Warren Buffett's investing prowess is known far and wide on Wall Street. The CEO of conglomerate Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) has made himself and his shareholders a fortune over the past five-plus decades by purchasing high-quality companies with sustainable competitive advantages on the cheap and, most importantly, holding them for long periods of time.
A comparison of Berkshire Hathaway's stock relative to the benchmark S&P 500 shows an insane outperformance since 1965. According to Berkshire's 2019 annual shareholder letter, its 2,744,062% aggregate return since 1965 is roughly 138 times greater than the S&P 500's total return, inclusive of dividends, over this same period.
Buffett's most surprising purchase from the second quarter was a gold stock
Aside from firmly believing in the buy-and-hold ethos, one of the biggest reasons the Oracle of Omaha has performed so well over the long run is because he has stuck to his areas of expertise. This is to say that Buffett has always been adept at researching bank stocks, insurance companies, and consumer staples, and he regularly puts his money to work in these industries and sectors.
Yet every so often, a Berkshire Hathaway purchase will come out of left field and completely surprise Wall Street and investors. That's exactly what happened last Friday, Aug. 14, when Berkshire Hathaway filed its form 13F with the Securities and Exchange Commission. A 13F provides a snapshot of what the most brilliant money managers were up to in the recently ended quarter.
What stood out the most for Berkshire was the roughly 20.92-million-share purchase of gold-mining stock Barrick Gold (NYSE:GOLD) during the second quarter. The value of this position, based on the filing, equates to almost $564 million. Along with rebuying Berkshire Hathaway stock and adding to the company's existing position in Bank of America, Barrick Gold is among Berkshire's biggest investments in 2020.
What makes this portfolio addition such a head-scratcher is that Buffett has never been a fan of gold, the physical metal. Buffett has for decades harped on physical gold's lack of utility. This is to say that gold isn't used to produce anything. When Buffett buys a bank stock or Coca-Cola, he knows these are businesses that'll keep churning out products or services that generate consistent revenue and cash flow. Meanwhile, gold is a piece of lustrous metal that, in Buffett's eyes, takes up storage space and racks up security fees.
So why did Buffett buy a gold stock if he's no fan of the underlying metal? I'd surmise the answer to this question is that he didn't.
The mastermind behind the Barrick Gold purchase
Although Buffett's name is imprinted on many of Berkshire Hathaway's long-term holdings, one thing that's become increasingly noticeable is that he's begun handing the reins over to his two investing lieutenants, Todd Combs and Ted Weschler, in recent years.
How do we know this? Just look at Berkshire Hathaway's two most recent 13F filings. With the exception of a big sell-down of Goldman Sachs during the first quarter, and the exiting of stakes in Phillips 66 and The Travelers Companies, Berkshire's other 16 sells in Q1 ranged between 0.01% and 3.24% of its total holdings in these companies. Buffett doesn't trim positions in Berkshire's portfolio this way. He's either full-bore buying for multiple quarters, or he takes two to four quarters to exit a position.
It was a somewhat similar story in the second quarter, with six of Berkshire's 18 sells representing a position pare-down of less than 9%. Historically, Berkshire Hathaway 13Fs have featured a handful of moves per quarter. The past two 13Fs have each approached two dozen combined buys and sells. This suggests that Combs and Weschler are exerting more day-to-day investment influence at Berkshire Hathaway.
Furthermore, we've witnessed a number of recent purchases that were either not made by Buffett by his own admission, or are clearly in industries that he avoids. For instance, Buffett has previously noted that neither Amazon nor Kroger were his selections. Given his disdain for physical gold as an investment, this makes it a virtual certainty in my mind that Combs or Weschler was behind the Barrick Gold addition.
Here's why Barrick Gold makes sense as an investment
Of course, who bought $564 million worth of Barrick Gold isn't as important as whether or not the decision to buy Barrick stock will make Berkshire Hathaway a profit. To this end, it looks like a good decision.
First off, there's a strong case to be made for significantly higher gold prices, if not a higher base price. Bond yields have been plunging globally and domestically for years, meaning income seekers have few avenues to put their money to work where their returns will outpace inflation. This makes gold an increasingly attractive store of value during uncertain times.
To build on this point, the Federal Reserve's pledge to employ unlimited quantitative easing to prop up the U.S. economy and financial markets is a recipe for a ballooning money supply and a weaker dollar. Since the dollar and gold almost always move opposite from each other, a weaker dollar should send gold significantly higher.
But there are company-specific reasons this purchase makes sense, too. Barrick Gold has sold off $1.5 billion in noncore assets to help reduce its debt, which in the June-ended quarter pushed net debt down by almost 25% to $1.4 billion. Higher gold prices, coupled with Barrick's leverage, should allow the company to deploy its extra cash flow to improve its balance sheet.
Additionally, free cash flow totaled $522 million in the second quarter, an improvement of $84 million on a $128-an-ounce increase in the average price of gold from the sequential first quarter. Based on this ratio, Barrick Gold should be on track for $700 million in free cash flow during the third quarter, with gold hovering near $2,000 an ounce.
Barrick Gold may not be a true "Buffett pick," but it fits the theme of a value stock with a competitive edge, at least based on its size.