Everybody, it seems, now has a price target for gold and a scenario to get it there. This is fun on a lot of levels, but the price target thing is a bit of a distraction. Gold, like every other bull market, will peak when the dumb money starts piling in. So to recognize the end, we just need a sense of who occupies the various regions of the smart money – dumb money continuum.
The smart end is easy: It’s home to people like Eric Sprott and Doug Casey who have been in gold since it was $300 an ounce and — far more important — who understand why they own it. Also out there are hedge fund managers like John Paulson and Stephen Einhorn who just started loading up on gold in the past year, but who have a good reason for being late to the party: until recently they were shorting financial stocks and asset-backed bonds, which were even better plays.
A few steps in from super-smart are some of the central banks, which are conflicted and untrustworthy, but at least seem to understand the concept of gold as money (they hate it, but they understand it). Lately they’ve gone from net sellers to net buyers.
Another step in would be the sharper mainstream money managers who, while not comfortable with gold and wishing the world would continue happily on its fiat currency way, are savvy enough to note the change and adapt to it.
The dumb end of the spectrum is more diverse, because “dumb money” doesn’t necessarily mean stupid people. Back in 1980 I had a college roommate whose physicist father looked up from his particle accelerator just in time to load up on gold at $800 an ounce. He was smarter than the average new gold investor, but his approach was pretty typical: He led a busy life and didn’t pay much attention to the economy. When gold became a topic of conversation everywhere he went and his buds started making easy money, he got excited and jumped in. So the dumb money will be regular folks, nurses and cops and teachers and scientists, who finally buy into the frenzy without the benefit of context or history.
Where is gold on this spectrum? Saturday’s Wall Street Journal provided a clue:
Some Managers Fear Inflationary Effect of Stimulus; Others See Fuel for Returns
Mutual funds that seldom indulged in commodities now have a lot riding on gold.
Diversified stock funds have been purchasing actual gold bullion, and also piling into gold exchange-traded funds and stock of gold-mining companies. They’ve been doing it partly as insurance against a worrisome monetary situation and possible inflation, and partly to goose their returns.
A downdraft in gold prices in recent days shows that the metal may be pausing to catch its breath or even moving into a correction. Still, widespread doubts about the world economy and large buying from India’s and China’s central banks convince many managers that gold will stay high for a long time. No one expects gold to plummet the way it did in the 1980s, from $2,300 per ounce in 2009 dollars to $298.
“This price drop is to be expected after such a rise,” says Abhay Deshpande, co-manager of First Eagle Global fund, which has 10% of its assets in gold. “We’re holding on to our gold.”
In the past, some funds dabbled with gold-mining stocks occasionally, but seldom owned bullion, says Bridget Hughes, an analyst with fund tracker Morningstar Inc. The funds are joining a crowd of big-time players, such as hedge-fund operator John Paulson, who have rushed into gold. “They’re taking small positions, as protection,” Ms. Hughes says of the mutual funds. “This is not a short-term move for them.”
Among funds, the most active buyers have been in the large-capitalization growth category, says Financial Research Corp. Since June, these funds boosted exposure to metals and to mining equity, most of that in gold, to an average 3% of their portfolios, from 0.9%.
Physical gold is up 26.7% this year, and many gold-mining companies are ahead even more, easily outshining the market. Comex gold for December delivery has dipped 8% to $1,119 per troy ounce after a favorable jobs report a week ago tempered the pessimism that often fuels gold buying. Yet few funds are dumping gold holdings. They still see plenty of reasons for concern.
“I didn’t own gold before, but when I heard Washington talking about a new economic stimulus, I changed my mind,” says Steven Leuthold, head of Leuthold Core Investment fund, which began buying bullion three months ago. Gold now makes up 2% of the $1.4 billion in the wide-ranging fund, whose positions include airline, bank and tech stocks. “This is insurance in case the house burns down.”
These fund managers all express varying degrees of unease about what they see as willy-nilly government expansion of the monetary base world-wide to combat the recession. “We’re creating money by fiat, and gold is historically the best protection against that,” says First Eagle’s Mr. Deshpande.
“I don’t go home glad that I’m holding gold, and in fact, I hate it,” says Stephen Leeb, whose Leeb Focus expanded gold assets from 5.3% last summer to 11.6%. “But the world is in trouble, and that depresses me.”
• One of the dirty secrets of money management is that most portfolio managers do whatever they feel like and then rationalize it with some canned response. “GE is the best managed-company in the world”, “No sovereign government has ever gone bankrupt,” “Networking equipment margins should rise in the year ahead”, that sort of thing. So “We’re printing too much money” sounds an awful lot like a rationalization for buying something that’s hot. At year-end, clients will note that the managers were long gold, without necessarily knowing when they bought it, and the managers will look smarter than their peers who didn’t buy gold. Right now, this fear of being left behind is probably 90% of the impetus for equity mutual fund gold buying.
• Gold isn’t a financial asset. It doesn’t pay interest, and it doesn’t have a balance sheet or income statement. So it’s not “real” to most MBAs who have been taught to assess and manage pieces of paper that represent cash flows. That explains how gold can quadruple in a decade and only now attract the attention of mainstream money managers. It’s so alien that it requires massive, sustained positive numbers to get the typical MBA’s attention.
Which brings us back to the original question: how far are we from the dumb money crescendo? Based on the fact that only a relative handful of money managers are buying gold, and that they’re not buying all that much, it sounds like we’re about half-way, in the realm of the early-adopter mainstream money managers who don’t get gold but do see it moving and are able to rationalize buying it. Reasonably smart but not especially wise, in other words.
This leaves plenty of ground to cover before the peak. In coming years gold will work its way through the normal (i.e. mostly clueless) portfolio managers, U.S. central bankers (too corrupt to be called smart), and traditional stockbrokers and financial planners. Then and only then will most regular folks pick the “gold” meme from the din of everyday life. And the smart money will happily sell them all they want.