High uncertainty among hedge funds supports gold

The uncertainty about the further development of global financial and commodity markets appears to be extremely high at present. However, they don’t follow the old market adage of “if in doubt, stay out”. Instead they invest in gold as a store of value. The risk is that once these investors decide to invest again in other higher yielding assets that the price of gold might collapse like in 1980. Currently, gold appears a suitable instrument for short-term trading, but not for long-term investing.

Stan Druckenmiller, a famous hedge fund manager, announced recently that he will close his fund and will retire. It was not only the tight time budget available for pursuing other interests like playing golf with friends, which led to this decision. Also the meager performance this year played a role as Mr. Druckenmiller got the development of the US Treasury market completely wrong. By the way, he is not the only one who got surprised by the more than 1.5 percentage point drop of yields on 10yr US T-Notes.

According to reports, other famous hedge fund managers like John Paulson and George Soros have invested heavily either directly or indirectly via ETFs in gold this year, while inflation is not on the horizon. As gold does not yield any return, one has to speculate on capital gains to make a profit. The major drivers of gold are also not providing a clear picture. The US dollar strengthened during the first half of 2010 against the euro due to the crisis of government debt in the southern eurozone countries. But the euro could pare a part of the loss at the beginning of the current quarter before giving back some of the gains. Crude oil is hovering sideways and was lately under pressure as the market fears the US economy might slip into a double dip recession. Only the falling bond yields are supporting gold as the opportunity costs of holding gold declined.

If hedge funds managers and CTAs were really convinced that the fundamental outlook for gold were positive, the other precious metals should also be bought by large speculators. However, the latest commitment of traders report compiled by the CFTC shows a completely different picture. In the week ending August 24, large speculators increased their long positions in Comex gold futures by 15,290 contracts or 6.3% to 256,244 contracts. Their net long position rose even stronger by 16,963 contracts or 8.3% to 221,191 contracts. Normally, silver posts stronger percentage gains when the price of gold advances. However, large speculators reduced their long positions in Comex silver futures by almost 1,000 contracts to 42,255 contracts, a decline of 2.3%. The net long position of the non-commercials declined less as the large speculators also closed some shorts. It decreased by 765 contracts or 2.2% to 34,807 contracts. Also the net long position in platinum and palladium declined.

This divergence between the development of net long positions in gold futures on the one hand and the futures on other precious metals does not support the argument that hedge funds were buying gold as a protection against medium- to long-term inflation risks. In this case, it would make more sense to diversify holdings and to buy also the other precious metals. From our point of view, it is an increased uncertainty (the unknown unknowns as former US defense secretary Ramsfeld described it) and the relatively low opportunity costs which induce hedge funds to buy gold.