Even as a long-term bear on the metal, I was initially puzzled by gold's underperformance over the past couple of months, just as the European sovereign debt crisis moved into high gear.
I thought I had the answer -- or a convincing explanation, at the very least -- for this conundrum. However, the Financial Times broke a story this week that has forced me to toss out my hypothesis.
The biggest gold bull of them all
I track a small number of investors, and John Paulson -- the man who made billions of dollars personally by betting against the subprime-mortgage market -- is among them. Was he at the origin of or a significant contributor to gold's underperformance? It seemed like a viable explanation when you put the following four observations together:
- Paulson's funds have performed atrociously this year, down by almost half this year after a one-fifth decline in September alone. Investors in his flagship fund have seen all their gains in the fund since 2008 evaporate.
- Gold was one of the firm's most profitable positions in 2010 and in 2011.
- Gold, by way of the SPDR Gold Trust (NYSE: GLD ) , is the firm's largest reported position, with a value of $4.6 billion at the end of June
- Paulson & Co. is the largest owner of the SPDR Gold Trust -- by a wide margin -- and the only hedge fund manager in the top 10.
Along with many others, I was expecting an enormous wave of redemption requests from Paulson's outside investors in response to the funds' miserable returns this year. Surely, Paulson is liquidating part of his gold inventory to meet redemptions, I thought.
There's no motivation to sell
Thankfully for Paulson, his investors have remained remarkably loyal -- for now, anyway. In a letter to his investors on Tuesday, he wrote that redemptions totaled less than 8% of firm assets -- less than the typical end-of-year redemptions the hedge fund manager receives. Consequently, it's highly unlikely that Paulson has been selling gold, or not in a significant proportion, at any rate.
What about on an ongoing basis: Does the overhang of that huge gold position present a risk to other investors? That's unlikely, and here's why. Paulson & Co. partners are now the largest investors in his hedge funds, representing more than a third of the assets under management, with John Paulson the largest single investor. The gold positions facilitate gold-denominated share classes in his hedge funds; the firm offers this option for every single one of his funds. However, the investors who have taken advantage of this option are mainly Paulson himself and some of his partners.
Conviction is very high
Everything I've read and heard -- including from people who have sat in on a presentation of the firm's thesis for gold -- suggests that the level of conviction regarding this trade is very high. (My colleague Chris Barker has high conviction on gold, and he's found 5 Clever Ways to Get Gold for Free .) Don't expect Paulson or his partners to bail out any time soon; in May, he told investors that gold could rise as high as $4,000 an ounce over the next three to five years. Given the link between the two, that high-conviction stance probably applies to the sizeable positions Paulson & Co. has accumulated in some gold miners:
|SPDR Gold Trust||--||1||$5.3 billion|
|AngloGold Ashanti (NYSE: AU )||10.4%||2||$1.8 billion|
|Gold Fields (NYSE: GFI )||6.7%||4||$824 million|
|NovaGold Resources (AMEX: NG )||8.4%||2||$185 million|
Position as of June 30, valued at Nov. 2 prices. Source: S&P Capital IQ.
So if Paulson isn't responsible for gold's mid-air stall in an environment in which it should be soaring, is there a wider trend at work that could mean the end of the bull market in gold? Remember that in July and August, gold experienced a meteoric rise, achieving an all-time nominal high above $1,910 on Aug. 22. Even though gold has been in a bubble at least since the third quarter of 2010, we had yet to witness such an acceleration in prices, which is characteristic of many bubbles.
Gold bulls: You're safe for now
Following that overheating, a decline and a period of pause is hardly surprising, and price increases in the last couple of weeks suggest that the rally may already be resuming. In other words, you look safe for now, gold bulls, as the European crisis and other problems provide fuel to the gold rocket. But don't forget that gravity will eventually assert itself -- make sure you've pulled the ripcord before then.
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