When I think of using gold for asset protection I think of it for protection against inflation. But obviously, according to the WSJ, I am all wrong (or maybe not). According to a Wall Street Journal article, billionaire George Soros sold his $800 million stake in precious metals in the first quarter of 2011 saying that he “no longer fears deflation”. What?
With inflation climbing, I can see why he no longer fears deflation… but why would he buy gold to hedge against deflation, in the first place?
In deflation, the traditional wisdom is to hold fixed assets like treasury bills or even cash because as the dollars increase in purchasing power you want something that will give you the same number of dollars back that you put in. Theoretically, commodities become worth increasingly less during times of deflation because prices are going down. But apparently, Mr. Soros wasn’t hedging against that. Perhaps he was using his gold holdings as a crisis hedge against the possibility of a total meltdown of bonds, treasury bills, and stocks. See my article “Gold is Crisis hedge not an Inflation hedge” Or perhaps he was just playing the trend he saw unfolding, regardless of whether it was inflation or deflation.
Soros’ most recent round of buying was in late 2009 when he bought 3.7 million additional shares of SPDR Gold Trust to bring his total shares up to 6.2 million. Interestingly, in January 2010, Mr Soros said: “When interest rates are low we have conditions for asset bubbles to develop, and they are developing at the moment. The ultimate asset bubble is gold.” By December 31st, 2010 his holdings had been reduced to 4.72 million shares of SPDR Gold Trust worth about $655 million. In addition, he held 5 million shares of iShares Gold Trust. Selling in early 2011 has gotten some press recently as 1st quarter SEC filings are released. They revealed that he has sold 99% of his SPDR Gold Trust and all of his iShares Gold Trust.
But what is interesting (and not often mentioned) is that he took the proceeds and put them into gold mining shares. So he is not betting against gold as the run of the mill news would have you believe, but instead, he is moving from physical gold to gold producers which are an even more leveraged way to play the gold rise. The two companies he purchased were Freeport-McMoRan Copper & Gold and Goldcorp.
Mining Company Leverage
Assume that a mining company has a cost of production of $400/ ounce. If gold is selling at $500 / ounce you have a choice of buying either gold at $500 or shares of the mining company making $100/ ounce profit. Assuming gold goes to $1000/ ounce you would make 100% profit on your gold holdings as the price of gold doubled. But the profit the mining company makes would increase by 400% ! So perhaps at this point Soros is no longer worried about safety but is now trying to leverage his investment.