St. LOUIS (ResourceInvestor.com) -- With the Dow hitting record highs near 12,000 this week, rumours have circulated that hedge funds may reallocate their investment portfolios further away from commodities to the equities market. RI examines the effect this has had and could still have on the gold price.
According to Hedge Fund Research, more than 2,600 hedge funds have opened their doors since the start of last year, and more than 1,000 have closed them.
Europe's Vega Select, once an $11 billion fund, is said by clients to have shed between 10% and 20% in September, adding to a loss of 9.6% in August after finding itself on the wrong side of an interest rate trade.
In August, MotherRock LP, a $400 million fund run by former New York Mercantile Exchange President Robert "Bo" Collins, went bust after natural gas futures fell 68% from their December 13 peak.
And this brings us to the Amaranth fiasco, and what it means for gold and other commodities.
According to a recent report by Exchange Traded Gold (ETG), a World Gold Council initiative, Amaranth’s massive loss of more than $6 billion in natural gas has had a negative impact on gold in the short term.
In mid-September, Connecticut-based Amaranth Advisors, a multi-strategy hedge fund with assets of $9 billion at the time, reported a loss of $6 billion in less than two weeks. As Amaranth liquidated its positions in natural gas, futures tumbled by 35% contributing to an 18% slide in crude oil quotes, according to the report.
“The announcement of the Amaranth loss led hedge and managed futures funds and other speculators to sell other commodities,” ETG noted.
Gold fell by 10% from $640/oz to a low of $574/oz in September.
Amaranth held plenty of gold mining stocks, including AngloGold Ashanti [NYSE:AU], Barrick Gold [NYSE:ABX; TSX:ABX], Freeport-McMoRan [NYSE:FCX], Glamis [NYSE:GLG; TSX:GLG], Gold Fields [NYSE:GFI], Goldcorp [NYSE:GG; TSX:G], Harmony [NYSE:HMY], Kinross [NYSE:KGC; TSX:K], Newmont [NYSE:NEM], Randgold Resources [Nasdaq:GOLD; LSE:RRS], Royal Gold [Nasdaq:RGLD; TSX:RGL] and Yamana Gold [AMEX:AUY; TSX:YRI].
According to the report, gold was sold on fears that Amaranth losses would lead to sales of other commodities and because lower oil prices would lead to lower inflation. Now, banks and investors are studying the risk implications of relatively illiquid commodity markets compared with foreign exchange and bond markets.
“It is well and good when prices are going up, but when they head south it is extremely difficult to get out,” said ETG.
Investors are thus likely to be wary of hedge funds that specialise in commodities, and “such caution could reduce the flow of funds into these markets.”
Amaranth could also discourage pension funds from allocating a proportion of assets to commodities via commodity index swaps. Since gold is one of the components in the indices, this could affect flows into the market, according to the report.
In fact, Amaranth’s loss impacted several pension funds including the 3M pension, the $7 billion San Diego County Employee Retirement Association pension fund and state pension funds in New Jersey and Pennsylvania.
However, ETG said that medium and longer term implications could be positive for gold, since the gold market cannot be described as illiquid.
On Comex in New York, the open interest of around 400,000 contracts is equivalent to around $24 billion. The counter derivative market open interest in London, Zurich, Asia and elsewhere was $334 billion in December 2005, according to the Bank for International Settlements.
Additional liquidity is now also provided by Exchange Traded Gold funds [NYSE:GLD; LSE:GBS; EURONEXT:GBS; ASX:GOLD; JSE:GLD]. StreetTRACKS Gold Shares traded more than 12 million shares ($784 million) per day in May when gold was hitting 26-year highs of $730/oz.
Sources say the e-CBOT electronic platform has been popular with hedge funds and on some days takes more than half of the trading volume in gold futures.
CBOT reported today that trading of its full-sized (100 ounce) gold futures contract reached an all-time high yesterday, as volume surpassed 70,000 for the first time. This new record of 72,193 contracts tops the previous high mark of 69,432 contracts set on September 11, 2006.
Jason Hommel, Editor of Silver Stock Report, told Resource Investor that many of funds still have yet to enter the commodities market.
CalPers, a retirement fund in California that manages over $200 billion, announced about 2-3 weeks ago that they were thinking about investing into gold, oil and commodities for the first time, according to Hommel.
“I'd expect that funds would re-enter commodities when they hit new highs,” he said.
Although precious metals are falling, lead is hitting new highs near $0.65/lb, as well as uranium at $55.75/lb. Molybdenum is up to $28.50/lb from $23 about 6 months ago. Zinc is currently flirting with $1.55/lb and inventories continue to decline at a rapid pace, according to Hommel.
“We may run out within about 3-6 months, and the zinc market is expected to have no major new supply in the next 1.5-2 years,” Hommel added.
These commodities are not traded on futures exchanges, so the only way for funds to get exposure to them is through buying the minerals directly and warehousing them, or buying the mining companies. However, ETF Securities recently announced the offering of 29 new Exchange Traded Commodities (ETCs) on the London bourse, which includes zinc.
Hommel suspects the dip in commodities to be almost over.
“Maybe things will stay calm through the November elections, but when they try to manipulate these things, sometimes it blows up in their face, like maybe a week before the elections,” he said.
Gold Price Activity
December gold closed up $8.80 at $575.50 an ounce on the New York Mercantile Exchange after hitting a high of $578.80.
However, gold futures lost $36.6 the previous two sessions, touching a low of $536 yesterday.
