John Paulson is no doubt scratching his head right now and philosophizing on just how wicked the markets can be after giving up part of his monumental gold trade just moments before the metal started to rally sharply in mid July.
Paulson, supposedly the trigger puller of “best trade ever” (see the latest edition of our magazine and the feature on Paolo Pellegrini – the man whom we believe to be the real architect of the monster subprime haul), seemingly needed to exit his large gold trade in order for the market to actually rally. He in fact cut in half his gold position in the second quarter of 2013. Since June 28, when gold hit an intraday low of $1,180 per a new uptrend commenced that led the metal to over $1400/oz in under 2 months – in excess of a 20% rise, something that is technically considered as a bull market (a rise of 20% from a low).
The latest 13F filings revealed that most hedge fund managers (with the exception of Titan!) cut their gold holdings during the second quarter and not even Paulson had the guts or tenacity to keep his entire position, comprised of 21 million shares in the SPDR Gold Trust. With the prospects for QE tapering rising, most hedge fund managers foresaw a decline in gold and deemed there to be no reason to keep the precious metal as a hedge against inflation anymore. Paulson sold 11.6 million shares on the SPDR Trust meaning that he missed a $200 million capital recoup.
The decline in gold prices from a record high near $1,900/oz in 2011 to less than $1,200/oz earlier this year actually led to a substantial increase in physical demand. While futures contracts and ETF holdings were exhibiting substantial weakness and almost universal expectations of more price declines to come, truth is that physical buyers kept buying more and more gold.
With the marginal cost of producing gold estimated to be near $1,275/oz in 2012, economic theory gives us the tools to understand that the market wasn’t in equilibrium and that futures and options markets were distorting reality. As we have mentioned several times before, a market can’t be manipulated forever and at some time its “financial part” has to catch up with the “real part”; that is the Comex market would have to adjust to the physical gold market reality. Sooner or later long contract holders would force delivery if they feel prices were too low and that contract writers wouldn’t be able to deliver gold.
During the last few weeks, gold prices have been surging as gold shorts in the futures and options markets have dropped for 6 out of the last 7 weeks. The non-commercial short position in fact fell by 60%, which corresponds to 81,700 contracts. Translating the number into gold and dollars, such a number equals 8,170,000 gold ounces, and which is worth $11.5 billion of paper gold. Just to put this in perspective, let me say that physical gold demand during the second quarter totalled 30.2 million ounces or $42 billion. The decline in the non-commercial short gold position corresponds to more than 25% of 2Q gold demand!
Improving economic conditions in Europe and China along with a strong likelihood of a war unfolding in Syria are also leading oil prices higher. Brent crude was trading at $96.75 in April but it is now near $115. At this pace, the Federal Reserve will be in trouble with its trillion-dollar asset purchase program, as inflation will eventually pick up. With fundamentals on gold’s side, there’s even more reason to hold some gold exposure in a balanced portfolios, especially through a mix of a position in the best gold miners and the physical asset.
If you’d like to be exposed to a professionally managed gold fund that takes positions in both gold stocks and other precious metals futures and companies, click the image below for more details on our Titan Precious Metals Fund.