We have obtained John Paulson’s latest letter to investors. Paulson’s letters are great because he goes into great detail. For example, a letter to investors dated February 2012, was 102 pages, the latest letter for Q1 is 44 pages, and mostly text, not legal jargon. Almost no other hedge fund managers write letters as long as Paulson’s.
Below is Paulson’s macro overview followed by his gold fund holdings:
While the U.S. economy appears to be doing better than expected and equity markets appear moderately priced, significant risks exist. At the global level, the Euro crisis remains the biggest risk to global activity and global markets. While the ECB has stabilized European credit markets in the short term through the injection of massive liquidity, the ECB maneuvers do not address the fundamental flaw of the Eurozone, a monetary union without a fiscal and political union. An unraveling of the Euro would affect not only European markets but also all markets in which we operate. We are also monitoring other risks, such as rising tensions in the Middle East, the rise in oil prices, and a potential slowdown in China.
In the short term, risks remain with Greece, Portugal, France and Spain.
A Greek exit from the Eurozone remains a concern. Portugal also remains an
unresolved issue, which despite its government’s recent positive statements, is likely to need a second bailout program to avoid a default.
New risks would present themselves if a new French government took a
radically different approach to European policy. The benefits of the LTRO are starting to wear off as Spanish CDS spreads are at all-time highs. Spanish banking stocks are also falling due to concerns about both Spanish sovereign and private sector credit risk. In the intermediate term, Spain will likely require bailout assistance as its deficit remains high, its economy continues to shrink, its unemployment rate continues to rise, and its debt to GDP continues to climb. Spanish Five Year CDS Spreads Above Peak Levels of November 2011 and Spanish Banks Stocks Plummeting Due to Increasing Sovereign Exposure.
The first quarter of 2012 was characterized by continuing volatility in gold and gold equities. Gold started the year at US$1,564/oz, and had risen to US$1,738/oz. by the end of January, driven by news that gold imports into China in the final quarter of 2011 were extremely robust. The rally continued into February, and by February 28th the metal reached US$1,784/oz, a gain
of 14.1%. The following day, however, gold lost almost $90/oz. on the back of comments from Fed Chairman Bernanke suggesting that no further quantitative easing would be required. After starting out strongly, gold shed 2.3% in February and a further 1.7% in March but still posted a positive return of 6.7% for the quarter.
Although gold prices rose, gold equities fell during the quarter. After rising along with the gold price through February 28, they fell at a more rapid pace for the rest of the quarter, with the gold mining index finishing down 3.7% for the quarter. In fact, the divergence of gold miner equity performance from the gold price has continued to widen since the fund was formed. Since the inception of Paulson Gold, the gold price is up 49%, the Gold Miners Index Market Vectors Etf Trust (NYSE:GDX) is flat and the Junior Gold Miners Index, Market Vectors Junior Gold Miners ETF (NYSE:GDXJ) is down 12%.
Gold equities have been lagging the price of gold since January 2010. After rising 13.5% in January, the gold fund dropped 4.8% in February and 13.5% in March, closing the quarter down 6.5%.
Despite recent negative performance, we believe that the outlook for gold and gold equities remains positive. The improved performance of the U.S. economy is consistent with our view that the Fed’s massive stimulus program is beginning to take effect, and that the effects of quantitative easing will eventually result in higher levels of inflation. We believe this will
ultimately be very positive for gold, even though we are currently in a low-inflation environment. Gold equities are now at historically low valuation levels. An analysis of the trailing 12-month EV/EBITDA ratio for the NYSE ARCA GOLD BUGS INDEX (NYSE:HUI) shows that the gold equities
are trading at their lowest valuation level in ten years, on par with the low point in valuation that prevailed following the failure of Lehman Brothers.
Given the financial performance of the gold mining companies in the current gold price environment, we believe the equities are substantially undervalued and poised for a revaluation. During 2011 the gold producers delivered EPS growth of approximately 50%, compared to an average year-over-year increase in the gold price of 28.2%. In the first quarter of 2012 the gold price averaged 21.9% more than it did in 1Q2011, and we anticipate further growth in earnings and cash flows when the industry begins reporting its quarterly results. In our view, this is a compelling entry point.
Paulson Gold Fund Equities
The gold equities in the Paulson Gold Funds delivered mixed results in 1Q2012. Randgold Resources Ltd. (NYSE:GOLD) (LON:RRS), which was one of the best performing gold equities during 2011, sold off towards the end of March following news that a group of junior officers had staged an unexpected coup in the West African nation of Mali. This country accounts for approximately 45% of Randgold’s gold reserves and 65% of this year’s production. Recently, the leaders of the coup and the Economic Community of West African States (ECOWAS) have brokered a resolution providing for a quick return to democracy. Randgold’s operations were not materially affected by these events, and the company has reaffirmed its
2012 production guidance.
Centerra Gold Inc. (TSE:CG) also suffered a setback when it announced that its production for 2011 would be impacted by the unexpected movement of waste sitting on the south end of its current production pit. Due to this movement, the company will have to devote its fleet to advancing the removal of waste, and will therefore not be able to access high grade ore that was scheduled for production in the fourth quarter of 2012. The shares sold off sharply before recovering the majority of its losses, once the market recognized that this was a timing issue and production is expected to recover in 2013.
On the positive front, NovaGold Resources Inc. (NYSE:NG) (TSE:NG) shareholders approved the corporate restructuring that was announced in November of 2011. The company will be spinning out a new company called NovaCopper, which has as its sole asset the Ambler project in Alaska, an exciting copper exploration project. NovaGold will sell the Galore Creek copper project, focusing solely on its flagship Donlin Creek gold project in joint venture with Barrick Gold. The company has recently appointed a seasoned and highly regarded executive to lead the company. As a pure play gold company, we believe NovaGold will be attractive to investors and corporate buyers.
Detour Gold Corporation (TSE:DGC) continues to move forward with the development of the Detour Lake gold project. At the end of March, the project was 60% complete and is advancing at about 5% per month. Mining activities have commenced, allowing the company to build a stockpile of ore ahead of the completion of the processing plant. The main critical path item, the connection of the high tension power line, is now scheduled for early August, which should allow commissioning of the plant in the fourth quarter of 2012. When fully complete, Detour Lake will be Canada’s largest gold mine, and we believe that the shares have significant upside potential.
The shares of Osisko Mining Corp. (TSE:OSK) recovered during 1Q2012 as the market recognized that the modifications to the processing plant at the Canadian Malartic mine were being implemented. The first of two secondary crushers began commissioning in mid-March, and the second remains on schedule for delivery in June of this year. This should allow the company to meet its production guidance for 2012 of 600,000oz
Gold equity prices are currently trading at very depressed levels, with the sector now on a valuation not seen since the fall of Lehman. The gold mining companies, however, continue to grow their earnings with the higher gold price, and we believe that it is only a matter of time before the sector re-values. The Paulson Gold Funds are poised to benefit in such an environment.