Was John Paulson right to sell gold? (GLD, ABX, SPY)

Uber-investor John Paulson was right to sell gold (GLD, quote) — as reported previously on www.emergingmoney.com — if other investors are bidding on the shiny metal as an example of “the greater fool theory” in action.

The greater fool theory operates when traders stop investing and start speculating on a bubble.  Its foundation is that “a greater fool” can be found to buy a bubble asset. 

But as Warren Buffett noted, “What the wise man does in the beginning, the fool does at the end.”

According to James Mackintosh, writer of “The Short View” column with the Financial Times, for gold, “the strongest evidence for a bubble comes from the price.” 

If gold was an investment rather than a speculation, it would be making long-term moves related to the equity markets.  It does not, however, even though rising demand from consumers in China, India and other parts of Asia provide much support. 

For the rest, gold’s movements are not based on economic value, rather speculative purposes — see for yourself how GLD does not correlate with the SPDR S&P 500 exchange traded fund (SPY, quote). 

Bill Smally, a vice president at Factor Advisors, noted this about the relationship between gold and equities: “It never really goes strongly one way or another for a long period of time.” 

Eventually, for any asset, fundamental economic demand prevails.  There is no fundamental economic demand for gold — over 90% of every ton mined is for investment, not industrial, purposes.  As a result, gold is now at a six-month low. 

As detailed in a previous article in www.emergingmoney.com, John Paulson sold off part of his position in SPDR Gold Shares (GLD) earlier in the year.  John Burbank, head of Passport Capital, established a short position on Barrick Gold (ABX, quote).  Both will look even wiser in 2012 as gold continues to fall.

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