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Monday, July 12, 2010

I Thought hedge Fund Managers Were The Guys Who Did intensive Research to Find Inefficiencies and Undiscovered Opportunities For Their Strategies and Profits...

.....instead it looks like many of them are joining into what has to be the most crowded trade in many years. And  many are later to the party than the most unsophisticated individuals who have been getting their strategic investing advice from advertisers on Glenn Beck and talk radio advertisers.

It seems that rather than depending on fundamental or quantitative research many hedge fund managers are content to simply ride momentum. Given the hedge fundies propensity for high leverage the potential for a crowded trade like this to trade down with a venegance if/when the market reverses the hedge funds once again are hardly hedged at all but simply taking large leveraged positions.

The FT reports  on the hedge fund rush into gold (my bolds and my comments in blue)

Hedge funds look for a golden edge

By Sam Jones and Jack Farchy
Published: July 9 2010 19:10 | Last updated: July 9 2010 19:10
Not so long ago, hedge funds would send their most junior analysts to the seminars that bullion bankers hosted.
Gold, for much of the past two decades, was the ultimate dreary asset – of interest only to central bankers and miners.
Now those same bankers are struggling to find time in their diaries to fit in many of the hedge fund industry’s biggest players.
In mid-town New York, funds that employ barely 100 staff are finding themselves with gold holdings larger than those of some developed nations.
Paulson & Co, one of the world’s most successful hedge fund managers, denominates a third of its $33bn of assets under management in a share class bolstered by huge positions in the gold market.
In fact, gold is the firm’s largest single position.hedge managers are becoming increasingly bullish about the precious metal. They are drawn to gold’s traditional status as a store of value in crises. 

Look at the gld chart aqt the top of the page doesn't it appear to any observer that it is rather late to become "increasingly bullish" . And are they really drawn to gold because of analysis of the economics are simply being afraid of missing the party ?

This expectation of further prices rises (gold has increased four-fold since 2002) is based in part on the view that bullion provides a hedge against a rise in inflation.
Some fund managers believe a sharp jump in inflation is unavoidable as a result of central banks’ monetary easing policies, which have, in effect pumped more money into the economy.
Historically, they say, the correlation between gold and inflation is hard to ignore.
Over the past half century, the gold price has tracked the amount of money in the world – measured broadly in terms of “M2” monetary supply – fairly accurately, peaking at times of inflation, such as the mid-1970s and early 1980s.
The hedge funds argue that the recent swelling of the monetary base will translate into a spike in monetary supply. When it does, gold prices will fo

I have pointed out the flaws in the above arguments several times:

1. the message of the market coming from the bond market is for anything but inflation in fact deflation is the forecast. The 10 yr treasury is at 3.07% and with the ten year tip yield at 1.21% the implied inflation forecase is 1.86%. Surely a more direct way to play a view on higher inflation is to short the long end of the treasury yield curve and/or to short tips, 

2. Although I am far from a Friedmanite on many issues it is inconsistent adopt monetarism ala Friedman ("inflation is primarily a monetary phenomenon" ) without at least paying attention to Friedman's entire approach relating increases in money supply to inflation. If the money supply is increased but economic activity doesnt increase and the velocity of money doesnt increase there is no or little potential for inflation. The central bank is effectively "pushing on a string"

I found this quote from Samuelson (on wikipedia of course) which well describes the current situation. In order to get to inflation one would even have to get past the point of weak demand into a situation of excess demand/inadequate supply and inflation, Seems to me that seems a minimal risk for the foreseeable future.

In terms of the quantity theory of money, we may say that the velocity of circulation of money does not remain constant. “You can lead a horse to water, but you can’t make him drink.” You can force money on the system in exchange for government bonds, its close money substitute; but you can’t make the money circulate against new goods and new jobs.

 at least some analysts like those above at lease are seeing a yellow light

“The number of funds who are exposed to gold has increased massively in the last three or four years,” says Philip Klapwijk, executive chairman of GFMS, a precious metals consultancy......
Many analysts agree that gold is likely to set fresh nominal all-time highs in the coming months. But they also see the weight of investment in the metal as a warning signal.

Mr Klapwijk says the rush to invest in the metal is not irrational. The motivation is fear about the debasement of paper currencies and of a panic in markets fuelled by any worsening in the eurozone debt crisis. But he also says that gold currently has “elements of a bubble”.

It seems to me the rush into gold both by individuals and supposedly sophisticate investors is not based on sophisticated economic analysis but has one simple rationale: trying to ride momentum

more evidence of the unsophisticated analysis (rationalization) leading to gold bullishness is evidenced from what should be one of the most sophisticated sources in the world:

Jeffrey Currie, head of commodities research at Goldman Sachs, points to a strong historical inverse relationship between gold prices and real interest rates. The time to sell, he says, will be when the economy returns to normal.
“It’s pretty simple. Just stay long until real rates rise, likely driven by central banks taking liquidity out of the system.”

 Why, if what could bet directly on real rates rising either by going short long term bonds or tips would one enter into a trade that has already factored in high guture inflation. Real rates go up long term bonds and tip prices go down it is a almost a certainty (for tips it is an identity real rates up tip prices down, The logical trade is in the bonds. That is truly" pretty simple"

Put me in the camp of the skeptics below.

“Don’t forget, gold is also a commodity with supply and demand fundamentals that can come into play,” says Mr Klapwijk.
Some managers are all to aware of the distinction, and view with derision the bets of their colleagues in a market they know little about.
“The problem is that people see it [gold] as both a commodity and a refuge,” said the manager of one London-based macro hedge fund. “It is not really a liquid instrument and there’s a danger that the market is being cornered.”
Paulson &;Co remains optimistic that the trade is not crowded(!!!). In a presentation to potential investors, salesmen from the firm point out that gold ETF holdings amount to $78.3bn,a fraction of the $2,849bn held by US money market funds. The implication is that, with massive unconventional monetary easing under way, gold will become the ultimate store of value.
All of the above in my view is addition evidence that hedge fund managers are often merely high risk leveraged momentum players. As a consequence at times they may have outsized gains.....and losses. Which leads me to (again ) conclude that on a risk adjusted and fee adjusted basis hedge funds are not a particularly attractive "alternative".