By Sam Jones and Jack Farchy
Published: July 9 2010 19:10 | Last updated: July 9 2010 19:10
Not so long ago, hedge funds would send their most junior analysts to the seminars that bullion bankers hosted.
Gold, for much of the past two decades, was the ultimate dreary asset – of interest only to central bankers and miners.
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Now those same bankers are struggling to find time in their diaries to fit in many of the hedge fund industry’s biggest players.
In mid-town New York, funds that employ barely 100 staff are finding themselves with gold holdings larger than those of some developed nations.
Paulson & Co, one of the world’s most successful hedge fund managers, denominates a third of its $33bn of assets under management in a share class bolstered by huge positions in the gold market.
In fact, gold is the firm’s largest single position. The $3.4bn stake in the SPDR Gold Trust, a listed US instrument backed by physical gold, equates to a greater tonnage of the metal than Australia holds.
The reason for this is simple. Amid fears that the global economy could be heading for a double-dip recession – and as financial markets continue to gyrate – some hedge managers are becoming increasingly bullish about the precious metal. They are drawn to gold’s traditional status as a store of value in crises.
Paulson & Co is the largest hedge fund to back gold, but others including Soros Fund Management, Tudor Investment Corp, Greenlight Capital and Third Point, are now converts.
“I have never been a gold bug,” Paul Tudor Jones, founder and chairman of Tudor Investment, wrote last year. “It is just an asset that, like everything else in life, has its time and place. And now is that time.”
The consensus view among the funds is that the price of gold – trading at around $1,200 an ounce – will rise to well above $1,500 before it suffers any sizeable correction.
This expectation of further prices rises (gold has increased four-fold since 2002) is based in part on the view that bullion provides a hedge against a rise in inflation.
Some fund managers believe a sharp jump in inflation is unavoidable as a result of central banks’ monetary easing policies, which have, in effect pumped more money into the economy.
Historically, they say, the correlation between gold and inflation is hard to ignore.
Over the past half century, the gold price has tracked the amount of money in the world – measured broadly in terms of “M2” monetary supply – fairly accurately, peaking at times of inflation, such as the mid-1970s and early 1980s.
The hedge funds argue that the recent swelling of the monetary base will translate into a spike in monetary supply. When it does, gold prices will follow.
“The number of funds who are exposed to gold has increased massively in the last three or four years,” says Philip Klapwijk, executive chairman of GFMS, a precious metals consultancy.
In common with other investors, hedge funds are also keen to hold their gold in physical form – either as bars in a vault or as an investment in an exchange-traded fund backed by physical assets.
Marcus Grubb, head of investment research at the World Gold Council, an industry-backed body, says the funds are looking to reduce counterparty risk in the event of another crisis: “In the past they might have been happy to just use futures strategy, now they are looking to have physical investment.” Many analysts agree that gold is likely to set fresh nominal all-time highs in the coming months. But they also see the weight of investment in the metal as a warning signal.
Mr Klapwijk says the rush to invest in the metal is not irrational. The motivation is fear about the debasement of paper currencies and of a panic in markets fuelled by any worsening in the eurozone debt crisis. But he also says that gold currently has “elements of a bubble”.
Jeffrey Currie, head of commodities research at Goldman Sachs, points to a strong historical inverse relationship between gold prices and real interest rates. The time to sell, he says, will be when the economy returns to normal.
“It’s pretty simple. Just stay long until real rates rise, likely driven by central banks taking liquidity out of the system.”
“Gold’s appeal is clear in this zero cost of carry environment,” says Mr Klapwijk. “But what if real interest rates were at 3 per cent? In my view, investor interest would be a good deal lower.”
At that point, other supply and demand factors may come into play.
As the price of gold has risen, jewellery buying in India, typically the backbone of gold consumption, has fallen sharply. So, if investors bought gold at a slower rate or became net sellers, the price would probably fall until other sources of demand picked up the slack.
“Don’t forget, gold is also a commodity with supply and demand fundamentals that can come into play,” says Mr Klapwijk.
Some managers are all to aware of the distinction, and view with derision the bets of their colleagues in a market they know little about.
“The problem is that people see it [gold] as both a commodity and a refuge,” said the manager of one London-based macro hedge fund. “It is not really a liquid instrument and there’s a danger that the market is being cornered.”
Paulson & Co remains optimistic that the trade is not crowded. In a presentation to potential investors, salesmen from the firm point out that gold ETF holdings amount to $78.3bn,a fraction of the $2,849bn held by US money market funds. The implication is that, with massive unconventional monetary easing under way, gold will become the ultimate store of value.
Not all hedge funds are convinced, however. While a third of Paulson & Co’s assets under management are denominated in gold, most of the holdings are those of its employees, including Mr Paulson.
In spite of having one of the best names in the business, Mr Paulson’s dedicated gold fund, which has a capacity of up to $5bn, has raised just $500m.