Hedge Fund Managers Join the Gold Rush

March 2, 2010

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798689_gold_panning_at_shantytownWe Canadians have a lot to be proud of as evidenced by our record-breaking gold medal haul. Not content to simply win a gold medal for the first time at an Olympic event on Canadian soil, we went on to top what any country had ever won at any Winter Olympics. And uncharacteristically we did not mind letting everybody know about our newfound national pride. Especially after Sid the Kid’s golden game winning goal!

But we are not the only people who are enamoured of gold lately.  It seems that some very important hedge fund managers have discovered the shiny metal.  It is well known that the first into the golden pond was our own Eric Sprott, who was well ahead of the crowd when he bought most (some say all) of the bullion the Bank of Canada sold several years ago. It now slumbers deep below the streets of Toronto in the safety of the ScotiaBank vaults.

After several months of poopoo-ing gold, George Soros suddenly became its greatest fan-presumably after his buying program was completed. And before him, another hugely successful and mega rich hedge fund manager, John Paulson started a fund to invest solely in gold and gold-related securities.  Now I have a very high regard for both of these managers and in my experience, neither lays a lot of money on the line without having a high probability of a win and furthermore, a low probability of losing money. (Not the inverse of one another.)

What property of gold gives it this unusual payoff pattern?

For over a year now economic forecasters have been evenly split between seeing a post crisis world of raging inflation and depressing deflation.  The inflation camp points at the high monetary creation and fiscal stimulus as the seed for future price increases.  The deflation camp points to the massive output gap, high unemployment and huge central bank balance sheet distortions as the source for deflation.  Frankly, who knows?

Gold responds positively to both of these events because of its inherent store of value characteristic.  If assets are devaluing, gold is the ultimate store of value.  Consequently, the only scenario where gold investors lose is if we slowly return to a normal functioning economy. They are winners in the deflation and inflation scenarios.

And the wild card in how this plays out is China.

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