So Paulson…About that Gold Stash…

“A billion dollars ain’t what  it used to be.”

Bunker Hunt reportedly said those words in the early 1980s after the Hunt brothers lost a large chunk of their family fortune in their ill-fated cornering of the silver market.  But John Paulson must be thinking the same thing.  After Monday’s 9.3% drop, Paulson has personally lost over $1.5 billion over the past two trading days in his gold investments, not to mention the sums he has lost for his clients.


It's only money...
It’s only money…

As much as I would love to, I can’t gloat because even after the recent bloodletting gold bugs can call scoreboard on me. I initially got bearish on gold in 2010 when it crossed $1,200, believing at the time that the gold bubble has reached the euphoria stage.  Well, it got a lot more euphoric from there, rising another 50% from that point…and I had to eat a lot of crow.

Though probably not as much as Paulson right now.

The recent action should finally lay to rest one of the common misconceptions about gold: that it is a stable store of value.

No asset that has risen in value by a factor of six is “stable.”  Gold is a speculative asset like any other whose price is determined by the whims of the market.  As the more “financialized” gold gets via ETFs and mutual funds, the more it behaves like the rest. Gold is not an antidote to stocks or other “paper” assets. It has now become a paper asset.

While gold may, in theory, have value as an inflation hedge, this matters very little in a world where most industrialized countries have inflation rates under 2%.  But most fundamentally, gold fails my test as an investment because it pays no interest or dividends and has no productive purpose.  It is a shiny metal…and nothing more.

But none of this matters in the short-term.  As any good trader knows, in the short-term the only thing that matters is supply and demand.  And this is why I would steer clear of gold for the time being.

As the Dow hits new highs and the 2008 crisis becomes more of a memory, investors are starting, albeit slowly, to return to the stock market.  This is very bad news for someone like John Paulson, who needs a large pool of greater fools on which to unload his massive gold hoard.

At the risk of picking on John Paulson, he’s really gotten himself into a mess.  By GuruFocus estimates, he owns 22 million shares of the SPDR Gold Trust (NYSE:GLD), holding more than 10% of all traded shares.  He also holds stakes in miners and in physical bullion.  When the size of Paulson’s gold bet became known, the New York Times calculated that Paulson owned more gold than the Australian government.

If you were a hedge fund manager or trader and you thought that there was even a slight possibility that Paulson was going to liquidate, you would rush to the front of the line to sell before he did.

I’m not saying that this is exactly what happened on Friday and Monday.  But a technical explanation like this is far more plausible than the explanation given in the media: slower growth from China.

Chinese growth of three tenths of a percent lower than expected does not “cause” gold to lose over 9% of its value in one day.  But a hedge fund stampede most certainly would.

Gold might enjoy a dead-cat bounce today and in the days ahead.  But given the large investors with enormous positions to unwind, I wouldn’t advise trying to bargain hunt here.

Disclosures: Sizemore Capital has no interest in any security mentioned.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.

Bitcoins and Gold: I Would Short Them Both If I Could

It is truly a digital age: gold bugs have gone virtual.

I’m talking about Bitcoin, of course.  I realize that Bitcoin is not gold and has nothing to do with gold; it is a true cyber currency made of nothing but ones and zeros.  But its popularity is driven by the same forces that have caused investors to run to gold over the past decade: fear of inflation and a general mistrust of the global financial system.

Five years from now, I have my doubts as to whether Bitcoin will still be around.  In order to be taken seriously, it has to reach that tipping point where it becomes a viable medium of exchange accepted by mainstream retailers and not merely a pet project for ideological anarcho-libertarians and other assorted malcontents.  It could happen; but I’m not betting on it.  It’s taken more than a decade for Paypal to be accepted at non-internet cash registers, and Paypal is denominated in a recognized currency.  I don’t see retailers spending the money to update their payment systems any time soon, and before they do I would see this little fad fizzling out.

But I digress.  Today, I have no recommendation to short Bitcoin.  As tempting as it is, it’s dangerous to short anything that is in the middle of a parabolic move.  (And, alas, I’m not sure if it’s even possible to short Bitcoin at this time, unless there are derivatives I am unaware of.)

Instead, I recommend shorting Bitcoin’s far older predecessor, the barbarous relic itself: gold.

Gold has been in virtual free far since October.  In that time period, we’ve seen six months of aggressive QE Infinity from the Federal Reserve, an inconclusive Italian election with the potential to plunge Europe back into crisis, a botched Cyprus bailout that threatened to set off a bank run, and the most aggressive monetary stimulus in modern history coming out of Japan.

If none of these developments can spark interest in gold, then it’s hard to see what will.  After a great decade-long run, it appears that the gold bull market has run its course.

Action to take: Short gold.  The easiest route is to short the SPDR Gold Trust (NYSE:$GLD), though if you want to throw a little gasoline on the fire, you can instead buy the Proshares Ultra Short Gold ETF (NYSE:$GLL), a leveraged inverse ETF.

Gold is a volatile commodity, and you should be careful when shorting it.  I recommend something along the lines of a 10% trailing stop.  Within 1-2 years, I expect gold to be trading back in the $1,000-$1,200 range.

Disclaimers: Sizemore Capital currently has no positions in any security mentioned.

What Will Gold Do in 2013?

Gold is a frustrating investment, even for its proponents.  Actually, “disciple” is probably a better a better word for the truly-committed gold investor.  More than any other asset class, gold tends to create a quasi-religious cult around itself.  An investor might buy a stock.  But they believe in gold.

Unfortunately, gold is often the god that failed.  It is billed as a “crisis hedge,” and in the lead-up to a crisis it tends to do well.  But when the crisis actually hits, gold tends to behave like any other traded risk asset.   This is more true today than in years past because of the popularity of gold ETFs, such as the popular SPDR Gold Shares (NYSE:$GLD) and other exchange-traded options favored by hedge funds and retail investors alike.  Gold has become more correlated to the stock market because now gold is the stock market.

As an “inflation hedge” or “currency hedge,” gold tends to hold its ground a little better.  But during times of macroeconomic stability it tends to lose its appeal.

As you might have guessed by now, I’m not the biggest fan of gold, particularly as a long-term investment.  It’s difficult for me to like an asset that pays no interest or dividend and has little real industrial value.  Your return on a gold trade is purely dependent on your ability to sell it to someone else at a higher price, and that bothers me.  If you buy an income-producing asset—be it a stock, bond, rental real estate, mineral rights, oil and gas royalties, a small business, etc.—you can realize a return irrespective of Mr. Market’s mood that day.

That said, gold can be a profitable trade if you are able to maintain your objectivity and not get wrapped up in the cultish ideology that tends to surround the barbarous relic.

All else equal, I would expect gold to perform well under the following set of circumstances:

  1. Loose monetary policy
  2. Sentiment neutral or bearish among individual investors
  3. There is the fear of a crisis, but the actual likelihood of a crisis hitting is small

Today, Condition 1 certainly holds.  The Fed is experimenting with the loosest monetary policy in history.  Just this week, Bernanke announced that “QE Infinity” was being expanded beyond the original $40 billion per month in mortgage securities to include another $45 billion in Treasuries.  And short-term rates would be held at virtually zero until the unemployment rate dipped below 6.5%.

Condition 2 is a little hazy.  Gold sentiment reached what I would call (in professional terms, of course) the “nutty loony” phase of bubble sentiment about two years ago.  Gold was all anyone wanted to talk about.  Since then, sentiment has settled down.  I wouldn’t call sentiment towards gold bearish by any stretch; this week the Financial Times reported that sales of American Eagle gold coins soared by 131% in November as investors feared the worst from renewed government gridlock and the ballooning debt.  But I would say that sentiment is on the slightly-bullish side of neutral.

I expect to get a little hate mail for my views on Condition 3, but I do not see any major crises hitting in 2013.

I know, I know, there is the fiscal cliff issue.  And the possibility that Europe might blow up…or that the recovery in China misfires…or that Japan’s day of reckoning finally comes

Any of these could happen, and the fear that they might happen is bullish for gold.  But I’m betting that the fiscal cliff crisis gets resolved by early January, that Europe muddles through, and that Japan’s day of reckoning is still a year or more in the future.

While I have laid out a modestly bullish case for gold over the next 6-12 months, I still don’t recommend it for most investors.  I see gold drifting higher in 2013, but I expect several other asset classes to perform much better.   With domestic energy production booming and interest rates near the lowest levels in history, I expect to see Master Limited Partnerships enjoy a monster rally.

I also expect European and emerging market stocks to have a good run, and U.S. stocks should have some life left in them too.

Gold will probably outperform bonds…but then, at current yields, begging with a soup can in front of the subway will probably be more profitable than investing in bonds.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog. This article first appeared on InvestorPlace.

A Greater Fool and Evil to Boot

The Mises Institute, dedicated to “proceeding ever more boldly against evil,” appears to take issue with some of my comments on gold ($GLD $GC_F):

Charles Sizemore, CFA, wrote back in June, “Gold today is as risky as tech stocks in 1999 and Miami condos in 2005, and the arguments supporting its rise are every bit as flimsy.”  Sizemore goes on to say that gold is not an investment and that anyone buying gold is only speculating, engaging in the “greater fool” theory.  The greater fools are those that don’t stash some yellow metal away.  (Source: “Who Are the Greater Fools“)

I suppose I should be flattered that a think tank found my off-the-cuff comments on gold so offensive that they felt obligated to denounce them in an article of their own.  Yet somehow “flattered” is not the word I would use.  “Bewildered” would be a better description.  It’s hard to see how the suggestion that gold is not an attractive investment at current inflated prices would be that offensive.

A gold hater, no doubt.

I will never understand the cult-like mentality that surrounds gold. With other investments, you have “bulls” and “bears.”  Only in the vocabulary of the gold bug do these words get replaced with “good” and “evil.”  Alas, in the mind of a gold bug, I must be evil.  Or if not evil myself, certainly led astray by the forces of evil.

In the August 29 issue of Barron’s, Gene Epstein wrote that “In addition to being a commodity, gold is also a cause.” The cause, of course, is that of sound money and responsible government–worthy goals indeed. Surely every American wishes that their government exercised some level of self control.

Yet investors who buy gold for ideological reasons are acting no more intelligently that investors who buy shares of McDonald’s ($MCD) because they like the taste of a Big Mac.  You do not put your hard-earned investment capital at risk because you “like” something or because it fits your utopian view of how the world “should” look.  You make an investment because you expect to earn a reasonable total return.

Returning to the theme of good and evil, this is precisely why vice investing is so much more profitable than “socially responsible” investing.  Because vice industries like alcohol, tobacco, gaming and defense tend to be shunned by the socially conscious, investors with no such moral qualms are often able to buy them at attractive prices and dividend yields.

The proof is in the pudding.  Consider the chart above.  The Vice Fund (VICEX) has outperformed the Domini Social Equity Fund (DSEFX) by roughly 50% over the course of its life.  And the difference would have likely been far greater had the Vice Fund’s investments in the gaming sector not been hit so hard during the 2008 meltdown.

I’m getting somewhat off topic, but my point stands.  You will never make outsized returns over the long term by investing in what you like or in what makes you feel good.  In order to do that, you need to follow Warren Buffett’s advice and be greedy when others are fearful and fearful when others are greedy.  Today, this means buying what no one else seems to want–European blue-chip equities selling at their lowest levels in decades (see “The Pain the Spain“).

As I write the article, gold has backed off of its recently-hit all-time highs.  Does this mean that the gold bubble is bursting?

Perhaps.  Perhaps not.  Given the wild volatility plaguing this market anything is possible, particularly if the European sovereign debt crisis takes a turn for the worse.

Still, the question to ask now is “Where is the best place to put my money going forward?”

This current spate of volatility will not last forever.  When it subsides, what then? Do you want to hold on for that last gasp of the decade-long bull market in gold, joining what has become a very crowded trade?  Or would you rather put together a portfolio of solid multinational blue-chips trading at valuations not seen in decades that have the financial strength to survive whatever may come?

Given the options, I’m taking the blue-chip stocks.

If you liked this article by Sizemore Insights, you’d probably enjoy The Sizemore Investment Letter, our premium members-only newsletter. Click here for more information.

3 Myths That Will Pop the Gold Bubble

Gold prices topped $1,500 per ounce yesterday, just days after Standard & Poor’s roiled the equity and bond markets by lowering its outlook on the AAA credit rating of the U.S. government. After a decade in which stocks went nowhere and the U.S. dollar lost value to every world currency except the Zimbabwean dollar, many Americans are ready to give up on the entire system. Quite a few already have.

After watching gold more than quadruple in value, investors might be tempted to wash their hands of financial assets altogether, convert their savings to gold bars, and bury it in their backyards. But frankly, I cannot fathom a worse idea.

Gold today is as risky as tech stock in 1999 and Miami condos in 2005, and the arguments supporting its rise are every bit as flimsy. Let’s take a look at some of these arguments and how they stand up to a brief reality check.
Continue reading “3 Myths That Will Pop the Gold Bubble”