This is too Funny…

We have nothing against hedge fund manager John Paulson…after all, we don’t know the man. In fact, he is inter alia known for his philanthropy, having gifted $400 million of his not inconsiderable fortune to Harvard’s School of Engineering and Applied Sciences. But ever since hitting the big time by shorting assorted MBS prior to the 2008 crisis, he has frequently served as an excellent contrary indicator.

John Paulson looking at a recent chart of gold …

Photo credit: Bloomberg

First he bought bank stocks in 2010, announcing that he was betting on a rebound in growth that would ignite the sector. Not long thereafter, bank stocks began to decline sharply, as the euro area debt crisis went into overdrive. Paulson finally admitted that his strategy was a failure and sold the bulk of his exposure to banks in the fall of 2011 – literally within days of the sector taking off sharply.

Bank stocks and John Paulson – click to enlarge.

Gold investors should have realized that this represented a warning sign. Paulson had decided to jinx them in 2010 – 2011 as well. He announced his thesis on investing in gold and gold stocks in 2010 and eventually launched a dedicated fund for the purpose. He even offered a version of it that was denominated in gold, which we thought was actually a great feature.

And yet, the thesis should have been seen as a red flag – it contained nothing that wasn’t already perfectly well known at the time. Considering this fact, wasn’t it reasonable to suspect that the factors he based his decision on were possibly priced in already at the time? It turned out in hindsight that it was. His bet on gold did work out initially, at least in terms of the metal itself (many gold stocks had already begun to struggle). But in 2011 things began to go awry.

However, he probably remembered his foray into bank stocks and was still stung by the fact that he sold them right before his idea would have borne fruit. Thus Paulson decided to largely stick with his gold bet, although he did sell a good chunk of his GLD position during the gold rout in 2013 (we suspect there must have been sizable outflows from his gold fund at the time). Intellectually, we agreed with him. His arguments were sound in principle – but it became increasingly clear that the market had other ideas.

Gold and the HUI index since 2010 – click to enlarge.

From a trading standpoint, being stubborn is generally a bad idea. The time will of course come when a trend has gone too far and is ready to reverse. The market is by no means “always right” as the old saying goes. On the contrary, near major turning points, it is always completely wrong.

However, when buying into a sector at already elevated prices (the HUI had gone up by more than 1,800% between late 2000 and its peak in 2011), one needs to be careful. Stop loss levels need to be taken into consideration, which Paulson apparently failed to do. Ever since, it has been a running joke between us and several of our e-mail correspondents that the easiest way to answer the question “when will gold’s bull market resume?” was “the day Paulson sells”.

Well, wouldn’t you know…as Reuters reports today, “Paulson slashed bullish gold bets before prices rocketed” – and so did a number of other hedge funds apparently.

“John Paulson, one of the world’s most influential gold investors, slashed his bullish bets on bullion at the end of last year, just before the beleaguered market took off for its biggest rally in years, a federal filing showed on Tuesday.

The New York-based hedge fund Paulson & Co, led by the longtime gold bull, cut its stake in SPDR Gold Trust, the world’s biggest gold exchange-traded fund (ETF), by 37 percent in the fourth quarter. It was Paulson’s third cut to its SPDR stake in 2-1/2 years.

The recent cut brought the stake to 5.78 million shares worth $585.9 million on Dec. 31, the U.S. Securities and Exchange Commission filing showed. It followed a heftier cut in the second quarter 2013 when Paulson almost halved his stake from 21.8 million shares, during gold’s historic sell-off. The move by the single largest SPDR gold shareholder highlights how investors shunned gold as the U.S. Federal Reserve prepared to cut interest rates [Ed note: sic – they probably mean to write “hike”] in December for the first time in a decade.

Paulson’s view on gold has been closely followed since he earned roughly $5 billion on a bet on the metal in 2010, following a similarly successful $4 billion payday on his bet against the overheated housing market in 2007.

Others, like Soros Fund Management LLC and Jana Partners LLC, which had already eliminated large stakes from Market Vectors Gold Miners ETF earlier in the year, stayed out. Also in the quarter ended Dec. 31, Caxton Corp eliminated its stake in Market Vectors Gold Miners ETF, having held 31,733 shares worth $436,000 in the third quarter, the filing showed.

We should add to this that Paulson most definitely did not “earn $5 billion in 2010” with his bet on gold, given that he eventually sold at lower prices in 2013 and again more recently. Paper profits don’t count – the actual outcome was a big loss (the loss in his positions in gold stocks was even greater).

Reuters also mentions that at least one big hedge fund correctly recognized the emerging opportunity and took it:

“In contrast to Paulson, CI Investments Inc an investment manager of Toronto-based CI Financial Corp, raised its stake in SPDR to 944,579 shares worth $95.8 million, according to a filing earlier this month.”

We guess these guys deserve to be designated the “smart money” this time around.

Conclusion

It seems now that Mr. Paulson did after all manage to repeat in the gold sector what he did with respect to bank stocks in 2011. He removed the last obstacle to the market’s revival by finally capitulating.

Charts by: StockCharts