Smart Money - What's Warren Buffett Buying?

Invast Insights
Week Commencing May 12, 2014

www.invast.com.au | 1800 468 278
This week we look at the following topics:
What’s Warren buying?
We follow the smart money and see what Buffett is buying for his investment
vehicle.
Bank earnings season, NAB and Westpac report
Two more Australian banks reported last week, we find out what they said and
where they’re going.
The DAX and Draghi – where to next?
It’s one of the most traded markets in Europe and very popular among our
clients. We look at the numbers.
Technical update on the Brent crude price
The lifeblood of the global economy. We tell you where it is going.

What’s Warren buying?
Some of you who read this report are purely traders focused on market
movements. Some might be investors who look at fundamentals. Some
occasionally fall into both categories. Others haven’t yet figured out which
category they fall into. Regardless of what you trade and
how you trade, following the smart money is always a
clever choice in markets. Track record is important. Every
experienced market participant will always want to look
at the track record of a trade, an investment or anything
else being sold to them which promises to make money.
If you are a forex trader looking at implementing an ex -
expert advisor trading robot, the first thing you do is backtest and look at
track record. With that in mind, this week we focus on one of the most
successful people in financial markets. He is Warren Buffett. One of the richest
people in the world. He’s rich and he knows how to make money. This is not

directly an article about ketchup but you will find out why we have a bottle as
the feature image as you read on!
Before all you savvy traders start discarding this post, take a deep breath and
please read on. It’s not a sin for a day trader to look at what Buffett is doing.
It’s ok! We aren’t proposing you drop your system, strategy or focus on
markets and try to copy Buffett. This is inappropriate, what we are suggesting
however is every now and then it is worthwhile looking at people in markets
who have successful track records and seeing where they are placing their
money. Even if you are a short term trading focused on immediate profits, it
doesn’t hurt at all to see where the big money is positioning themselves and
hopefully getting on the right side of the momentum when it eventuates.
Sometimes it’s good to get the big picture.
Buffett hasn’t been buying many things recently, certainly not as aggressive
as he was during the depths of the financial crisis where he saw good
opportunity and done some major deals. Buffett isn’t perfect either. There

are many traders out there who can beat his performance in the interim but
over a long period of time it is hard to compete with Berkshire Hathaway’s
performance. No matter how good you might think your trading strategy or
system is, over the long term, consistent gains are difficult to replicate, unless
you have patience and control of your strategy. That is why we constantly talk
about having the right frame of mind in this publication. We have spent
numerous occasions over the past year focusing on certain guides and
forecasts to help you get the wiring of your mind right. To help you get your
way of thinking in the right place and hopefully to get you in a position
where you are organised, you are disciplined and consistent in your overall
trading or investing strategy.
What Buffett is buying should be of interest to everybody. We don’t propose
you go out and buy the same investments and hold them forever like him.
What we do suggest is that the themes he is chasing will be prominent over
the medium to long term and every time you place a trade it is helpful to
have those long term themes in place. You might be day trading the Euro
against the US Dollar for a few pips here and there but if the ECB comes into

the market and starts cutting interest rates, to help export nations, your
position might be at risk and having the fundamentals in the back of your
mind does not hurt you at all. If there is a big shortage of a certain
commodity into the future, traders can exploit the squeeze on price which will
eventuate.
So where is he placing his money? Buffett’s Berkshire vehicle made two large
acquisitions last year spending almost US$18bn. The companies he acquired
were NV Energy and H.J. Heinz. Pretty simple really. NV Energy is a public
utility based in the US state of Nevada. It has a very strong penetration into
the energy distribution market. It provides natural gas and powers around
2.4m customers. This represents around 88% of Nevada’s population. It’s a
retail distribution business but the reason Buffett wants the business is
because the underlying utility it distributes to its customers is likely to
continue rising in price over the medium to long term. The real upside in the
business is from its investments in the renewable energy space. Buffett
doesn’t just want to purchase a renewable energy technology business with a
lot of promise, he wants a solid business with huge market penetration that

has upside through renewable energy. This should be a careful reminder for
all you investors out there when trying to seek upside.
The smart money shows us that upside is possible but the vehicle you invest
in matters just as much. It’s all very well to invest in a potential life changing
technology – a new drug, a new form of energy, a new piece of technology –
but you don’t want to be in a business that has one product and its future is
dependent on that technology working. You want to buy a drug company
that has a nice position in the market with potential upside from new
products, or a mining or energy company with existing operations with
potential upside form new ventures. You want to purchase an IT or online
business that is dominant in its field with potential upside from new services
– like eBay for example and the upside it has through PayPal etc.
Buffett made the energy acquisition through his energy holding company
called MidAmerican. The business has become one of its largest non-
insurance arms within Berkshire, generating US$10.8bn in pre-tax earnings for

2013. Buffett clearly sees energy prices rising into the future despite all the
rhetoric about the United States becoming energy dependent over the next
few decades. If you are trading energy markets, you want to keep an eye on
future acquisitions by Berkshire’s MidAmerican division and see just what
types of renewable energy.
The other acquisition is also fairly simple – Heinz. We all know the brand from
our pantry shelves and super market aisles. Heinz manufactures thousands of
food products in plants across the globe and markets these products in more
than 200 countries and territories. The company claims to have 150 number
one or number two brands worldwide. It is really an amazing business. The
business is now owned by Berkshire and 3G capital and Buffett said last
month that he intends to never sell a share in the business. Heinz is basically a
play on food prices, there is a fair amount of volume growth opportunity as
global populations increase but we are talking about a mature business here,
not necessarily something with low penetration. The argument about China
and India is perhaps not that relevant here. Diets and different and both the
Chinese and Indian consumer food markets are very well developed and

serviced anyways. What Heinz can do though is continue to increase its prices
over time to reflect the diminishing value to currency and hence become a
perfect inflation hedge, like Coca Cola, which is without surprise, a major
investment of Berkshire Hathaway already.
Warren is investing on two things – rising energy prices and rising food prices.
The cost of things is going up. This is important to note if you are trading
stocks, forex or commodities. You won’t necessarily make an immediate profit
by just buying anything, but over the medium to long term you need to
realise that the smart money is investing to hedge themselves against the
value of paper currency. The average food price only needs to rise by a small
amount of money each year to make the compounding effect on Heinz’s
business significant over the next few decades. MidAmerican is buying
guaranteed earnings with leverage to gradually rising energy prices and
potential upside to renewable energy without having to worry about new
technology working or not in the near term.

Bank earnings season, NAB and Westpac report
Last week we wrote about one of Asia’s largest banks – ANZ, which is listed in
Australia. We spoke about the rising loan arrears and the potential trends
which are emerging. We said that we would need to pass judgement on which
geography is actually seeing an elevation in loan arrears until we had a better
look at both National Australia Bank (NAB) and Westpac (WBC) numbers
which came out last week. The data from NAB and WBC confirms what we
were thinking – arrears in Australia are under control.
The beauty about NAB’s reporting is that it breaks down its business
segments and provides excellent disclosure. The Australian business is
performing strongly and arrears in Australian loans have not seen a major
increase over the period. The same story goes for Westpac which is a
completely Australian focused bank.

The problems for both NAB and Westpac though is that the Australian
businesses are suffering from margin pressure. It’s becoming difficult for the
domestic banks to maintain their pricing power as competition heats up.
NAB’s result was driven by an improvement in the UK business which has
been problematic for the past few years. Westpac continues to promote its
local business and push hard in the residential mortgage lending space where
it is fairly dominant across the Eastern states of Australia. Below we provide a
snapshot of the arrears and asset quality trends for both Westpac and NAB
from their recent interim reports.

Our net convictions aren’t changed from last week. In summary we think that
CBA, NAB and WBC are all fairly valued and offer little attractive upside on
current valuations. Our preference in the banking space is ANZ and while we a
true believers of the Asian growth strategy we think there will be some pain to
take through the balance sheet over the next few years. Because of that, we
want to purchase ANZ at a reasonable discount and based on our analysis last
week that discount would need to see the ANZ share price fall from its current
level to around $27-28. If the shares fall to this level we would start adding to
our model portfolios – even if there are Asian loan losses being announced.
We aren’t discarding the banks, we are picking and choosing the entry points

based on our own preferences.We have time on our side.
The DAX and Draghi – where to next?
We wrote about the DAX last October for our clients and went through the
index constituents, pinpointing the few stocks that need to do well for the
broader index to move higher. The DAX has risen around 11.8% since our
report despite recently coming off its high levels. The performance has
certainly been better than some of the Asian markets and while the US
market has been scaling all-time highs, we think Europe is still yet to catch up
completely. We thought it would be a good opportunity to touch base with
the DAX index again in light of the ECB’s likely intervention in the market to
contain the rise of the Euro in the coming few days.

Chart: GER30 (DAX) daily price chart via Invast MT4 platform

We have written about Draghi’s need to back his words up with action and
the rally of the EURUSD towards the 1.4000 level for us spells a line in the
sand. Germany – as a major export powerhouse – would be one of the main
beneficiaries of lower interest rates although its capital in the ECB as the
largest contributor would be an issue for central bankers to sort out
separately. Our focus here is the stock market and not necessarily the
sovereign situation.The key index constituents for the DAX are listed below:

These are the top 10 stocks on the DAX which combined represent around
66% of the total index weighting. What happens in these stocks is very
statistically significant. There is massive concentration here. As you can see
from the list, most of the stocks are in the business of exporting their goods
and services to the global economy. The strong EURUSD is definitely a drag on
their earnings. As the EUR weakens – potentially on Draghi’s comments –
most of these companies should start to see their relative share price value
become cheaper in USD terms and also their translated earnings higher as
they repatriate funds back home to Germany for their shareholders. These
businesses are all major beneficiaries of low interest rates – their cost of
borrowing is benchmarked to the ECB’s interest rate policy and so they can
continue to tap the market for cheap money and reinvest for growth.
We call this the DAX double whammy – low interest rates and potentially a
central bank who wants to ensure corporate competitiveness through
capping exchange rates. Draghi has not yet moved but we feel the ECB will
have to do something. We see EURUSD 1.4000 as being ‘out of the question’.
We see these DAX names as major beneficiaries. The DAX may have rallied

well since October but we think the gains will likely continue. As you can see
from the chart the current price action suggests some support near current
levels but there is a chance that momentum will start slowing in May.
In terms of the largest index constituent Bayer, it recently reported a 5%
increase in its underlying operating earnings for the first quarter of this year
when compared to the prior corresponding period. Bayer’s Healthcare division
sales were 3% higher which is a little to the negative side on face value but
when adjusting for the higher EUR against other counter parts, sales were
actually 8.9% higher in constant currency terms.
Let us reiterate that point. Bayer’s Healthcare division sales were only 3%
higher in EUR terms but on a constant currency basis (stripping out the EUR’s
impact) the group’s sales were actually three times that amount at 8.9%. The
largest stock in Germany through this example is showing us just how much
the higher EUR is hurting ordinary corporate earnings. The corporate sector
will continue to lobby hard over further currency appreciation. Draghi is

listening but he needs to act. When he does, stocks like Bayer will push the
DAX higher. Bayer expects the full financial value of the higher EUR to impact
its 2014 sales by around EUR800m and reduce its earnings by EUR450m!

Technical Update On The Brent Crude Price
When we sat down to discuss as a team last week what the latest movements
in the Brent crude price were suggesting, we reached a unanimous verdict –
nothing much! Brent continues to trade wildly within boundaries of US$105
and US$110, with an overall bearish tone. We notice support levels building up
around US$107 and this is the key support level to focus on in the next few
days (as of the time of writing).
We also like to point out that the Stochastic Oscillator still points for potential
move lower than the current market price at US$108. The US$107 level is
crucial as there are no significant support levels until US$105.50 should
support at US$107 become breached. From a medium term time frame we are
definitely looking for a bounce in Brent Crude to occur, either from US$107 or
US$105.50.

Chart: Brent crude daily chart via Invast MT4 platform

Key resistance to the upside remains at US$108.70 and US$110.50. Taking a
look at the shorter time frame of 4 hours, US$108.70 is the key resistance level
to monitor. This is where the Ichimoku cloud resistance ends. For Brent to
push higher, it will need to close above US$108.70. Between US$108.70 and
US$110.50 we would also like to point out the longer term resistance trend-
line building up around US$109.50-75. This will be the next resistance above
US$108.70 before ultimately facing US$110.50 key resistance, that has capped
Brent from progressing any further in the past two months.

Chart: Brent crude four hourly chart via Invast MT4 platform
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Smart Money - What's Warren Buffett Buying?

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