Einhorn's Objectivity

In this morning’s Early Look I said that I would post David Einhorn’s full rebuttal.


David does his own work, and I have a great deal of respect for his independent research process. I have not edited any part of his reply to my Early Look note from January 29th, titled “Red Light Risk.”


This is one of the most even-handed and intellectually objective replies I  have had since I started this firm. Some people get very emotional when I stand on the other side of their timing in a position. There is zero emotion in this rebuttal.


Many thanks to DE for letting me pass this along to you, unedited (his comments are in red, within the body of the original text).




"As investors, we can't change the course of events, but we can attempt to protect capital in the face of foreseeable risks."

-David Einhorn


Admittedly, when "bottom's up" we are bottom up investors, but bottom’s up drinkers hedge fund manager David Einhorn proclaimed his new macro mystery of investing faith at the 'Value Investing Congress' on October 19, 2009, I was smiling. Our Hedgeyes call this proactively managing macro risk and I do support Mr. Einhorn's message thanks.


Einhorn and I are about the same age. We both grew up in a hedge fund bubble. For a decade, we were probably both overpaid I can’t speak for you, but even though I have started a valuable business that has created high paying jobs and provided a good value to my customers, I would agree with this.  I feel very fortunate. He still runs money and sometimes my mouth and I run my mouth, so I am thinking that he's probably worth a lot more than me. But what does that mean?


To some in this business, that means a lot. To others, it means nothing at all put me in this group. We all wake up early every morning with a passion to play this game. David's Greenlight Capital now has its macro views. I have mine. Game on much less conflict here, than you think.


The global macro risk manager's job in this business is to acknowledge amber flashing lights, before they go red. It's also being keenly aware of when one of your big "ideas" is everyone else's too. Measuring consensus is part of any repeatable Red Light Risk Management process.


Embedded in our macro risk management process are 3 dominating Global Macro Themes. We change them quarterly, because the math changes daily. As a reminder, my team's current Macro Themes for Q1 of 2010 are:


1.       Buck Breakout (bullish on the US Dollar; bearish on gold) We are bullish on the dollar vs. the yen, euro, & pound.  We like the dollar more than most everything but gold at the moment.  Or maybe we just hate it less than the other currencies.  We are long various European sovereign CDS.


2.       Rate Run-up (bearish on government bonds)  agreed at some point, but no real view on this quarter.


3.       Chinese Ox In A Box (bearish on Chinese equities; bullish on Chinese currency) I would tend to agree, but have no position and no real conviction.  It seems to be working.


I do not know what Einhorn thinks on Macro Themes 2 and 3 but, now that he does macro, he obviously better have a view. That said, I do know that he stands on the other side of me with regards to both the US Dollar and Gold.


In that same speech, Einhorn made the following conclusions about gold:


1.       "Of course, gold should do very well if there is a sovereign debt default or currency crisis."


2.       "I subscribed to Warren Buffett's old criticism that gold just sits there with no yield and viewed gold's long term value as difficult to assess."


3.       "Gold does well when monetary and fiscal policies are poor and does poorly when they are sensible."


After being bullish on gold since 2003, and vehemently bearish on what I labeled the "Burning Buck" in early 2009, I do think I have the credibility associated with understanding the bearish dollar/bullish gold case Agreed. There are many aspects to Einhorn's conclusions that I agree with, but not at every price and every duration. My guess is your current quibble is more about duration than price.  I’d be willing to bet there will come a time where you will like gold at a substantially higher price.


Now, if you really want to manage Red Light Risk in global macro, you better manage those two things dynamically  - price and duration. I have written about this before, but it's worth mentioning again. Duration Mismatch is one of the top 3 risks that has hurt me over the course of my risk management career. We need to monitor it systematically and measure it scientifically. Just as I am still trying to learn and improve (like incorporating more macro thinking), I am hopeful to improve here, as well.


Back to Einhorn's points on gold. On an immediate (TRADE) to intermediate term (TREND) duration (3 weeks to 3 months), gold has not done well in the face of sovereign debt default risks rising. I don’t know.  I wouldn’t say my speech was an important date….but since then gold is up a little and the S&P is down a bit.  It was about 3 months ago. (Since our actual entry, the results have been much more decisively in our favor) Gold is up a lot in Euros, where the sovereign crisis appears to be at the moment  Now maybe he meant a sovereign debt default crisis in the USA it would do very well in a US crisis and that was my point.  My guess is that such an event, if it ever happens, is quite a ways away and would not fit into the thinking of someone investing for 3 months or less and, to be fair, we should give him the benefit of the doubt the benefit of the doubt is always appreciated here until he replies to this. But, so far, with CDS (credit default swaps) in Greece blowing out to 414 basis points last night, gold is still going down not relative to the place where the crisis exists.


Gold is going down because I am right on the Buck Breakout. Yes, as Mr. Buffet pointed out to David We didn’t discuss this.  I was relying on his public statements. way back when, there are many risks embedded in evaluating the gold price. But those difficulties work both ways! Today, in terms of measuring the risks of being long gold, the r-square is highest relative to up moves in the US Dollar. I haven’t done the math, but it feels more correlated to equities than the dollar to me at the moment.  I suspect that that correlation will break down in gold’s favor at some point.


Managing Red Light Risk is just that. You have to accept that there are many types of investors telling many different types of qualitative stories about what it is that they are bullish on. You also have to accept that Mr. Macro Market's math will rule the day over all the storytelling I strongly agree with this.


This morning the US Dollar is making a 5 month-high at $78.94. Gold is trading down another -1% for the week to-date at $1083/oz. I am long the US Dollar and short Gold via the UUP and GLD etfs, respectively, and I have a zero percent allocation in our Asset Allocation Model to Commodities.


The long term TAIL of resistance for the US Dollar Index is up at $80.21, and I think it's going to test that line this year. My long term TAIL line of support for the gold price is down at $997/oz. That's another -8% of Red Light "foreseeable risk" that these Hedgeyes are calling out for you Mr. Einhorn. I do think we have a different view on duration.  I have no idea which way the next $80 in gold will be.  If I had a strong view, I would modify my position, as I’d rather buy it back cheaper.  Sadly, I don’t and you may well be right.  I do have a strong view as to which way the next $500+ will be and I don’t want to give that up just because I might have to temporarily give up a fraction of our gains to date to the volatility gods in the meantime.  Welcome to the game of proactively managing macro risk. It's a full contact sport. I don’t see it as full contact.  I am still not betting these things big enough to look at it that way.


Best of luck out there today, and have a nice weekend  (de)




Keith R. McCullough
Chief Executive Officer

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