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Gold and Financials: Looking Deeper Under the Hood

September 4, 2009

As an ardent X-Files fan,  the conspiracy theorist in me can’t resist taking a few more stabs at what is going on in gold and financials. Being Canadian, I have no fear of the “smoking man”–a private government operative lurking in the background trying to silence me. Let’s enter the elephant in the room for this discussion: John Paulson. For those that do not know who John Paulson is, he is the legendary hedge fund manager who made triple digit returns in 2008 by positioning himself to profit from the credit collapse that he anticipated well in advance. Now even CNBC (controlled by the US government), calls him the most watched investor above even Warren Buffet (lent Goldman Sachs during the crisis–also working with the government). Lets fast forward to 2009, where Mr.Paulson discloses a couple weeks ago that he has substantial stakes in Bank of America and Citigroup :

Curiously Mr. Paulson has also commissioned none other than the bubble-builder himself– former Fed Chair Alan Greenspan to serve as an advisor to his fund.  It is obvious that after making himself one of the richest people in the world profiting from the armageddon last year, the government may have decided to lean on him to co-operate to help fix everything. You know how this works, its sort of like when the mob tells you that you need them for protection. After all, what better vote of faith to have the ultimate cynic buy a large stake in worthless Citigroup and tell everyone that it is “undervalued.” This helped to launch the most recent leg of the financial rally, the one that sent every worthless company flying up 50%-100% or more. Now just to complete the picture, you should know that John Paulson is a major owner of GLD (gold ETF), he is also a major owner of SKF (ultrashort financials). Would it be not unrealistic to believe that Mr. Paulson has recently sold large blocks of his financial holdings–helping account for the dramatic turnover in these names—- and has replaced them with additional holdings in GLD? This would leave him heavily long gold and short financials. If so, what is that Mr. Paulson knows? If he was smart enough to foresee the disaster in 2008 and even smarter to figure out how to best profit from it, how much wiser  would this financial wizard be now that he is (was?) a major owner of the largest banks in the country and likely privy to private government information? Or maybe he and Alan Greenspan just get together for idle cocktail conversations.

I think that if the government knows that financials are in deep trouble, then they know that eventually they will have to pull back the curtain and reveal what is happening. Both the government and financiers like Paulson are aware that three things will likely happen when this information is revealed: 1) financials will fall 2) the US dollar will rise as it has become a carry trade currency that investors across the globe have used to speculate with 3) gold will rise temporarily, first allowing everyone to pile in as a bastion of safety prior to its sudden and unexplained collapse. Position yourself accordingly.

There is one important piece of information that is highly useful to consider when trading gold: central banks actively manipulate the price–which Mr. Greenspan himself alluded to in the past. There is a distinct possibility that the breakout in GLD was engineered to allow Paulson, the US government, and others to liquidate to the excitable gold bugs. After all, mere rumors of bank failures  can get a gold bug calling up his broker to load up the gold positions, while reaching for the rifle and the canned food. Who better to sell to than a person that would sell everything they owned to buy more of the shiny stuff.  How do we track the actions of the central banks in the gold market? One has to look at the COT (Commitments of Traders) Report where we see that the central banks have a much smaller position that normal and have been selling/shorting over the last week. In contrast, institutional players are heavily long—nearly the longest they have been in a long time and have been increasing their exposure. Ditto for the small trader who is also heavily long the shiny stuff.  This means that everyone is pretty much “all in” leaving me wondering whether this leaves much room for a sustainable breakout. So what were our institutional holders—likely including Paulson and co—doing after this fantastic rise in the price of gold? What are they doing with their financial positions? Curiously when I looked at the money flows today in the Wall Street Journal, I saw the following : Note that the top positions indicate heavy institutional selling into strength. What are the top positions? None other than GLD, Goldman Sachs and JP Morgan. Coincidence? I think not!

Expect a possible fakeout in GLD in the short-term, and further weakness in financials.

11 Comments leave one →
  1. scrilla_gorilla permalink
    September 4, 2009 12:49 am

    Wow… whether you end up being right or wrong, that was a great post.

    Not as awesome as the analysis on CNBC, mind you, but pretty close.

    • david varadi permalink*
      September 4, 2009 12:54 am

      thanks……just wanted to excercise the old fundamental analysis muscles for a change– a nice departure from Quantworld! btw who can hope to ever measure up to CNBC or the almighty Cramer?

  2. Joe Marc permalink
    September 4, 2009 5:49 am

    Wow is right. Really good stuff. Again thank you.

  3. Alain Machefert permalink
    September 4, 2009 10:10 am

    I find it quite disappointing that you seem to be moving away from “quantitative” research to something I would hesitate to call “qualitative”. It is my experience that this type of “analysis” comes in the way of a more scientific approach to trading for various reasons: opinions tend to back-up biases, opinions lead to endless discussions (who is more of a fascist, Bush/Obama?) and as such are at best entertaining and at worse distracting or even counterproductive (if you express an opinion on gold or financials, you might trade according to your opinion and not according to your quantified approach).
    Obviously, just my 2 cents, as it is still a free country after all. But I am looking forward to your refocusing on the quantitative you. Regards

    • david varadi permalink*
      September 4, 2009 12:28 pm

      alain, all of your points are valid. currently i trade via computers so this is just observation–however i used to be in research many years ago. nonetheless i plan to demonstrate down the line how to quantitatively integrate game theory into a prediction model which is very valuable in combination with standard models.


  4. Joe Marc permalink
    September 4, 2009 1:40 pm

    Hey David,
    It is your site, you obviously can do whatever you want, quant, opinions, theorys. musings, complaints.
    No one HAS to look in.
    I for my part love it all and again am very grateful for your sharing your obviously vast knowledge base.
    AND I FOR ONE WILL NEVER MENTION POLITICS AGAIN. I didn’t mean to ruffle feathers. Those were just “thinking out loud “thoughts that I was thinking MIGHT explain some of the weird trading of late. I was not trying to convince anyone to think as I do about obviously corrupt and power hungry politicians from both the right and the left.

    • david varadi permalink*
      September 4, 2009 2:13 pm

      joe, of course this won’t prevent me from making further postings nor should it prevent you from commenting. as alain said it is a “free country” —-or is it? for purposes of the blogosphere it is. cheers

  5. September 5, 2009 10:17 am

    I for one like it when you wear your tin foil hat, David.

    As an ardent X-files person myself, it makes for great Saturday morning reading.

  6. fredrik permalink
    September 7, 2009 4:46 pm

    having read your article and found it interesting a friend of mine pulled out the latest SEC filings for paulson and found he was long $3.5bn of individual banking equities vs short about $85m of financials through a long position in SKF, should we dismiss your theory?

    • david varadi permalink*
      September 7, 2009 7:11 pm

      hi fredrik, i am well aware of the filings but as you know they are delayed and don’t account for what has been happening recently.


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