Last week, a fund rumored to be on deathwatch, was Toronto-based, gold and energy-focused hedge fund Salida Capital (whose gold exposure, in addition to Paulson's, were both factors in the rapid drop in the price of gold last week, following concerns that it was being liquidated in the open market - for more on Salida's gold exposure, read the attached letter). The fund promptly came out and refuted said rumors, however upon review of its monthly P&L, we are somewhat skeptical about its survival chances, even if, in principle, we agree with the fund's investment philosophy. The reason for our skepticism is that Salida was down a whopping 37.2% in September, and 49.4% YTD, a collapse which only compares to that of Paulson's Advantage Plus, and demonstrates vividly just how much of a misnomer the name "hedge" can be when applied to members of the asset management industry. What is worse, however, is that the reason attributed for this epic collapse is amateur hour 101, and any LPs should be far more concerned by the explanation provided for this underperformance than the actual underperformance itself.
Salida says: "September was an extremely difficult month for the Salida Strategic Growth Fund, which fell 37.17% in the month and 49.44% year-to-date. On the back of August's market selloff, we felt that our core gold, energy, and other resource names were trading at very attractive levels, particularly in light of prevailing commodity prices. We further felt that the Fed was moving ever closer to a QE3 announcement, and even more importantly, U.S. money supply had been growing extremely strongly through the summer months even without a QE program. U.S. money supply growth in recent years has proven to be very reliable leading indicator of risk asset markets. So far, however, it appears that this newly printed money has this time flooded into U.S. treasuries offering record low yields." In other words, it's all M2's fault. The problem with this simplistic observation is that as we pointed out two months ago, the move in M2 has nothing to do with the Fed, and everything to do with asset reallocation, when investors scrambled out of equities and into the "safety" of their bank accounts. Furthermore, the unwind of Regulation Q was also a main driver for this surge in the broad monetary aggregate. Alas, Salida made the most fundamental rookie mistake in finance and assumed correlation to be causation (as did Art Cashin, Dennis Gartman and Andy Lees) of Fed stimulus. The irony is, as we said, that we agree with Salida's underlying premise: "With an election year looming, a sputtering economy, and a Fed Chairman who has in the past touted the ability of unconventional monetary policy to cure such economic woes, we believe the [QE3 Large Scale Asset Purchases] announcement will come." Alas, the question is when. And as Salida just found out the very hard way, in finance you may be 100% right eventually, but if your timing is off, well, as Salida itself says, "True money–printing QE3 will come — timing is the question." In that, at least, they are 100% correct.
As for the reason why gold sold off so precipitously two weeks ago, a lot of it has to do with feedback loop concerns that Salida (as well as Paulson and other long-heavy funds) may be liquidating. From the fund's letter:
On the back of this surge in money supply, we made two mid–August investment calls:
1. We continued boosting our exposure to gold, believing it to be a relative safe haven, and that it would continue to attract inflows as QE3 speculation grew in the face of a renewed U.S. recession. While bullion performed well in 2011 through August, it was hit hard in September, falling a dramatic US$200/oz in only a 3–day span. Margin hikes by the CME and the Shanghai Gold Exchange, disappointment from the Fed, and rumours of redemption/margin call–driven fund liquidations and European central bank selling took their toll. These factors tend to be temporary in nature. In fact, with much of the developed world now in or close to recession, European sovereign debt concerns intensifying, and Chinese growth appearing to slow, the fundamental backdrop for gold has rarely been more compelling. A bet on bullion is a bet that central banks are about to ramp up money printing — a logical bet in our view. In fact, we feel safer in gold than anywhere else in today’s market.
2. We felt that a money growth–fuelled market rally would provide a good bounce to beaten–up energy stocks given the relative resilience of the oil price. Not only did the bounce not occur, but the sector has continued to sell off. Sell off is an understatement — it’s been decimated, with the WCAT ETF (a basket of mid–cap energy stocks) falling almost 40% over August and September alone. Our impression is that the sell–off is at least partially driven by forced fund liquidations (i.e. selling to meet margin calls or redemptions). While these factors tend to be temporary in nature and unsupported by fundamentals, we admittedly have less confidence in the short term outlook for the price of oil than we do in gold. It’s not $80 WTI (or $100 Brent) that has investors spooked — it’s the potential for oil to head lower in the near term. And with recessionary conditions spreading, we can’t totally dismiss such a scenario. Accordingly, we’ve now raised our level of hedging in both the energy sector and the broad market.
These two calls have been costly, as the market has moved against us. We still believe that the reasoning was logical, but arguably ill–timed. In hindsight, we underestimated the short term impact of forced selling.
Considering that the letter was written October 3, it is probably safe to assume that Salida was not the source of gold liquidation. At least not yet.
Salida's Monthly Performance Letter (pdf)
And Salida's October Commentary - worth a read (pdf)