Gold-denominated hedge funds

By Felix Salmon
October 22, 2009
creating share classes denominated in gold. By far the biggest fish in this pool is John Paulson, and as a result he's been buying gold, literally, by the ton. (Indeed, with gold at $1,050 an ounce, and 29,167 ounces per ton, Paulson's $4.3 billion gold investment would buy him 140 tons of gold.)

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For a while now, hedge funds have been creating share classes denominated in gold. By far the biggest fish in this pool is John Paulson, and as a result he’s been buying gold, literally, by the ton. (With gold at $1,050 an ounce, and 29,167 ounces per ton, Paulson’s $4.3 billion gold investment would buy him 140 tons of gold.)

I’m a little unclear on how these share classes work, but it seems similar to a portable-alpha strategy. The problem with gold is that while it fluctuates in value, it doesn’t generate any kind of returns unless and until you sell it. But with these share classes you get to have your cake and eat it: you’re essentially parking your money in gold, while at the same time investing it in obscure and wonderful trading and investment strategies across all manner of other asset classes.

Hillel Aron has a friend who was just at breakfast with John Paulson, being sold on investing in his funds:

His conclusion – not a shocker here – there will be a rush into Gold. Paulson personally has all his own assets in Gold and his funds own 5 different Gold Mining Stocks. By the way, Paulson notes, of the 200 Trillion dollars of investible assets in the world, only 800 Billion of that is Gold.

This means, I think, that Paulson’s own investments in his funds are all in the gold-denominated share classes. And I can see how a multi-billionaire would do something like that: when you have that much money, the only things which can wipe you out are hyperinflation or outright confiscation. Gold is a good way of protecting yourself from both eventualities.

For people with less dynastic amounts of money, however, I’m less keen on the gold-denominated share classes. For one thing, there are substantial hedge-management costs involved. But more to the point, if the price of gold falls, then you can end up in the very painful position where your investment loses money in dollar terms and you still have to pay a large 20% performance fee, since it could still have done well in gold terms. Ouch.


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I realized last night what Paulson’s plan is: buy up all the gold he can, nuke fort knox. It’s fool-proof!

Keeping the system working was a little bit more important that who was talking to who in Moscow. Read the book and you’ll get a bit of the seriousness of the crisis. When a system has as much leverage as we did, a mistake, it must resort to extraordinary acts, that the common reporter would deem as you do as inappropriate.

Good day.

Posted by john | Report as abusive

A gold-denominated share class is pure madness!
Gold is a numeraire that moves in value so your accounting unit can have a positive correlation to your underlying asset, rather than the normal zero correlation of nominal money.

Given that inflation moves much slower than asset price returns, you will have to make heroic assumptions about the speed of the impending hyperinflation that would be required to compensate you for the massive increase of risk that you are taking by denominating your investment in gold and taking in the correlation risk.
Similarly crazy is the idea to use gold as collateral to futures at the CME. Again you can have a situation where you have a margin call not because you have a loss on your futures position , but because the value of your collateral ( gold) has fallen.
So you can get a double whammy if, again, your collateral is positively correlated to your position.

Posted by Fred Engels | Report as abusive

RE: realized last night what Paulson’s plan is: buy up all the gold he can, nuke fort knox. It’s fool-proof!
- Posted by Hillel Aron

Auric Goldfinger tried that in the 1964 movie “Goldfinger” but as we know James Bond and Pussy Galore defeated him.

Posted by Steve Numero Uno | Report as abusive

Felix –

Your cautiousness is right on.

Paulson’s purchases of gold can also be seen as a hedge because he is acting on the other side to massively short gold, as follows:

(1) His clients give him new money in gold at the present. Paulson sells the gold at the present, to get the money for his fund.

(2) Paulson must then be a buyer of gold in the future, whenever his clients are ready to redeem.

Sell something you don’t own now, with the requirement that you must buy it in the future: That is the definition of shorting.

Posted by Dan | Report as abusive

If Paulson has a gold denominated fund, he must buy levered gold (i.e. miners and such) if he is to be covered on his effective short position and still have money left over for investing.

Otherwise he would just be a plain old gold fund.

Posted by Dan | Report as abusive

Good topic to discuss Felix, as I’ve always wondered if we’ll start to see more of these now that a prominent player has done so. Dan’s right-on that his buying could be seen as a huge hedge since that particular fund share class is denominated in gold. But he obviously has other motives as well that make it even more attractive. Need to get ahold of some of their paperwork from when this first came to fruition.


“By the way, Paulson notes, of the 200 Trillion dollars of investible assets in the world, only 800 Billion of that is Gold.”

Or, put another way, $800bn is invested in a shiny, inert metal. If I had $4bn, I might put it all in gold right now. But if I could actually suffer as a result of losing most of my money, like 99% of people, I’d be insane to do so.

Posted by Ginger Yellow | Report as abusive

Paulson’s thesis is that the US Dollar is going to fall. If that is true, being a US dollar investor in his fund would generate phantom dollar gains that would be taxed away. If you invest using gold, say putting in 1000 oz of gold,and gold doubles in dollar terms, you would receive 1000 oz of gold back (plus other gains) and thereby owe no tax on your initial gold investment when cashing out. Its a brilliant idea.

Posted by Pete | Report as abusive

Pete — Whats the difference? You dont get taxed on oz of gold you hold, just the $-value of the investment. So assume $1000 in investment vs $1oz gold in investment. No change except USD gets cut in half. The $1000 of securities are now worth $2000 in devalued USD or 1 oz of gold rises to USD 2000.

I am not clear on the tax treatment of such funds but gains on holding gold (in ETF or commodity form) is often disadvantageous from a tax perspective (taxed as collectible as short-term CG rate).

I’m also not clear why anyone would want to pay 2&20 for gains on gold fwd trades. Cant you replicate that yourself if you are investing in size?

Posted by mc | Report as abusive

Precious metal investors have been on a wild ride so far in 2011. After falling to start the year, gold took off from its level just above $1,300/oz., skyrocketing higher on inflation concerns and an increasingly weak dollar. Many of the world’s largest (and most successful) managers have put huge chunks of their assets into precious metals ETFs over the last year, and investors seeking to replicate their strategies have utilized the exact same instruments to express similar views. George Soros has reportedly sold nearly $800 million worth of shares in gold exchange traded funds, while fellow hedge fund manager John Paulson kept his big stake in gold ETFs unchanged in the first quarter, according to regulatory filings. With so much uncertainty in the market, what is going to happen to the price of our jewelry?


Posted by onotoman | Report as abusive