Sharp drop in gold caught many funds off guard

Date: Tuesday, April 16, 2013
Author: Svea Herbst-Bayliss, Reuters

Hedge fund manager John Burbank, a long-time investor in gold, said the recent sharp selloff in the precious metal came as a surprise to many investors as some economic improvement and a general decline in commodity prices took their toll.

The San Francisco-based manager called last week's dramatic decline an "unexpected event" that caught some hedge funds off guard because they were betting that inflation would rise at a time global central banks are sticking to easy monetary policy.

The slump in gold prices could complicate second quarter returns for hedge fund managers that went into gold several years ago as a long-term hedge against a jump in prices across the economy.

Up until this year, gold was a sure-fire bet for many managers, as the precious metal has risen sharply. But Burbank said the slump could be punishing for managers who did not adequately prepare their portfolios for the selloff.

"Most people who are long gold are only long," Burbank said in a telephone interview.

His own fund, $3.7 billion Passport Capital, however was hedged by owning physical gold and betting against gold mining companies, whose share prices have dropped dramatically, he said. The fund rose 5.9 percent during the first quarter and has gained a net 18.6 percent per year, on average, since Burbank launched the fund more than a dozen years ago, an investor said.

Others, however, did not seem to take the steps Burbank did.

Hedge fund manager John Paulson, who owns both gold miners and physical gold, has likely lost millions in the most recent sell off. At the end of the first quarter, a gold-only fund Paulson managed was down 28 percent.

But Paulson & Co, which oversees $18 billion in assets and whose moves are widely followed ever since the firm made billions off bets against the overheated housing market and on gold a few years ago, is sticking by his strategy.

"The recent decline in gold prices has not changed our intermediate to long-term thesis," Paulson & Co partner John Reade said.

"We set up the gold share class at an average cost of around $950 in April 2009 and while it's down from its peak, it's up considerably from our cost," Reade who is a co-portfolio manager at the New York-based hedge fund said.

At the end of last year, Paulson also owned stakes in a number of gold-related companies and gold mining companies such as Anglogold Ashanti, Barrick Gold Corp (ABX.TO), Randgold (RRS.L) and Novagold (NG.TO). His single biggest investment was in the SPDR Gold Trust (GLD.P), the world's largest gold-backed exchange-traded fund, where he owned 21.8 million shares at the end of the fourth quarter.

Daniel Loeb's Third Point Capital Management told investors that gold was one of his five biggest losers during the first quarter. Greenlight Capital's David Einhorn told investors that gold ranks among his five biggest holdings. He has not yet told investors how gold performed for his fund and whether he had hedged for the sell-off.

It is difficult to pinpoint exactly why gold began fizzling last week, Burbank said noting that a combination of improved economic conditions and a general sell-off in commodities hurt gold. A research report issued by Goldman Sachs last week which pointed to a lower gold price likely also accelerated the drop.

"Rates have been low enough for long enough that it made western investors believe they didn't need to hold gold the same way any more," Burbank said.

On Monday the selling continued with gold tumbling more than 8 percent, on track for its biggest one-day decline in dollar terms.

Eventually he expects the drop in prices to bottom out because the demand for physical gold is still strong. He did not give a price for when the drop may slow or stop.