Is This Just The Beginning For Gold?

It is said that when an investment becomes too mainstream it may be time to sell. Despite the plethora of headlines touting gold investment, gold is still not quite mainstream yet and the fundamentals suggest continued growth. See the following post from Expected Returns.

Even for the staunchest of bears, it's getting harder and harder to deny the power of the most recent move in gold. All corrections are shallow, buying pressure is intense, and the dollar is clearly on life support. The shaky fundamentals of our monetary system made such a move in gold inevitable. The truly amazing thing is that this move in gold is just beginning.

We are starting to see more headlines touting gold as an investment, which is usually a good short-term sell signal. Nonetheless, here's an interesting article from Marketwatch, which looks into the recent phenomenon of hedge fund gurus buying into gold.

Gold has long been favored by a fringe of the investment world, but this year some of the world's leading hedge-fund managers have loaded up on the precious metal amid concern government efforts to avoid another Great Depression that could undermine major currencies and fuel rampant inflation.

"I have never been a gold bug," Paul Tudor Jones, chairman of hedge-fund giant Tudor Investment Corp., wrote in an Oct. 15 letter to investors. "It is just an asset that, like everything else in life, has its time and place. And now is that time."

Tudor has been building positions in gold and other precious metals in recent months and they now represent the firm's largest commodities exposure, he noted.

I would disagree with Marketwatch that gold is going mainstream now that elite hedge fund managers have hopped on board. In order to be truly successful in investing, you have to by definition shy away from mainstream thought. For example, John Paulson made his billions by shorting subprime securites, essentially betting that the market that "always goes up" would come crashing down. As we all know, he was dead right.

Paul Tudor Jones made a name for himself by predicting the 1987 crash in the midst of a powerful bull market. His views definitely were not mainstream, and he was rewarded when the market crashed in October.

Gold Bugs: Lunatics or Rational Investors?

"I can't remember in 20 years so many respected investors focused on a single strategy," said Bradley Alford of Alpha Capital Management, which invests in hedge funds. "Some of these people are icons of the industry with at least 15-year track records. It's a losing proposition to bet against guys like that. They aren't billionaires because they make bad bets."

It's not only hedge funds. Managers of mutual funds and insurance company portfolios are often limited in how much gold they can buy, but these investors have been purchasing the metal for their personal accounts, according to Ed Yardeni, president of Yardeni Research.

"A surprising number of level-headed folks, who I have known over the years, are confessing to me that they've become gold bugs," he said. "They're starting to give more respect to what was for a long time considered the lunatic fringe."

The worst trait you can have as an investor is stubbornness. I can guarantee you will miss bull market after bull market if you are not open to new ideas. Lets just look at how one of the best in the business, David Einhorn, has changed his mind about gold in recent years:

Since Einhorn launched Greenlight in 1996, he's shunned gold and other broad economy-based trades in favor of tracking down under-valued and over-priced stocks.

"We never thought we would ever buy gold or gold stocks," Einhorn wrote in January, recounting the lesson he learnt from his grandfather's obsession with the precious metal.

"The lesson that I have learned is that it isn't reasonable to be agnostic about the big picture," he said during an Oct. 19 speech at the Value Investing Congress in New York.

At the same conference four years earlier, Einhorn advocated his Grandma Cookie's approach of investing in stocks like Nike, IBM , McDonald's, over his Grandpa's holdings of bullion and gold stocks.

"I explained how Grandma Cookie had been right for the last 30 years and would probably be right for the next thirty," Einhorn said. "However, the recent crisis has changed my view."

Gold should do "fine" until policymakers and politicians show more monetary and fiscal restraint. The metal will likely do "very well" if there's a sovereign debt default or currency crisis, he added

The key lesson here is to always be open-minded, and to not be afraid to change long-held personal views.
It's Supply and Demand, Stupid

Tudor also expects central banks, which have been net sellers of gold for many years, to become net buyers during the second half of 2009, a "remarkable" turnaround for a market that's used to absorbing big sales from this official sector.

The large, developed countries of the G-7 already have roughly 35% of their reserves in gold, but the remaining members of the G-20 only have 3.5% of reserves in the precious metal, Tudor estimated.

These 13 countries, which include China and India, have seen a $2.2 trillion surge in reserves in the past five years, making up well over half of the increase in global reserves during that period, Tudor said.

If non-G-7 countries in the G-20 lifted gold holdings to 10% of their reserves, they would need to buy 370 million troy ounces, or 20% of current above-ground supplies. If they lifted holdings to 35% of reserves, they could need to buy 1.3 billion troy ounces, or 35% of above-ground supplies, Tudor estimated.

"There is huge potential for more buy-side interest to emerge from central banks," Jones wrote in his Oct. 15 letter to investors.

"The scope for increased investment demand over the coming years is much stronger than the potential from new supply," Jones wrote. "As a result, incremental new demand must buy gold from current holders... We doubt the transfer of gold from current holders to its new owners will occur at, or near, current prices."

All I can say is that continued skepticism over the viability of gold as an investment just adds fuel to the fire. Most people buying gold right now aren't looking for 5-10% gains, but 100-200% gains. So we are talking about strong hands here. As net buyers, Central Banks will put a floor in this market; think of it as the "Central Bank put".

This post has been republished from Moses Kim's blog, Expected Returns.