Hedge Funds empty their pots of Gold or do they?

According to figures recently released by the US CFTC (the Commodity & Futures Trading Commission) hedge funds have reduced their long exposure to Gold over the course of July and this was in fact the first time that the “Hedgie’s” had trimmed their long bets in five weeks.

The net reduction in their futures and options long position was some 6.5%. However, perhaps most tellingly of all, the exposure of these managers positioned to the short side actually increased by some 6.8% at the same time.

Of course Gold had enjoyed a significant rally in July gaining some 7.3% (its biggest monthly upside move since January 2012) as fears of Fed tapering its QE program receded. The shorts must be hoping that the downtrend will resume in earnest as if it does not and the precious metal can get a handle on the $1350 level then there will likely be a mad scramble for the exit on these positions which will propel the yellow metal over $1400 and towards $1500.

Gold is still sharply lower over medium term time frames, having peaked above $1900 an ounce in August 2011, although if you were long from late 2007 onwards you are still sitting pretty as it has gained around 70% over this timescale (see chart below).

So what exactly is going on here, are the “Hedgie’s” who have been amongst the yellow metals biggest fans in recent years (in particular one Mr John Paulson) changing their views and going negative on Gold?

The answer to that is almost certainly no. After all, many major investors have made long term Macro bets through their exposure to Gold because they believe that current monetary policy in the US and Europe will inevitably lead to inflation and a devaluation of paper money and associated asset classes. The validity of that investment thesis is yet be fully tested, not least because the inevitable unwind of QE in the USA has been pushed  back to 2014/15 at the earliest, though the impending change of Governorship at the Federal Reserve may change that time scale yet again.

What seems more likely to us is that Hedge Fund managers are trading around their central positions in Gold and basically took advantage of the rally seen in July to “top slice” their long positions (as we did in our Titan funds and rolled into structured option positions from a risk/reward perspective) and having seen such a significant bounce (+7.3%) in the price of Gold over July chose to put on some downside protection to benefit from any retracement in the price. Given the uncertain price action seen in Gold, over the last few sessions that looks like a sensible thing to do.

There are further clues as to what may be behind the Hedge Funds decisions to reduce net long exposure to physical gold. Respected Hedge Fund manager David Einhorn of Greenlight Capital said in a recent conference call that one of his divisions had sold some bullion to buy the shares of Gold miners that he saw as being in “free fall”. So, it’s also probable that there is certain amount of portfolio adjustment or “jockeying for position” if you will between Gold and Gold related assets. Again, we rotated into selected gold mining stock exposure post our gold future profit take.

Last Friday’s Non-Farm Payrolls numbers were inconclusive as far providing directional clues about the US economy are concerned and job creation in particular was not as strong as many had hoped. Whilst such uncertainty remains it’s highly unlikely that the big Hedge Funds will seek to unwind their Gold positions. But given that many of their managers made their names as traders, we can certainly expect to see them finesse their exposure to Gold around  key macro data points and significant price action as and when it occurs.

Richard Jennings, CFA.  Fund Manager Titan Investment Partners. 

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