It seems like somebody have taken the great investor wizard by surprise, this time. The “sage of Omaha” has declared recently that derivative instruments are “potentially lethal-weapon of mass destruction” and Mr. Buffet does not see the day of getting rid of his unwanted derivative-trading unit, General Re Securities.
This highly speculative markets are a zero-sum game, meaning that for every contract traded, you have two opposite views and at the close, one party will loss some amount and the other will win ¾without commission being considered¾ exactly the same amount, a simple fact of life though. His comments are reflective of his disturbance and lack of knowledge of a go-go type of activity. Obviously he has gotten the wrong side of the equation and he is blaming of his misfortune saying derivatives is a pervert industry. No sir; with all respect, you are wrong this time. It is only that you are mal-positioned.
Mr. Buffett is missing some key points that he should better consider. The derivative industry is essential because it plays a key role in society; it provides liquidity to some otherwise stagnant markets. It is the perfect mean to protect and fix prices of uncovered positions as those of commodity goods producer such as agriculture, energy, metals, etc. This industry has led to efficient and sophisticated opportunities and protection to many economy agents. From time to time, derivatives are being blamed as a destabilizing factor, but such statement is also missing the point. What really shake financial markets, besides wrong monetary and fiscal polices, are fear and greedy factors. Then, it appears that his complaints are more related to Berkshire’s investing strategies mishmashes than some structural problem with the industry itself.
The bottom line with the Omaha guru dilemma, lays on the differences between the investing and the speculative approach to financial markets. Mr. Buffett is a very well known entrepreneur with a cutting-edge acumen on how industrial and commercial sectors really work and how to make them more profitable. For a real investor, it is unconceivable to see how a mistakenly placed contract loses value only because the clock is ticking or just because some supply-demand forces are acting contrary to his long-term view. The logic behind investing is that intrinsic value should increase as a company expands his operations and efficiencies. Decades of hard work on that direction will not change because of “General Re” needs. Mr. Buffet is consistent at complaining at it. The common problem for any layman is that every single new or any market event has already been ¾with all likelihood¾ discounted, so that most of the time small investors miss their target.
The speculative approach is like water and oil in relation to the investing focus. It is not about value: it is about rival forces taking advantages of ex-ante market conditions, that is, actual events that have not been yet discounted. Therefore, headline news has little worth as a predictive tool. The derivative industry is the natural ground on which speculative thinking should be exercised. Pure rational thinking is not always the best allied on an intensive speculative arena; so, it is for Mr. Buffet and his General Re viability best interest, to start playing by the subgenera rules of speculation. If not, I am sure somebody will be taking advantage of him.