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These Prices Are So Cheap, They're StupidBy
Tuesday, August 25, 2009
Last month, I was listening to a quarterly results conference call, when the CEO dropped this bomb:
"Prices have now reached a point where there is no room to go lower – they must go up." He thinks his company is facing its best market opportunity in its 42-year history. CEOs tend to exaggerate. But I think this one might not be blowing smoke... He runs a property and casualty insurance company. In the insurance industry, low prices lead to excess demand and insufficient supply. A supply crunch, in other words. Big price increases always result from this situation. I think that's what we're about to see. For more than a year, commercial property and casualty insurance premiums have been plummeting. Take a look...
For a fee, insurance companies will accept financial risks from individuals or organizations that don't want to take those risks. Take your house as an example. It could catch fire. Do you wish to bear the financial consequences of a fire? Most people don't. So they pay an insurance company to take that risk. If their house burns down, the insurance company pays. In the business, they call the fee the insurance company collects a "premium." Insurance moves in cycles. Some years, there are few competitors but a great demand for insurance products. High premium prices result. In the industry, they call this a "hard market." In other years, there are many competitors, plenty of supply, and low premium prices. They call this a "soft market." The key to a successful insurance business is discipline. You cut back operations in the soft market, when premiums are low, and then expand in the hard market, when premiums are high. The turn from soft market to hard market usually follows a catastrophe. It could be a hurricane... a major bankruptcy... or a financial crisis. The catastrophe acts like a forest fire. It wipes out the weakest, most-aggressive players, leaving the survivors with greater market share and higher prices. There's been a soft market in most segments of the insurance industry for the last few years. The market has gotten so soft, I heard the CEO of another property and casualty insurer berate his competitors for writing "stupid and absurd" policies at 66% discounts to the correct prices. In other words, the price of insurance is so cheap, it can't get any cheaper. The thing is, in 2008, the insurance industry suffered not just one, but three catastrophes. First, Hurricane Ike destroyed Galveston, Texas. This was the third most costly hurricane in America's history. Then, AIG collapsed. AIG was the largest insurance firm in the world. Finally, the stock, bond, and real estate markets collapsed, destroying insurance companies' investment portfolios. These catastrophes all thinned competition in the insurance industry. "Many of the industry's leading lights are on the ropes..." says the CEO of one Canadian insurance company I follow. "If these companies are consumed by a credit event or if the rating agencies lose patience, the current soft insurance market could become hard quickly." In other words, it appears the soft market is close to turning into a hard market. This is great news for the best-quality insurance companies. They're about to earn higher prices... and enjoy a larger market share at the same time. Berkshire Hathaway is the "blue chip" of the insurance industry. It owns half a dozen insurance companies including General Re, Geico, and National Indemnity. As the insurance market hardens, these insurance operations will crank fresh cash flow into Warren Buffett's investment portfolio, where he'll use his legendary investment skills to magnify and compound it even further. Good investing, Tom P.S. In the latest issue of The 12% Letter, I told my readers to buy one of the world's most disciplined insurance companies. When the stock market collapsed in 2008, its stock price rose 10%. Now this company has over a billion dollars in excess cash, and it's about to reap a bumper harvest as prices rise... To learn more about The 12% Letter, click here.
Further Reading:
How to Play the Collapse in Meat Prices Market NotesNATURAL GAS IS NOT AT A SEVEN-YEAR LOW... TRY 15
Awful headlines for the energy business: The price of natural gas – America's largest source of clean electricity – dipped to a seven-year low last week.
Yes... it's bad news for natural-gas producers. But bad as it is, it's also wrong. You see, when measured in "real money," natural gas is actually trading at a 15-year low. One of the biggest mistakes the average market participant makes is measuring asset performance without factoring in the declining value of the U.S. dollar. The greenback has lost about 25% of the purchasing power it held in 2002. This makes folks believe they've made a "killing" on their home – when after adjusting for dollar depreciation, they really haven't gained a bit of real wealth. That's why a seasoned investor measures things in terms of "real money," gold. Gold is an objective measure of value that cannot be debased at the whim of politicians. Our chart today displays natural gas in terms of gold over the past 15 years. As you can see, natural gas is at its lowest point relative to gold since 1995. If you're looking for a "blown-out" commodity, this is it. |
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