Paul Tudor Jones Favors Gold & Curve Flatteners (Investor Letter) ~ market folly

Thursday, October 29, 2009

Paul Tudor Jones Favors Gold & Curve Flatteners (Investor Letter)

In his latest letter to investors, hedge fund manager and legendary trader Paul Tudor Jones outlines his firm's thoughts on the topics of equities, bonds, and currencies. Tudor's letter is one of those 'must reads' as his macro sense is phenomenal and he is one of the greatest traders of all time (performance returns summary here). What's interesting about his latest letter is the fact that they included a special section addressing the all too talked about precious metal.


The macro perspective section of their letter notes how gold is not consumed but rather accumulated as a store of value as it has been a 'medium of exchange for over 5,000 years.' What's interesting is that they plot out inflation-adjusted gold prices and note that we are still far off from the highs seen over 2 decades ago. Tudor puts the inflation-adjusted peak price of gold to be between $1,600-$2,400, with the previous high coming in at $2,422. While Tudor says he has never been a gold bug, he says all assets have a time and a place. And conveniently enough, he says now is gold's time. Tudor joins an army of other prominent hedge fund managers bullish on the precious metal including David Einhorn of Greenlight Capital who has gone as far as storing physical gold. Additionally, John Paulson of Paulson & Co has $4 billion in gold investments, among many other managers.

Tudor's econometric model has determined that gold is 20% undervalued over the next 24 months. This takes into consideration real rates on the price of gold, inflation, and M2 growth. Tudor expects the velocity of money to rise over the next two years, enhancing the bullish case for gold. Additionally, they also cite the supply/demand equation and prudently bring up the fact that a new class of investors has arrived: retail investors gaining access to the metal through exchange traded funds (most notably GLD). Tudor then presented these amazing facts: "The trailing 12-month ETF accumulation has "bought" the equivalent of 25% of new mine production consistently since the beginning of the year. By year-end 2009, the total ETF gold position will hold 3% of global available supplies, making ETFs the sixth largest holder of gold in the world." Tudor expects inflows into these vehicles to continue, furthering the case for a position. Lastly, Tudor highlights another important factor in the gold equation: central banks. He notes that in the second half of this year, the 'official sector will become a net buyer of gold.' We also yesterday posted up an excellent technical analysis video on gold which concurs that gold is in a long-term uptrend. The video outlines $1000 as a key level to stay above and outlines buy points at support as well as price targets going forward (watch it here).

Curve Flatteners

Turning to the bond markets, Tudor has found it difficult to find good risk/reward setups with only the curve flattener seen as appealing. This is very interesting to note given that we've covered prominent hedge fund player Julian Robertson had previously been in the opposite trade, a curve steepener. It's always great to see two prominent minds in hedge fund land differ in this ongoing debate. (Interestingly enough, Robertson also disagrees with Tudor in regards to gold, as he favors gold miners instead). Tudor notes that curve flatteners provide 'tail risk insurance' against the trades of long gold, short the US dollar, and long equities. Tudor writes, "As deflation recedes to the background, market participants will start expecting a removal of policy accommodation. If the markets begin to price early, fast and large tightening before inflationary expectations are allowed to take hold, then curves could bear-flatten significantly from current historically high levels."


On the topic of currencies, Tudor shares the views of many other hedge fund managers in that they feel currencies of commodity producing nations should benefit, specifically citing the Australian Dollar. And, of course, we would be remiss not to mention that Tudor thinks the dollar will continue its decline.


Turning his focus to equities in the letter, we found this paragraph on the technicals to be intriguing: "Technical considerations can be characterized as suggesting that near-term risk should be limited at worst. Market breadth has remained mostly favorable, even rendering a third "thrust" signal of the rally in early September. These are noteworthy not only because they are rare, but more importantly, because they indicate a level of demand that typically proves sustainable. Within the half-year following such signals it is unusual to see corrections of even 10%. Seasonally, equity markets will soon exit a period of traditional weakness to enter one flattened by the impulse to chase performance and generate returns by year-end. While many of our surveys of aggregate hedge fund positioning would say net long exposure has rebounded to late 2007 percentages (though on a smaller base), and mutual fund cash/asset ratios have come in significantly, markets continue to trade as if most are not satisfied with their current commitment to equities." Great insight from Tudor and we'll have to see if that pans out. As far as their equity selections go, they favor emerging markets and in particular Brazil and Taiwan.

Overall, great insight and it's definitely interesting to see an in-depth presentation on gold from the global macro specialists. In the letter, we also find out that Tudor is up 14.88% year to date for 2009 and currently has over $11 billion in assets under management. Jones has somehow managed to perfectly summarize the market action, labeling it "The Great Liquidity Race: Wall of Money Climbs Wall of Worry."

Embedded below is Tudor's Q3 letter, courtesy of Dealbook where we recommend using the full-screen option for reading:

For more on Paul Tudor Jones' hedge fund firm Tudor Investment Corp, check out our post where we covered their UK positions. Also, you can see Tudor's historical returns here as well as their August commentary where they deemed action in US markets a bear market rally. As always, we'll continue to track the movements and insight from one of the greatest traders and hedge fund managers in the business, Paul Tudor Jones.

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