(April 20, 2011) – The recent purchase of nearly $1 billion in physical gold bullion by the University of Texas Investment Management Company (UTIMCO) is raising questions among endowment and other asset managers: was it a political statement, or a prescient investment?
"Gold has had a huge run-up – which suggests a bubble,” according to Dean Baker, co-director at the left-leaning Center for Economic and Policy Research in Washington, who has previously warned about institutional investors over-allocating to gold. “I would not consider investing in gold. I assume they expect higher inflation, but I don't understand it. I think it's silly. In this case, I don't see why UTIMCO would do this."
According to multiple reports, UTIMCO executed the purchase of 6,643 gold bars – to be stored at an HSBC vault in New York City – at the behest of Kyle Bass, a UTIMCO investment board member and managing partner of hedge fund Hayman Capital Management. This equates to 5% of the university system’s total assets. The investment thesis, according to sources, is predicated on the idea that if even 5% of COMEX futures were called, the company would not have enough physical gold to meet demand. “If you own a paper contract where they can only deliver you 10 cents on the dollar or less, you should probably convert it to physical,” Bass told Bloomberg earlier this week.
"I think clearly that politics are a big factor – someone wants to blame the Obama Administration,” Baker states. “They think investing in gold is a way to counter that. If you think Obama is destroying the economy, and we're on the edge of the economy, you want to have pounds of gold. That's the story. They really think we're on the edge of this huge collapse – and the only thing good is gold. I think that's crazy. Some people think President Obama wasn't born in the country, that he's a socialist - people think this way."
If nothing else, the storage of physical gold in this quantity is cheaper than accessing the market via exchange-traded funds, a more common route for investors. According to Bloomberg, at current prices, it will cost UTIMCO approximately $1 million to store the delivered gold – well below the $4 million that the common 0.4% of invested assets going toward an ETF provider such as SPDR Gold Trust. It also avoids any concerns over ETF counterparty risk.
Baker, however, raises concerns over liquidity – and what would happen if a quick sale was necessary. "The premise is that we're on uncharted territory,” he says. “I don't know what people envision. If we're in a situation where it's every person for themselves, I really don't know. Gold is not great with liquidity. You'll always be able to get something for gold but you can't guarantee a price." He also takes issue with concerns over counterparty risk. “At the peak of the crisis in the fall of 2008, it could be a reasonable concern,” he says. “But it shouldn't be that much of a concern right now. Counterparty risk will never go to zero, but it should be low right now. It's generally low. In 2008, it was unusually high."
Inflation concerns are also credited with the UTIMCO gold buy. "We are hedging against the devaluation of currencies such as the dollar, euro and yen because of the monetary and fiscal stimulus that has taken place,” Bruce Zimmerman, UTIMCO president, is quoted as saying in The Daily Texan.
However, multiple endowment managers contacted by aiCIO suggest that this conventional wisdom was out of step with reality, and that gold is far from the hedge it is thought to be. Baker agrees. "It's not a good predictor,” he says. “People turn to gold as a hedge against inflation, but since it has already risen, you'd have to have an awful lot of inflation to justify current gold prices." Adam Tosh, a consultant with Rogerscasey, agrees – with a caveat. “I don't disagree that gold is not a good predictor of inflation, but investors seek a safe-haven from inflation with gold… [thus] gold could continue to run if people fear inflation will be higher than it is,” he says.
Recent academic work on the subject is decidedly mixed.
As with any investment, price matters – and some think that buying gold at record levels suggests a bubble. "It's like buying into the housing bubble at an all-time high,” Baker asserts. “You end up a big looser." A more appropriate investment? “A basket of commodities,” Baker says. “It looks to me like this is a gold bubble. But the risk that all commodities will fall in price is less than the risk that gold itself will fall in price. A basket of commodities will more closely track inflation." Tosh agrees, again with a slight caveat. “It could be better for investors to diversify with a commodities bucket,” he says. “We would advocate a diversified inflation-protected bucket if it's a hedge against inflation. But if it's a hedge against 'I have no confidence in government' then gold isn't a bad store of your purchasing power.”
This isn’t UTIMCO’s first foray into gold purchasing. In July, 2010, the fund made a “$500 million commitment in gold [which was] a tactical allocation decision made by management," UTIMCO President Zimmerman told aiCIO at the time. "UTIMCO has been laddering in this exposure over a number of months. The investment in gold was a hedge against lack of confidence in financial assets due to lack of government fiscal and monetary discipline."
UTIMCO was unavailable for comment as of press time.