Should You Follow Soros Out Of Gold?

By Stephen D. Simpson, CFA | September 22, 2011 AAA
Should You Follow Soros Out Of Gold?

Investors can't seem to get enough of stories talking about what this or that famous investor is doing with his or her portfolio. In the latest example, news that George Soros has liquidated his gold holdings has some investors and commentators wondering whether the markets are looking at the end of an impressive run in gold. Whether Soros is right or wrong with this latest move, investors ought to consider some of the reasons to reject or copy his move.

TUTORIAL: Commodities: Gold

Less-Legitimate Reasons to Copy Soros
Playing a Different Game
Simply put, investors like Soros, Paulson, Gartman and the like are playing a different game than you or me. In many cases, the funds run by famous hedge fund managers are leveraged up the hilt, and have relatively inconsequential trading costs. What that means is that fund managers can sell on Monday, buy on Wednesday, sell again on Friday and make money all along the way. That's something that the average investor cannot do. Playing an anticipated 2% move makes sense in an environment of minimal taxation, minimal transaction costs and massive leverage. For the regular investor, it's a sure way to get poor quickly.

There is a difference between holding gold for price appreciation and holding it as an insurance policy or portfolio hedge. Gold tends to have low correlation with other financial assets and there is a credible argument that gold should have a permanent place in portfolios because of that diversification benefit. For those investors who like gold as insurance, it would make little sense to follow Soros. Selling all of your gold just because Soros does makes about as much sense as canceling your car insurance because your neighbor sold his car. (For related reading, see Gold: The Other Currency.)

Rebalancing
Although Soros reportedly sold all of his gold, famous investor moves are often presented without context. How much did they own? How much do they own? How large is the fund? What may look like bailing out of a position may in fact just be a portfolio rebalancing. For instance, a manager purporting to run a diversified fund may not be able to allow having a single position dominate or dictate the direction of the fund's performance. Likewise, some funds operate with statutory limits on position size and may have to trim positions to stay in compliance. (For more on George Soros, see George Soros: The Philosophy Of An Elite Investor.)

Lying
Another good reason not follow the actions of Soros, Paulson or any other high-profile fund manager is that you don't always, or even often, know what they're actually doing. Lying is rife in money management and financial journalism. Managers will lie to each other, they'll lie to reporters and they'll "plant" stories with reporters to skew coverage in the direction they want. Manipulating asset prices through the media has a long history, and the fact of the matter is that it can work. More than a couple of stocks have gone up on little more than a weakly-sourced rumor that a famed investor was buying or looking to buy.

At a bare minimum, investors should try to confirm rumors with U.S Securities and Exchange Commission (SEC) filings. Few fund managers are going to risk the wrath of the SEC by outright lying in their filings. Unfortunately, these filings come well after the actual transactions, and may be entirely out of date by the time an investor can see them, to say nothing of the fact that some funds are outside the jurisdiction of the SEC. (For more, see Using Public SEC Filings To Analyze Companies.)

Legitimate Reasons to Copy Soros
Maybe Gold Has Topped Out
It is at least worth considering the possibility that Soros could be right and that gold has had the best of its run. If gold is peaking, or in the midst of a parabolic blow-off, it is certainly wise to look for the exits. Although it is tempting to stay to the last minute and get every dollar of appreciation that's possible, that is also very dangerous. Those who stay too long often get caught in a rush for the exits and lose a lot of their gains.

Along similar lines, Soros may believe that the markets have seen the peak of fear. There is almost certainly more fallout to come from the European banking and sovereign debt messes, but the U.S. seems to have managed to survive the worst of the crisis. Should the U.S. Congress find that the voters now demand some real solutions and sustained fiscal discipline, gold could have a much harder path upward.

Other Assets May Be Cheaper
If big names like Soros are in fact getting out of gold, there is another angle to consider - the rise of gold has left other attractive assets looking cheap by comparison. One of the chronic complaints about gold is that it has value, but produces no value. In contrast, land can produce both near-term cash flow and long-term price appreciation (timberland produces lumber, farmland produces crops or rent, etc.). While any investor can buy gold or gold ETFs, land is harder to purchase and the combination of a big run in gold and a terrible housing market has created some relative value opportunities in some types of land.

TUTORIAL: The Greatest Investors: George Soros

The Bottom Line
It's unrealistic to tell investors to just ignore whatever Buffett, Soros or Paulson have to say about the market or what they are doing with their money. After all, these men did not get to be wealthy just by accident or luck, and they often have valuable insights on the market. That said, every investor operates in his or her own world and what makes sense for Soros or another hedge fund manager may have little or nothing to do with an individual investor's situation. Hedge fund managers are paid extremely well to outperform each and every year, and that encourages a great deal more risk-taking and turnover than is necessary for an individual investor.

When it comes to gold, investors should certainly care what an experienced commodity investor like Soros is seeing in the market, but it is simply one data point to consider. Soros has been wrong before and may be wrong now, and investors may be holding gold for different reasons and with different expectations. Investors should absolutely consider whether gold has gone too far too fast or whether it makes up too large a percentage of their portfolio. Blindly copying the moves of even the most successful investors is often a recipe for profoundly disappointing performance at the individual level. (For related reading, see The 5 Most Feared Figures In Finance.)

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