Paul Tudor Jones goes for gold

Weekly Wanderings 3 November 2009

This weeks musings feature…

• King World News interview with Rick Rule summarized.‎

• Paul Tudor Jones goes for gold.‎

• Nouriel Roubini and the carry trade bubble

‎(a)  Rick Rule‎

This week among the wealth of material at King World News (, Eric has ‎an interview with Rick Rule, who is the founder and owner of Global Resource Investments LP, and ‎affiliated entities, which are involved in securities brokerage, investment management and corporate ‎finance, focused on natural resources and basic industries. Mr. Rule and his firm are successfully ‎involved in agriculture, alternative energy, conventional energy, forestry, infrastructure, mining and ‎water resources investing on a worldwide basis. Mr Rule is well known as an extremely astute ‎resources investor He is intending to visit Auckland this coming January, and I for one will be very ‎intent on what he has to say. In this week’s column, I summarize the contents of this interview. ‎

‎(a)‎ At present, the US dollar may be somewhat oversold, and gold somewhat overbought, ‎suggesting that the dollar may undergo some sort of rebound in the near-term. Gold could fall ‎back once again below $1000/oz, possibly down as far as $850/oz. ‎

‎(b)‎ If the gold bull market, which appears to be entering its Phase 2  (out of 3) up-leg, continues ‎to develop, then the silver market, which is much smaller, “could get goofy” to the upside. ‎Rick pointed out that the silver market is difficult to analyze, because of the opacity of supply ‎and demand factors in South Asia, where gold and silver have always been traditional stores ‎of wealth.‎

‎(c)‎ As we have pointed out in other articles also, the Chinese government is actively encouraging ‎its citizens to purchase gold and silver. The implication here is that, if a 3rd manic phase were ‎to develop in the precious metals markets, then there are millions more potential buyers out ‎there than there were the last time around.‎

‎(d)‎ With regard to precious metals stocks, there are a few quality junior companies that are ‎currently substantially undervalued, suggesting that there may be a number of takeovers ‎arising at some stage.‎

‎(e)‎ Gold and silver mining stocks are still stocks. Hence if there were to be a stock market sell-‎off, these stocks would likely sell off as well, as a panic sell-off causes a rush to liquidity as ‎margin calls have to be met….‎

‎(f)‎ With regard to the markets in general, Rick sees a number of factors that suggest that it is far ‎too early to be talking of green shoots. One of the more ominous things on the horizon is the ‎massive amount of commercial real estate debt that has to be refinanced over the next 2 – 3 ‎years.‎

‎(g)‎ The gold market is cyclical in nature….there will come a time to get out and into other ‎resource markets, such as the market in water and water rights…..BUT that time is not yet. ‎


‎(b) Paul Tudor Jones‎

Paul Tudor Jones is arguably the most successful hedge fund manager of all time. When he joins David ‎Einhorn and John Paulson in going for gold, it pays to prick up an ear and listen….‎

The following material is paraphrased from the appendix of the third quarter letter of the Tudor BVI ‎Global Fund, in which he outlines his rationale for investing in gold.‎

He begins by pointing out the dynamics of the gold market are very different from other commodity ‎markets. Gold is not consumed; it is accumulated. Also, in times of (hyper)inflation, or at  times when ‎the financial system appears unstable, gold becomes a more reliable store of value than fiat currencies, ‎which have intrinsically have no value, being based on faith.‎

How do we determine, at any given moment, whether gold is cheap or expensive? ‎
A number of charts, presented below, enable us to obtain at least a partial answer to this question. One ‎measure is to look at total market capitalization of gold compared to the amount of global (G-20) and ‎US base money, as measured by M2. The important point to note is that gold’s value should increase as ‎its scarcity relative to printed currencies increases. We concur with this view, as B52 Ben has declared ‎himself as a money printer par excellence. ‎

Source: the Tudor Group.‎

This is but one measure that the Tudor group examines to determine the value of gold at the present ‎time. Their proprietary model suggests that gold is currently, and likely to remain so over the next 2 ‎years, 20% undervalued. They also observe that the base of M2 growth is likely to quicken over the ‎next 2 years.‎

Also of note is that the inflation adjusted all time high of the gold price was $2422 on 21st January, ‎‎1980.‎

It is also important to consider supply and demand factors.‎

Below is a chart (Chart G) of annual world gold production. The rate of increase in production is ‎declining.‎

On the demand side, we have a number of factors leading to increased demand. There is continued ‎strong investment demand for physical gold in the face of heightened global uncertainty and ‎unprecedented global monetary stimuli. Secondly, the advent of physically backed gold (and silver) ‎ETFs has increased demand from a new investor class. Chart J below indicates the rate of increase in ‎Gold ETF holdings.‎

Another fundamental change in the demand for gold is the shift of the official sector from being a net ‎seller to a net buyer.‎

The Tudor Group state that, in their opinion, the scope for increased investment demand over the ‎coming years is much greater than the potential for lower demand resulting from new supply. As a ‎result, incremental demand must be supplied from current holders – many of whom will not wish to ‎transfer their gold at or near current prices. ‎


c) Nouriel Roubini

The following column was carried by the Financial Times. Professor Roubini discusses the ‎development of the dollar carry trade that we have talked about previously, and points out the ‎obvious, really, namely that when this bubble bursts, the carnage will be terrible to behold. ‎

Mother of all carry trades faces an inevitable bust

By Nouriel Roubini
Published: November 1 2009 18:44 | Last updated: November 1 2009 18:44‎

Since March there has been a massive rally in all sorts of risky assets – equities, oil, energy and ‎commodity prices – a narrowing of high-yield and high-grade credit spreads, and an even bigger rally ‎in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has ‎weakened sharply , while government bond yields have gently increased but stayed low and stable. ‎
This recovery in risky assets is in part driven by better economic fundamentals. We avoided a near ‎depression and financial sector meltdown with a massive monetary, fiscal stimulus and bank bail-outs. ‎Whether the recovery is V-shaped, as consensus believes, or U-shaped and anaemic as I have argued, ‎asset prices should be moving gradually higher. ‎

But while the US and global economy have begun a modest recovery, asset prices have gone through ‎the roof since March in a major and synchronised rally. While asset prices were falling sharply in 2008, ‎when the dollar was rallying, they have recovered sharply since March while the dollar is tanking. ‎Risky asset prices have risen too much, too soon and too fast compared with macroeconomic ‎fundamentals. ‎

So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero ‎interest rates and quantitative easing. But a more important factor fuelling this asset bubble is the ‎weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the ‎major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do ‎so for a long time. Investors who are shorting the US dollar to buy on a highly leveraged basis higher-‎yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they ‎are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the ‎fall in the US dollar leads to massive capital gains on short dollar positions. ‎

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis ‎on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry ‎trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge ‎bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per ‎cent range since March. ‎

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been ‎increasing due to a rising correlation of the risks between different asset classes, all of which are driven ‎by this common monetary policy and the carry trade. In effect, it has become one big common trade – ‎you short the dollar to buy any global risky assets. ‎

Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is ‎diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn ‎‎(£1,000bn, €1,200bn) purchase of Treasuries, mortgage-backed securities (bonds guaranteed by a ‎government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the ‎volatility of individual asset classes, making them behave the same way, there is now little ‎diversification across markets – the VAR again looks low. ‎

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive ‎purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother ‎of all carry trades and mother of all highly leveraged global asset bubbles.‎

While this policy feeds the global asset bubble it is also feeding a new US asset bubble. Easy money, ‎quantitative easing, credit easing and massive inflows of capital into the US via an accumulation of ‎forex reserves by foreign central banks makes US fiscal deficits easier to fund and feeds the US equity ‎and credit bubble. Finally, a weak dollar is good for US equities as it may lead to higher growth and ‎makes the foreign currency profits of US corporations abroad greater in dollar terms.‎

The reckless US policy that is feeding these carry trades is forcing other countries to follow its easy ‎monetary policy. Near-zero policy rates and quantitative easing were already in place in the UK, ‎eurozone, Japan, Sweden and other advanced economies, but the dollar weakness is making this global ‎monetary easing worse. Central banks in Asia and Latin America are worried about dollar weakness ‎and are aggressively intervening to stop excessive currency appreciation. This is keeping short-term ‎rates lower than is desirable. Central banks may also be forced to lower interest rates through domestic ‎open market operations. Some central banks, concerned about the hot money driving up their ‎currencies, as in Brazil, are imposing controls on capital inflows. Either way, the carry trade bubble ‎will get worse: if there is no forex intervention and foreign currencies appreciate, the negative ‎borrowing cost of the carry trade becomes more negative. If intervention or open market operations ‎control currency appreciation, the ensuing domestic monetary easing feeds an asset bubble in these ‎economies. So the perfectly correlated bubble across all global asset classes gets bigger by the day.‎

But one day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead ‎the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-‎funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their ‎dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset ‎classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, ‎commodities, emerging market asset classes and credit instruments. ‎

Why will these carry trades unravel? First, the dollar cannot fall to zero and at some point it will ‎stabilise; when that happens the cost of borrowing in dollars will suddenly become zero, rather than ‎highly negative, and the riskiness of a reversal of dollar movements would induce many to cover their ‎shorts. Second, the Fed cannot suppress volatility forever – its $1,800bn purchase plan will be over by ‎next spring. Third, if US growth surprises on the upside in the third and fourth quarters, markets may ‎start to expect a Fed tightening to come sooner, not later. Fourth, there could be a flight from risk ‎prompted by fear of a double dip recession or geopolitical risks, such as a military confrontation ‎between the US/Israel and Iran. As in 2008, when such a rise in risk aversion was associated with a ‎sharp appreciation of the dollar, as investors sought the safety of US Treasuries, this renewed risk ‎aversion would trigger a dollar rally at a time when huge short dollar positions will have to be closed. ‎

This unraveling may not occur for a while, as easy money and excessive global liquidity can push asset ‎prices higher for a while. But the longer and bigger the carry trades and the larger the asset bubble, the ‎bigger will be the ensuing asset bubble crash. The Fed and other policymakers seem unaware of the ‎monster bubble they are creating. The longer they remain blind, the harder the markets will fall.‎
The writer is a professor at New York University’s Stern School of Business and chairman of Roubini ‎Global Economics

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