Markets have recovered from this week’s reminder that things have changed: risk is being rediscovered and downside is now an option and not something someone remembers from history.

Monday it was booming house prices, Tuesday it was booming retail sales: the New Zealand economy is starting to be buffeted by pressures that are proving almost impossible to control without causing wider damage.

There’s been a lot of talk about big nasty private equity buyers and how they are buying up Australia.

While China’s exports continue to grow like topsy there’s good news for Australian exports (especially resource companies) from our largest trading partner, Japan.

On Monday Rio Tinto chairman, Paul Skinner said in the company’s 2006 annual report that the company expected the resources boom to continue because of the strength of demand from China.

Stand by for a rough day on the markets.The gathering US subprime mortgage crisis we’ve been writing about for the past month reared its ugly head today and hit Wall Street hard, assisted by lower than expected retail sales and a fall in the US dollar.

According to ABARE’s Outlook paper last week world gold mine production is estimated to have fallen by around 2 per cent last year, to 2463 tonnes, as higher production in China and South America was more than offset by lower output in South Africa, Australia, the United States and Indonesia.

It’s been one of the most striking features of the world gold market in recent years: the fall of South Africa and the rise of China.

The AMP’s head of strategy, Dr Shane Oliver last week said that ‘it was only a correction’ and we should relax.

It should be a modest start to trading in local stockmarkets today but the factor to look for is the weakness shown by key commodities such as gold, copper, oil, lead and zinc in European and US trading on Friday.

The problems in the US subprime mortgage market continue to resonate through American financial markets, despite official attempts to downplay the problems.

The highlight of the American financial year is the Berkshire Hathaway annual meeting in Omaha, Nebraska, in the great American mid-west.

Each May thousands upon thousands of people gather there for what amounts to a festival whose centrepiece is an annual meeting that can go for hours, with a suitable break for lunch.

No tea and biscuits and a furtive chat with the shareholders before fleeing in a smoked glass limo to an expensive eatery or back to corporate HQ for Buffett, Charlie Munger and others.

It’s been called ‘Woodstock for Capitalism’ and quite a few Australians travel there each year for the experience as much as anything else.

It’s Mid-west folksy, it’s very American and quite a few modern business people would scoff at it but it will draw the best part of 25,000 to 30,000 shareholders from the US and many other countries.

Read this carefully, especially the events surrounding it such as furniture and jewellery sales and special meal deals: many of these businesses are owned by Berkshire Hathaway and the money shareholders spend pays for the whole event and more.

Simple, but obviously something too hard for many of our businessmen in Australia and many elsewhere.

In fact you can imagine some of the types at Macquarie Bank and other high flying investment and financial products companies looking askance at Buffett and Berkshire, or eyeing the annual report (http://www.berkshirehathaway.com/2006ar/2006ar.pdf) and wondering about break up values, and completely missing the point about Buffett, the company and shareholders.

Here are details for this year’s outing.

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Our annual meeting this year will be held on Saturday, May 5th.

As always, the doors will open at the Qwest Center at 7 a.m., and a new Berkshire movie will be shown at 8:30. At 9:30 we will go directly to the question-and-answer period, which (with a break for lunch at the Qwest’s stands) will last until 3:00.

Then, after a short recess, Charlie and I will convene the annual meeting at 3:15. If you decide to leave during the day’s question periods, please do so while Charlie is talking.

The best reason to exit, of course is to shop. We will help you do that by filling the 194,300 square foot hall that adjoins the meeting area with the products of Berkshire subsidiaries.

Last year, the 24,000 people who came to the meeting did their part, and almost every location racked up record sales. But records are made to be broken, and I know you can do better.

This year we will again showcase a Clayton home (featuring Acme brick, Shaw carpet, JohnsManville insulation, MiTek fasteners, Carefree awnings and NFM furniture).

You will find that the home, priced at $139,900, delivers excellent value. Last year, a helper at the Qwest bought one of two homes on display well before we opened the doors to shareholders. Flanking the Clayton home on the exhibition floor this year will be an RV and pontoon boat from Forest River.

GEICO will have a booth staffed by a number of its top counselors from around the country, all of them ready to supply you with auto insurance quotes.

In most cases, GEICO will be able to give you a special shareholder discount (usually 8%). This special offer is permitted by 45 of the 50 jurisdictions in which we operate. (One supplemental point: The discount is not additive if you qualify for another, such as that given certain groups.) Bring the details of your existing insurance and check out whether we can save you money.

For at least 50% of you, I believe we can. And while you’re at it, sign up for the new GEICO credit card. It’s the one I now use (sparingly, of course).

On Saturday, at the Omaha airport, we will have the usual array of aircraft from NetJets available for your inspection. Stop by the NetJets booth at the Qwest to learn about viewing these planes.

Buffett is 76 this year so succession is looming larger in his mind.

There are candidates, but finding someone with longevity seems to be the key objective.

Here, Buffett spells out the criteria and the way the company is going about renewing the existing succession plan: there’s a telling confession of a big mistake, there’s some good criticisms of CEO remuneration and there’s news of some changes on the BH board.

And there’s an explanation for shareholders on Buffett’s decision to push much of his wealth into charitable foundations and what he expects will be done with it.

All in a direct and forthright commentary:

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I have told you that Berkshire has three outstanding candidates to replace me as CEO and that the Board knows exactly who should take over if I should die tonight. Each of the three is much younger than I. The directors believe it’s important that my successor have the prospect of a long tenure.

Frankly, we are not as well-prepared on the investment side of our business.

There’s a history here: At one time, Charlie was my potential replacement for investing, and more recently Lou Simpson has filled that slot. Lou is a top-notch investor with an outstanding long-term record of managing GEICO’s equity portfolio.

But he is only six years younger than I. If I were to die soon, he would fill in magnificently for a short period. For the long-term, though, we need a different answer.

At our October board meeting, we discussed that subject fully. And we emerged with a plan, which I will carry out with the help of Charlie and Lou.

Under this plan, I intend to hire a younger man or woman with the potential to manage a very large portfolio, who we hope will succeed me as Berkshire’s chief investment officer when the need for someone to do that arises.

As part of the selection process, we may in fact take on several candidates.

Picking the right person(s) will not be an easy task. It’s not hard, of course, to find smart people, among them individuals who have impressive investment records.

But there is far more to successful long-term investing than brains and performance that has recently been good.

Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes.

We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered.

Certain perils that lurk in investment strategies cannot be spotted by use of the models commonly employed today by financial institutions.

Temperament is also important. Independent thinking, emotional stability, and a keen understanding of both human and institutional behavior is vital to long-term investment success. I’ve seen a lot of very smart people who have lacked these virtues.

Finally, we have a special problem to consider: our ability to keep the person we hire.

Being able to list Berkshire on a resume would materially enhance the marketability of an investment manager. We will need, therefore, to be sure we can retain our choice, even though he or she could leave and make much more money elsewhere.

There are surely people who fit what we need, but they may be hard to identify.

In 1979, Jack Byrne and I felt we had found such a person in Lou Simpson. We then made an arrangement with him whereby he would be paid well for sustained over performance.

Under this deal, he has earned large amounts. Lou, however, could have left us long ago to manage far greater sums on more advantageous terms. If money alone had been the object, that’s exactly what he would have done.

But Lou never considered such a move. We need to find a younger person or two made of the same stuff.

* * * * * * * * * * * *

The good news: At 76, I feel terrific and, according to all measurable indicators, am in excellent health. It’s amazing what Cherry Coke and hamburgers will do for a fellow.

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The composition of our board will change in two ways this spring.

In selecting a new director, we were guided by our long-standing criteria, which are that board members be owner-oriented, business-savvy, interested and truly independent.

I say “truly” because many directors who are now deemed independent by various authorities and observers are far from that, relying heavily as they do on directors’ fees to maintain their standard of living.

These payments, which come in many forms, often range between $150,000 and $250,000 annually, compensation that may approach or even exceed all other income of the “independent” director.

And – surprise, surprise – director compensation has soared in recent years, pushed up by recommendations from corporate America’s favorite consultant, Ratchet, Ratchet and Bingo. (The name may be phony, but the action it conveys is not.)

Charlie and I believe our four criteria are essential if directors are to do their job – which, by law, is to faithfully represent owners. Yet these criteria are usually ignored.

Instead, consultants and CEOs seeking board candidates will often say, “We’re looking for a woman,” or “a Hispanic,” or “someone from abroad,” or what have you. It sometimes sounds as if the mission is to stock Noah’s ark.

I suppose one of the bugbears of many investors, large and small in every market is the amount of money fund managers make and the excuses they invent when they don’t perform.

The complaints are similar the world over, even from someone like Warren Buffett.

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Wall Street’s Pied Pipers of Performance will have encouraged the futile hopes of the family. The hapless Gotrocks will be assured that they all can achieve above-average investment performance – but only by paying ever-higher fees. Call this promise the adult version of Lake Woebegon.

In 2006, promises and fees hit new highs. A flood of money went from institutional investors to the 2-and-20 crowd (that’s private equity).

For those innocent of this arrangement, let me explain: It’s a lopsided system whereby 2% of your principal is paid each year to the manager even if he accomplishes nothing – or, for that matter, loses you a bundle – and, additionally, 20% of your profit is paid to him if he succeeds, even if his success is due simply to a rising tide.

For example, a manager who achieves a gross return of 10% in a year will keep 3.6 percentage points – two points off the top plus 20% of the residual 8 points – leaving only 6.4 percentage points for his investors.

On a $3 billion fund, this 6.4% net “performance” will deliver the manager a cool $108 million.

He will receive this bonanza even though an index fund might have returned 15% to investors in the same period and charged them only a token fee.

Let me end this section by telling you about one of the good guys of Wall Street, my long-time friend Walter Schloss, who last year turned 90. From 1956 to 2002, Walter managed a remarkably successful investment partnership, from which he took not a dime unless his investors made money.

My admiration for Walter, it should be noted, is not based on hindsight. A full fifty years ago, Walter was my sole recommendation to a St. Louis family who wanted an honest and able investment manager.

Walter did not go to business school, or for that matter, college. His office contained one file cabinet in 1956; the number mushroomed to four by 2002. Walter worked without a secretary, clerk or bookkeeper, his only associate being his son, Edwin, a graduate of the North Carolina School of the Arts.

Walter and Edwin never came within a mile of inside information.

Indeed, they used “outside” information only sparingly, generally selecting securities by certain simple statistical methods Walter learned while working for Ben Graham.

A highlight of Buffett’s letter to shareholders is always the disclosure of his big equity holdings: investments worth $US700 million or more.

Warren Buffet is known as the Sage of Omaha. He hasn’t become the world’s smartest investor without learning quite a bit along the way.

Signs of stability among lenders as investors accepted assurances from US Treasury Secretary, Henry Paulson, that the problems would not spread and would be contained to the subprime area.

Australia’s trade deficit dipped below the $1 billion mark in January thanks to a rise in exports and a small pullback in imports.

The Australian Bureau of Statistics said the trade balance of goods and services in January was a seasonally adjusted deficit of $876 million compared to the upwardly revised $1.379 billion shortfall in December.

Imports fell one per cent, while total exports rose two per cent except rural exports which fell one per cent because of the drought.

The figures were another tantalising hint of the still to really be achieved boom in exports from all the investment in resources in states like WA, Queensland plus the Northern Territory, and to a lesser extent, NSW and South Australia.

It’s not that exports haven’t been flowing in rising volumes from the iron ore, coal, copper, lead, zinc and alumina mines and plants: they have, it’s just not in the volumes we are demanding.

Much of the rapid rise in value reflect higher world prices and not significantly higher volumes: that has been true to an extent in coal, iron ore, copper, zinc, oil products, lead and gold.

Still any rise is better than a ballooning deficit so the forecast yesterday from the Australian Bureau of Agricultural and Resource Economics is to be welcomed.

ABARE issued its forecast for 2007-08 at the start of its annual outlook conference in Canberra.

The forecast assumes that the drought is breaking (it certainly is in northern and northwestern and central Australia) and it says that commodity exports will hit a record of $148 billion in the 2007-908 financial year.

That would be seven per cent above the expected level for the year to June 2007 of $138 billion. That’s down 1.4 per cent from the December forecast of $140 billion: a fall driven by the drought.

This slowing pace of growthwill continue for the next five years according to forward projections by ABARE.

The agency expects the value of Australian commodity exports to rise in real terms in 2008-09, before a gradual easing toward the end of 2011-12. Exports are still projected to be worth about $141 billion in 2011-12, two per cent higher than in 2006-07.

If that happens it doesn’t sound promising for some of those ‘blue sky’ forward valuations from impressionable investment analysts for BHP Billiton, Rio and the like.

What it does say is cost cuts and restructurings are on the agenda from around 2008 onwards for many mining companies.

ABARE Director, Phillip Goyle said in the March edition of its quarterly outlook that “The growth in export earnings forecast for 2007-08 mainly reflects increased shipments of iron ore, coal, LNG copper, grains and oilseeds in response to strong demand in overseas market”.

A rebound in markets yesterday and overnight, driven mainly by a recovery in Japan and a drop in the value of the yen, ending the recent appreciation of the currency against the Euro in particular.

How figures can tell a different story:

Holden yesterday cut around 600 jobs from its Adelaide car manufacturing business as sales of the new fuel-thirsty six cylinder Commodore continued to underperform the company’s expectations.

The cuts came as figures were released showing that car sales have jumped 9 per cent in the first two months of the year: but sales of locally-made Holdens are sluggish.

Hence the pressure on employment.

The company said the cuts would be made through voluntary redundancies and follow the ending of the dual manufacturing of the new and old Commodores models and the more efficient plant after half a billion dollars was spent upgrading it.

Yes, but the latest figures on car sales show the new Commodore isn’t doing well, so there’s a big hint the company is matching labour force to car production levels.

With Ford selling fewer Falcons (Ford’s performance is worse than Holden’s so far in 2007), there will now be questions over the Melbourne operations of that struggling US giant.

The Adelaide job losses follow a slide in sales of the locally built Commodore range in 2006 and the carmaker’ $144 million after tax loss for 2005.

Holden cut 1,400 jobs in August 2005 when it decided to axe its third shift at Elizabeth due to falling local and global demand for large cars: that situation hasn’t improved here or in many foreign markets.

Likewise Mitsubishi has seen some stability in the sales of locally made versions of the 380 model, but at a low level. Sales have risen slightly in the first two months of this year but nothing like the 14 per cent rise in locally made Toyotas (for the Camry and the Aurion).

So it could be more bad news for Adelaide later in the year with continuing speculation about the future of the Mitsubishi car making operations there. There was considerable speculation late last year that they could be closed in 2007.

The Reserve Bank board meets later today and no change in the current interest rate level of 6.25 per cent is expected, although there’s a worry or two in some figures released in the last day or so.

It’s going to be a nervy day on local markets today after Wall Street fell sharply on Friday and the prices of major commodities also slumped.

After our market shed 4.1 per cent on the ASX 200 last week (and which closed lower on Friday at 5786, with the All Ords also down at 5775) the last thing investors would have wanted was a bone rattler on Wall Street and other markets on Friday night.

But that’s what they got.

The Dow lost 120 points or about 1 per cent, while the broader S&P 500 index fell 1.1 per cent. NASDAQ composite fell 1.5 per cent on Friday: all big falls but amplified by the nervousness ignited by Tuesday’s big fall, the biggest since September 11, 2001.

For the week, the Dow lost 4.2 per cent and saw its worst decline on a percentage basis since late March 2003; The S&P 500 lost 4.4 per cent for the week, in its worst weekly performance since late January 2003 and NASDAQ fell 5.8 per cent this week, the worst drop in just over two and a half years.

US Government 10 year bonds finished at 4.5 per cent, equal to the level set in the aftermath of Shanghai Tuesday last week and a sign that more and more investors are retreating from the sidelines.

Here the SFE Share Price Index was showing a 47 point fall Saturday morning for the ASX 200 when trading resumes today. But everyone will be watching how China and especially Tokyo open later on.

US investment banks such as Goldman Sachs, Merrill Lynch, Bear Stearns, Citigroup and big banks in Europe such as HSBC, UBS and Credit Suisse all saw their share prices under pressure last week because investors perceive them to be engaging in risky activity: whether it is emerging markets, private equity, hedge funds, aggressive proprietary trading or servicing the troubled US housing market, including the imploding subprime sector.

Anything to do with risk is now being avoided by investors so it will be interesting to watch the prices today of Macquarie Bank (up in Friday’s down market after a profit upgrade), Babcock and Brown, Allco and Allco Equity Partners and similar sorts of listed investors.

Qantas firmed to over $5.20 on Friday in the wake of the ACCC’s approval of the buyout on Thursday.

In London on Friday the Financial Times was reporting that commodities, though down over the week, had shown some resilience.

A few hours in New York it was clear that apart from oil (which eased a touch only) commodities were much weaker than thought.

For example LME copper prices eased $US87 a tonne to $US6013 a tonne, a fall of 1.4 per cent. Several hours later in New York the price closed down 2.56 per cent at $US2.63 a lb, a loss of 7USc a lb.

Gold closed down sharply around $US648 an ounce in London, and was off more in New York at $US644 an ounce, a loss of 3.1 per cent.

Traders said that what was notable was the way the instability in stocks fed into other markets (with US bonds the only one benefiting as prices on bonds rose and yields fell sharply).

Much of the shuffling in equities and commodity markets was done by financial investors (AKA speculators, hedge funds and the like) who liquidated positions to generate cash and de-risk their books.

Copper prices in New York fell 5.2 per cent last week ending the February rally.

Gold fell 6.2 per cent last week, silver 12 per cent. Analysts said $US1.3 trillion in value was wiped from equity markets around the world and hundreds of billions more disappeared in commodity and other markets.

Bonds, not precious metals were the only safe haven for nervous investors.

Copper is being hurt by the withdrawal of speculative positions built up in the rally last month: as US copper consumption fell, dragging prices down in January Chinese buyers started picking up the cheaper priced metal, leading to a rush of money punting on a rise in Chinese consumption.

What many forget was that China withdrew from world copper markets in the last half of 2006 because prices were too expensive and ran down internal stocks.

In the words of an adviser to President Clinton back in the race for the 1992 presidential election, a sign was placed in the campaign office which read “It’s The Economy, Stupid”.