau of Engraving and Printing and Mohamed Ali, all rolled into one.’” And it was. This iconic Buffett investment was the ultimate “one decision” stock — the stock to buy and hold forever. And yet, despite its red, white and blue pedigree — and Warren Buffett’s wholehearted endorsement — Coke lost some of its effervescence during the last few years. Not only did KO’s investment returns fail to keep pace with raw cane sugar during the last 15 years, they also failed to deliver even half the return of the S&P 500 Index over that timeframe. In other words, circumstances change. The investing world is never constant. National boundaries move, governments meddle, patterns of international trade shift and economies go boom and bust. These changing circumstances sometimes compel a change of tactics. “For Buffett,” Grant continues, “Coca-Cola is a prime example of the procreative investment, gold the archetypical other. [But] we submit that Buffett has failed to take proper account of today’s unique monetary backdrop. Interest rates are uncommonly low, worldwide monetary policy unprecedentedly easy. No institution under the sun is so procreative as the quantitatively easing central bank. Faster than even the best businesses can spend cash flow, the Federal Reserve can materialize scrip.” In other words, the America of Berkshire Hathaway’s future is very unlikely to resemble the America of Berkshire Hathaway’s past. Today, the Federal Reserve’s printing presses are “firing on all eight,” not the engine of US economic growth. Today, therefore, it is the gold price that is climbing ever higher, not the share price of Berkshire Hathaway. “Gold is no investment,” Grant winds up. “It is money, and money is, by definition, sterile...Gold is the refuge of the wary. The constructively anxious goldbug will ask germane questions. For instance, what if QE spins out of control? What if the inflation rate gets out of hand? How can I preserve purchasing power sufficient to allow me to buy oodles of Coke at the next bear-market bottom?” Good questions. And these are exactly the kinds of questions all forward-looking investors may wish to ask themselves, no matter whether they decide to buy gold or Berkshire Hathaway...or both...or neither. Challenging one’s complacent assumptions can be a very constructive exercise...and a profitable one as well. The appeal of any investment — sugar as well as Coca-Cola, gold as well as Berkshire Hathaway — relies greatly upon the precise monetary and macroeconomic conditions in which it resides. Price also plays a role, of course. As the writer of Ecclesiastes observed, “There is a time for everything.” In fact, as recent history proves, there is even a time to favor “non-procreative” assets over procreative ones. Notwithstanding this irrefutable evidence, Buffett insists there is never a “time for gold.” Maybe so, but chose your cults carefully. Regards, Eric Fry,  for The Daily Reckoning   Here’s Your Personal Invitation to “Join” Me on a Free Worldwide Guided Investment Adventure As We Search For... — Clues behind the gold legend of El Dorado, along with ways to play a brand new gold boom... — Investment opportunities along revived trade routes stretching from the Middle East to China... — The No. 1 inflation-beating asset of the rich and famous... and more.  The adventure begins this Thursday, April 12. No fees, passports or credit cards required. And you won’t have to wait in customs or airport security lines. For details, see your invitation right here.   And now over to our resident breakthrough technology expert, Patrick Cox, for a refreshing word on generics...   The Generic Drug Boom   Patrick Cox [What counts is] competition from the new commodity, the new technology, the new source of supply, the new type of organization... competition which... strikes not at the margins of the profits and the outputs of the existing firms, but at their foundations and their very lives. The words above were penned 70 years ago by an economist named Joseph Schumpeter in his book Capitalism, Socialism and Democracy. In that book, Schumpeter describes how transformational innovation disrupts the businesses of established market players in a capitalist economy. Of course, our own legal framework serves to protect innovations made by existing companies. Enshrined in the US Constitution is the authority granted to Congress to “promote the Progress of Science and useful Arts, by securing for limited Times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.” Often called the “Copyright and Patent Clause,” the patent protections granted are time limited. The inventor enjoys a period of virtual monopoly, and then anyone else can use the technology described in the patent. If the inventor, however, fails to engage in new patent-protected innovation, the business is at risk of falling apart after the term comes to an end. This is what’s happening in the pharmaceutical industry today — but on steroids. Big Pharma is in Big Trouble. Many of its most-popular and profitable medicines are nearing the end of their patent- protection periods. As blockbusters begin to face competition from generics, Big Pharma stands to lose billions of dollars in yearly revenue. At the same time, shrinking in-house pipelines mean that Big Pharma won’t have the new product sales to replace what it will lose to generics. The industry is turning to partnerships and acquisitions of small biotechnology companies to plug the innovation gap. It will take a great many new products to make up for the ones being lost, however. Just this past November, for example, Pfizer’s cholesterol-fighting drug Lipitor fell off the dreaded “patent cliff.” As the world’s top-selling drug, and with annual sales north of $10 billion, Lipitor accounts for more than 10% of the world’s largest pharmaceutical’s revenues. To make matters worse, on the same day that Lipitor lost patent protection, Indian pharmaceutical company Ranbaxy Laboratories was cleared by the FDA to market a generic clone. Lipitor, however, is just the beginning of Big Pharma’s woes. The second-biggest drug on the market, Bristol-Myers Squibb’s blood thinner, Plavix, is scheduled to go into generic status in 2012. More than a third of BMY’s sales are tied to Plavix. Other multibillion-dollar sellers — such as Forest Laboratories’ antidepressant Lexapro, AstraZeneca’s anti-psychotic Seroquel and Merck’s asthma drug Singulair — also have a date with doom in 2012. All told, of the world’s top 20 drugs by sales, seven will go into generic status. By 2015, an estimated quarter-trillion dollars in sales of patent-protected drugs will be at risk of competition from chemically equivalent generic compounds. All other factors being equal, generic competition reduces prices. For the millions of patients dependent on these drugs for their health, steep price drops make prescription drugs more affordable. This is a natural outcome stemming from an end to monopoly status. Generic competition to these drugs will enjoy strong sales through government health care programs looking to cut costs. We are already seeing aggressive cost-cutting measures to reduce what these programs have to pay to provide beneficiaries with drug coverage. Millions of Americans will begin receiving coverage under the provisions of the 2010 Affordable Care Act over the next few years. Add the millions of boomers entering retirement age, and the generic drug business will boom as well. Regards, Patrick Cox,  for The Daily Reckoning Joel’s Note: We’ve had a flurry of reader mail praising Patrick for his past picks of late. Here are a few... “The $45,000 profit I made...is staying in my portfolio,” writes one happy Reckoner from Texas. “I’ll...invest in more of your future recommendations.” “I want to thank Patrick Cox for his recommendations of [stocks],” writes another, this time from Arizona. “They have made me over $500,000!” “Of my dozen or so newsletters, yours is the most fun and the most scholarly,” chimes a third, from South Carolina. “I bought 500 [Company] at $4.45 and sold at $15.88 tripling my stake.” Not too shabby, eh? To help you take advantage of his stellar research, we’re currently offering Patrick’s Breakthrough Technology Alert trading service at a 60% discount...but only until midnight tonight. Claim a spot for yourself, right here. ---------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com