Position: Long gold via the etf GLD
“The dynamics of the gold market differ greatly from other traditional commodity markets. Gold is accumulated, not consumed, and acts as the ultimate store of value.”
-Paul Tudor Jones, October 15th, 2009
As part of his third quarter letter to investors, Paul Tudor Jones and his team added an appendix outlining their bullish case on gold. In hedge fund parlance, this is called “pushing your book”. That said, Jones’ long term record in trading global macro markets is an enviable one and when “he pushes his book” it is likely worth listening, even if we disagree. In this instance, we too are long gold and it is currently a major position in our asset allocation model.
In fact, we have been long gold most of the year and for most of the last two years. In our last detailed gold note, on May 13, 2009, we wrote:
“Keith and I have been readers of Dennis Gartman's (aka Garty) in the past and have enjoyed his ability to uncover interesting data points, even if his timing is sometimes suspect. This morning, though, we are drawing the line in the sand, while Garty may be short of gold, we are long of the glittery metal.”
A lot has changed since early May, including the fact that Garty is now long gold. A trend follower is as a trend follower does it seems.
Coincident with our reading of Jones’ thesis on gold today was of course the announcement from the IMF that they had sold 200MM metric tonnes to India’s Central Bank for $6.7BN. The transaction was no surprise to gold markets as the plan of the IMF to diversify from their gold position to solidify their finances has been in the works for a year, and this is roughly half of their 400 ton estimated allotment. The purchase by India, of course, is also part of a continuing trend of nations diversifying away from U.S. dollar based reserves.
The broader dynamic at work here is comparable to the GDP chart we showed yesterday. There are a number of countries that are global share takers below the G7 and therefore their reserves are growing at a dramatic pace. According to some estimates, non-G7 nations have seen their reserves grow by $2.2 trillion over the last five years, which is roughly half of all global reserve growth. In contrast to the G7 countries that have roughly 35% of their reserves in gold, the remaining countries that make up the G20 have only 3.5% of their reserves assets in gold. Obviously, and especially in context of the weakening U.S. dollar, there will be additional transactions like the one announced by India today as the G20 nations below the G7 continue to broaden their reserves diversity into a more normal allocation to gold.
Another important point that Jones’ makes in his letter is related to production of gold. His idea here is similar to our thesis on oil, which is that despite massive investment in oil exploration, overall production has remained largely stagnant. According to Jones, “despite a three-fold increase in worldwide metal exploration expenditures, new mine production has remained stagnant at 80 million troy ounces over the last decade.” Jones’ statement is corroborated by many independent studies and supports the idea that there are constraints on gold production, which in a world where demand for gold, either from emerging markets consumers or from nations looking to diversify their reserves, will increasingly lead to upwardly trending prices as supply and demand are tight.
The other incremental point of demand is coming from exchange traded funds. According to Jones’ analysis, there is only $50BN of total gold assets in listed funds. The implication is that there is potential for massive inflows when, and if, investors continue to want to own gold as an asset class, particularly in the private wealth world. As one example, one of the largest gold etf’s is GLD, which is sold by State Street and has a total asset value of ~$37BN. This fund did not exist five years ago, so its creation has led to massive incremental demand for the metal. In the last 12-months inflows into gold etfs have varied between 20 and 30% of production over that time period.
So, where could gold go? Obviously assigning a value to a commodity, or a reserve metal, such as gold is very difficult and can be done based on various econometric or quantitative methodologies. Longer term, though, one way to think about the upside is where it has been in the past on an inflation adjusted basis. The inflation-adjusted all time high for gold was January 21st, 1980, which was $2,422 versus $1,085 today. Therefore, and this is obviously nothing more than a benchmark, there is more than 100% upside from gold’s current price to its inflation adjusted high. Now a lot would have to happen to drive gold back to those parabolic highs, but many also said the same about oil in mid-2008 . . .
Below we’ve outlined our risk management levels on gold.
Daryl G. Jones