Investment U E-Letter: # 580
Wednesday, September 13, 2006

The Housing Boom: Warren Buffett Hangs Onto A Real Estate Boom Relic
by Karim Rahemtulla, Chairman, Mt. Vernon Research

Editor’s Note: Few money managers hold all of their positions for more than one year - the average mutual fund has a turnover rate of 85%. To be sure, buy and hold has lost its appeal. Today, Karim Rahemtulla, options specialist and Chairman of Mt. Vernon Research, takes a look at the king of the long-haul approach… and why one play in particular is starting to pay off.

Good investing,

Mark

Believe it or not, there are still some long-term investors in the world. And every once in a while, we are reminded that the guru of long-term investing is the one and only Warren Buffett.

What is most impressive about Buffett is not that he has the ability to pick good stocks (he’s had his share of losers), but his ability to withstand a dramatic decline in share price without flinching - at least not publicly.

And he’s been at it again…

As the market works out its short-term kinks, let’s see how Buffett’s managing one of his big housing boom holdings - USG Corp. (NYSE: USG). His approach here is a timely lesson in the long-haul approach to value investing.

USG Stock: From Drywall to Free Fall

USG was the premier way to play the housing boom, as it was the dominant maker of drywall. But all through the housing explosion, the company was in Chapter 11 bankruptcy. Still, Buffett held on.

He bought in when the share price was less than $20. At its peak earlier this year, USG traded up to $120. Still, Warren held on.

Then came the double-whammy: First, USG announced a settlement for its previous asbestos-related problems - a settlement that would cost the company almost $4 billion. The only way to pay this and emerge from bankruptcy (it was the asbestos-related claims that put them there) was to initiate a rights offering which entails raising more money from existing shareholders, and to pay it out of the company’s swelled coffers and some debt.

Second, the bottom dropped out of housing…

Today, USG is trading at $49, down from $120. Still, Warren is not done. He could have sold at the top, or near it, but he chose not to. Instead, he rode it all the way down, and is now adding to his position through both the rights offering and the open market, to the tune of tens of millions of dollars.

And Buffett is buying more shares with - at least partially - proceeds that are the result of financial agreements he engineered with USG to protect his investment. So he’s using his money and the house’s money, too. A clever man.

Three Reasons Warren Buffett’s Going Long on this Housing Boom Relic

Is Buffett crazy? Or does he see opportunity while others are panicking?

There are three possible answers.

• First, Buffett believes that the global housing construction boom is not over, but going through a correction. And materials companies like USG are oversold to a point where a valuation of 9 times earnings is attractive to him.
• Second, he can’t sell. If he sold now, he would cause a huge meltdown in the shares and remaining holdings would be harder to get out of. Not that he would have lost money if he sold before the rights offering. His cost now is probably closer to $30 because of the more expensive shares he just purchased. In fact, with the current purchase and agreements he has in place with USG, he can buy up to 40% of the company’s shares.
• Third, the government is going back and forth about setting up an asbestos trust fund. Such a fund could reduce USG’s liability and may result in the company actually recouping some of its outlay from the recent settlement. If that happens, the shares may be worth more in a heartbeat.

Regardless of what Buffett’s true intentions are, it is important to note that he is now speaking with his money. And USG shares are beginning to respond.

Of course, only time will tell if Buffett’s bet on the housing boom will pay off. But that’s the key: time.

Good investing,

Karim

Today’s Investment U Crib Sheet

• Speaking of time… The Hulbert Financial Digest recently confirmed that the average holding period for Oxford Club recommendations is 921 days - and that they’ve outperformed the Wilshire Total Market Index 85.4% to 24.7% in the past five years. The Club’s next pick will be electronically delivered to members in nine days. Here’s how to get in.

• Another ethanol plant kicked into production last month… The Prairie Horizon Agri-Energy plant in Kansas produced its first gallon of ethanol in late August. And in June, construction began on three new plants in Illinois, Nebraska and Iowa. Mt. Vernon Research Analyst Lee Lowell, a former energy trader on the New York Mercantile Exchange, has been covering the ethanol market in full detail. Here are his top three picks.

• Special Event: If you want a complete immersion in the art of smart investing (along with a great networking opportunity), I encourage you to check out the New Orleans… Investment Conference 2006, scheduled for November 15-19, at the Marriott Hotel in beautiful downtown New Orleans only blocks from the French Quarter. The event’s going to feature an entire day of Oxford Club, Stansberry Research, Mt. Vernon Research and Agora Financial speakers. Joining me will be top speakers Karim Rahemtulla, Horacio Márquez, Porter Stansberry, Jeff Clark, Justice Litle, Kevin Kerr, Louis Basenese, and Bill Bonner. Other fantastic headliners are keynote speaker Newt Gingrich, Jim Rogers, Dr. Marc Faber, Dennis Gartman, Doug Casey and the always memorable P.J. O’Rourke. For information, click here, or contact Kristin Keeney at 410.223.2658, or 800.992.0205. You can e-mail her, too, at kkeeney @ oxfordclub.com

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