Martin Kronicle

A reader asked a great question about how or why Soros would choose gold futures over bullion or vice-versa?

Yesterday, I wrote two posts about George Soros and his recent gold purchase. One was how he did it, the other why he might have done it.

By owning the bullion via the SPDR Gold Trust (GLD), Soros owns bullion as the underlying asset – this is an investment, not a trade. He owns it outright and there is no margin requirement. If his prime broker settles the transaction in a margin account, Soros can lend the GLD shares to another entity that wants to sell short and exact a rebate for doing so (he’d never let the PB keep it all, if they get to keep any of it). This enhances his yield to own the GLD shares.

If he’d owned the same exposure in the COMEX futures market, he’d need to post margin, which he’d undoubtedly be able to do as it would be between 5% – 10% of the over $600 MM position he has. However, he may run up against a few other hurdles by doing so. One, he’d be right up against the maximum position limit in that one can hold in futures. Two, there may not be sufficient liquidity to move the type of size he might want to at a specific time.

In both investments he’d be able to stand for delivery and accept gold if he wanted to.

I think the main reasons Soros bought the bullion are as follows:

-he can hedge all/part of his position using futures in the short-term by selling futures against his long GLD
-he can lend the GLD to a short seller and capture incremental income via rebate, whereas GLD has no dividend yield
-he can very reasonably enhance his long position by purchasing COMEX gold futures in addition to his GLD
-no margin calls for GLD
-no carry charges for GLD, but has Trust expenses
-he most likely can accept the physical gold bullion against his GLD ( b/c of his size)
-tax treatment is more favorable with GLD (28% capital gains tax rate in taxable accounts)*

You, the retail investor, can buy GLD though a regular brokerage account – you don’t need to be approved for commodity futures trading, which may be a barrier for some given the financial litmus test that you must pass. Soros can pass the test.

*Gains/losses from the purchase and sale of commodity futures are subject to a blended tax rate: 60% is considered a long-term gain or loss, and 40% is considered a short-term gain or loss.

August Comex Gold - No Bubble Here

One thing that was not covered in the BusinessWeek article was the overall size of Soros’ stake in gold wrt the marketplace. By adding another $421 MM to his gold position, he took his entire SPDR Gold Trust corpus to $631 MM.

At today’s price of $1,100 per ounce, that would put the Soros stake at approximately 5,975 contracts had he been trading futures. But since he’s owned his initial stake for quite some time, it’s pretty safe to say that he’s at or over the equivalent of 6,000 contracts – and I stress equivalent because his firm owns shares of the SPDR Trust.

The Position Limit for COMEX Gold futures is 6,000 contracts, with no more than 3,000 contracts being in the expiration month. The 13F that investors with over $100 must file does not include futures contracts. Soros may hold COMEX Gold futures in addition to his SPDR Trust holdings, and if he did, he’d be getting around the position limit guideline.

Soros may not be the risk lover he once was when he and Jim Rogers ran the Quantum Fund. At that time, according to my most recent Jim Rogers podcast interview, Jim said they used excessive leverage to generate their gains.

BusinessWeek reported that Soros Fund Management increased its already large stake in the SPDR Gold Trust by $421 MM to a total of $663 MM, making gold the largest position in his fund.

His initial gold stake had almost doubled, yet he more that doubled his existing position. Why? Soros is a trend follower, and trend followers typically add to winners to ride the trend further: they know when they’re getting out, and they don’t know where the top is. In adding to his already large, wining position, he has signaled to the market that he doesn’t know where the top for gold is. Soros made this investment despite saying that gold was in a major asset bubble.

Think about it and send this post to your clients who want to know why Soros makes the money he’s made over the years.

–Soros had an existing winning position.
–Soros added to his existing position and didn’t feel stupid b/c he was paying a much higher price.

Traders can add to winners and invest their gains into their Stop. By doing so, they will have a larger position to “ride the bucking bronco” as Bill Dunn would say, and by investing their gains into their Stop, get liquidated on the entire position and still walk away with gains, albeit not with the most gains they could have.

For example, say you are long 1 contract at $600 and you buy another at $1,200. You have $600 in unrealized gains (that’s your money, not the market’s). To invest your gains into your stop, you enter a protective Sell Stop order to sell 2 contracts at $1,000 for example – liquidating your entire positions and still walk away a winner.

Any price over $900 will work, b/c that is the break even and you don’t lose any of your original investment.

Even though the market is 2x where it was when you bought, it still looks cheap if it’s going to $2,500…something in fact that you have in common with George Soros: you don’t know how high it can go despite how foolish you might feel buying more at $1,200.

The positive intention of those foolish feelings might be telling you something very important: they might be the feelings of doing something different from what losing traders do, and it’s just a new feeling for you…so try to feel that foolish feeling more.