Markets & Finance

Hedge Fund Whiz Einhorn Jumps on the Gold Wagon


Why a top hedge fund manager who sought not to repeat his grandfather's bad bets in gold has changed his view and bought into the metal

With the price of gold racing higher over the past two months, more investors are coming around to the notion that the precious metal may be the best option to protect against a possible economic catastrophe. Among the surprise new buyers? Star hedge fund manager David Einhorn.

Gold rose steadily from its November 2008 low of $682 to close at $910.70 on Jan. 26, a five-month high. Despite selling off about $10 an ounce over the next two days, investors, it seems, have realized that much of the Federal Reserve's plan for fighting the credit crunch and reviving the economy are also likely to bolster gold's prospects.

Shying Away from a Forebear's Mistakes

Einhorn, famous for predicting the fall of Lehman Brothers and taking on Allied Capital (ALD), a commercial lender he accused of fraudulent accounting practices, has previously stayed away from gold and the theories of doom that gold bugs frequently offer. But amidst the unprecedented government moves to shore up the economy and ward off deflation, Einhorn's views of catastrophe have come around.

His Greenlight Capital ended a decade-long streak of avoiding losses last year with a 22.7% drop—still far better than the Standard & Poor's 500-stock index's 37% plunge. In a confidential Jan. 20 letter to his investors obtained by BusinessWeek, Einhorn explains why he long avoided buying gold. His grandfather, Benjamin, an amateur gold bug, lost money for 30 years waiting for the U.S. currency to succumb to a catastrophic bout of runaway inflation that never arrived.

"Being a patient investor is one thing," Einhorn writes. "Being wrong for three decades is quite another."

Hedging Against a Debased Currency

The Federal Reserve's recent moves, particularly the central bank's commitment to combat deflation by pumping up liquidity via massive rate cuts and other actions, prompted Einhorn to change his long-held view. "Combined with an aggressive fiscal policy, it is clear that the authorities are going 'all-in' to try to mitigate the near-term effects of the economic collapse," he writes. "Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself."

Einhorn, who declined to comment for this story, wrote that his firm has bought gold, call options on gold, and an index of gold-mining stocks tracked by the Market Vectors Gold Miners ETF (GDX). "To everyone's dismay, we believe that some of Grandpa Ben's predictions are playing out," Einhorn says.

The old man may look right as rain now, but for most of the past year, it hasn't been clear exactly how gold would fare amidst plunging economies and falling stock prices. After peaking at more than $1,000 in March, gold zig-zagged before reaching its 2008 low in November. The current rally coincides with an end to the dollar's 2008 upward phase and a growing recognition of the magnitude of the losses suffered by lenders around the world.

A Leading Analyst's Gold Picks

The wild ride is far from over, but the price of gold will likely be higher by the end of 2009, according to Richard Gray, a mining sector analyst at investment bank Blackmont Capital in Toronto. Gray's 2008 forecast was dead-on, as the analyst said gold would trade between $700 and $1,000 while averaging $850. Gold averaged $872 and traveled between $682 and $1,033 for the just-completed year.

This year, Gray says gold will average $950 and trade as high as $1,100. He also notes that some expenses for gold-mining companies, like the price of oil, have dropped sharply. His top picks among mining stocks are Canadian listed outfits Goldcorp, Agnico-Eagle Mines, and Jaguar Mining.

Pressman is a correspondent in BusinessWeek's Boston bureau.

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