Warren Buffett's annual letter to shareholders came out last week..

 by Stansberry & Associates Investment Research

Warren Buffett's annual letter to shareholders came out last week… And the first thing I noticed was that Berkshire Hathaway's per-share book value (Buffett's favorite method of valuing the company) grew 4.6% compared with last year… one of the three worst years in the company's 47-year history. Still, Buffett said he's happy with the results. He outperformed the S&P 500 (which returned 2.1% pre-tax, nearly all in dividends). He wrote…

Our major businesses did well last year. In fact, each of our five largest non-insurance companies – BNSF, Iscar, Lubrizol, Marmon Group, and MidAmerican Energy – delivered record operating earnings. In aggregate these businesses earned more than $9 billion pre-tax in 2011. Contrast that to seven years ago, when we owned only one of the five, MidAmerican, whose pre-tax earnings were $393 million. Unless the economy weakens in 2012, each of our fabulous five should again set a record, with aggregate earnings comfortably topping $10 billion.

Buffett also said he thinks book value is a "considerably understated" proxy for intrinsic value.

Hedge-fund manager Whitney Tilson, a foremost expert on all things Buffett-related, said in an e-mail today that he thinks "over time, as Berkshire's value has shifted from its stock portfolio, which is valued at market (i.e., book value), to operating businesses like GEICO and [BNSF Railway], that Berkshire's intrinsic value is a greater percentage premium to book value – yet the stock is currently trading near the lowest premium to book in its history."

Also in the letter, Buffett reaffirmed his intent to repurchase Berkshire shares at 1.1 times book value (or $110,000 a share). Shares currently trade at $120,300. And they're trading near their lowest premium to book value in history. According to the Wall Street Journal…

After dropping 4.7% in 2011 and rising only half as much as the S&P 500 index so far this year, Berkshire shares are trading near their lowest valuation in decades: close to 1.1 times book value, versus its average valuation of about 1.6 times book value over the past two decades.

What struck me most about this year's letter was Buffett's discussion of languishing stocks… and how he likes flat markets (perhaps another reason he was so happy with Berkshire's 2011 performance).

When you buy high-quality companies, as Buffett does, you should only concern yourself with the company's earnings and shareholder payouts… Ignore the market noise. Buffett uses his recent IBM purchase as an example. (Berkshire owns 63.9 million shares, or 5.5% of the company.) As a long-term shareholder of IBM, what should Berkshire wish for over the next five years? Buffett says he wants the stock to "languish." Below is a long excerpt, but his reasoning important…

Let's do the math. If IBM's stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.

If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the "disappointing" scenario of a lower stock price than they would have been at the higher price. At some later point, our shares would be worth perhaps $11.2 billion more than if the "high-price" repurchase scenario had taken place.

The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day's supply.

So the next time someone complains about Microsoft "going nowhere" over the past 10 years, enjoy a private chuckle. And enjoy the increasing earnings power and growing dividends. It's the beauty of buying a capital-efficient business… These businesses earn large returns on tangible assets without large capital expenditures. And they can increase their returns without big increases to capital spending.

Buffett also dedicated part of his letter to discussing his distaste for gold and gold stocks. He still prefers farmland, operating companies, and cash. But according to executives at the world's largest gold mining companies, their stocks are poised to rally.

"At some point, we become so inexpensive on a cash flow per share multiple that it makes no sense for buyers not to acquire the stock," Goldcorp CEO Chuck Jeannes said in a February 15 interview with Bloomberg. Gold-mining shares have fallen out of favor as investors moved capital into gold-backed exchange-traded funds (ETFs) and other proxies for physical gold. Over the past five years, the NYSE Arca Gold BUGS Index (the HUI), which includes the world's biggest mining stocks, has advanced 53%. Spot gold prices have more than doubled over the same time frame. Aaron Regent, CEO of the world's largest gold miner, Barrick Gold, said gold-mining stocks are heading for an "inflection point" and will soon rally.

You should consider buying gold stocks right now…

The opportunity is just too good to pass up. The last time these particular conditions came together, gold stocks rallied 121% in 12 months.

Let me explain the opportunity…

Typically, if gold goes up, gold stocks move even higher. And if gold goes down, gold stocks fall even more.

But during 2011, that relationship broke down. Take a look…

The chart shows the price of gold in blue and gold stocks in black. You can see that in 2009 and 2010, gold stocks performed as expected… They tracked the price of gold, but with more volatility.

But as you can see, that relationship fell apart in 2011… Last year, gold moved higher for the 11th straight year, gaining 10%. But gold stocks actually fell 16%.

Matt Badiali, our resident gold expert, sent me the following note about China's huge appetite for gold…

Imagine going to your favorite Macy's department store to pick up a couple of quarter-ounce bars of gold. In China, you can. Beijing's Caishikou Department Store carries gold jewelry, but it also sells gold bars. The Chinese people are so gold-focused that they are lining up at the gold-bar counter of the department store.

China will likely become the world's largest consumer of gold this year. The average person in China views gold as safety… and so do the country's leaders. China is quietly building up its gold reserves. That could become a major problem for you and me.

Matt has recently released a report describing China's quiet initiative to amass an immense gold reserve… and ultimately back its currency with gold. Given the trillion-plus dollars we owe them and the huge volume of dollars we're creating to cover our debts… this plan represents a danger to our standard of living.