Thursday, January 29, 2009

Einhorn on Inflation

David Einhorn is now buying gold, the yen, and calls on long-term interest rates. In fact, he sounds a lot like Jim Rogers nowadays – the Fed is going to debase the currency, Ben Bernanke is obsessed with money printing, and so on.

But there are a couple of problems with this line of reasoning.

First, it’s not at all what we’re seeing. The risk of a depression is higher than the risk of hyperinflation, at least right now, so to a large degree the Federal Reserve is doing the right thing. They contracted the money supply and didn’t support banks after 1929, and the result is well known.

Second, gold is a horrendous investment under all other scenarios except for high inflation. The supply of gold is massive – there is more gold available now than ever before in history – and demand has dwindled to basically nothing more than use as an inflation hedge. It is one of the most inferior commodities in terms of fundamentals.

If inflation does not occur as predicted, you have no margin of safety. You are left holding a nonproductive lump of metal. In buying gold at current prices, roughly the highest in thirty years, there is not much room for error.

Yet it sounds much more reasonable to tell your investors that you’re holding gold, as opposed to sugar futures or lead futures or whatever else. The fact is that Einhorn’s investors may be better served if he simply held the Rogers Index instead.

Third, higher inflation appears to be turning into a consensus view, and the consensus view is rarely correct. You have to question why investors like Einhorn would even get into these big macro questions, and what competitive advantage they have there.

Incidentally, here are some of my views on inflation. I have held similar views to what Einhorn is currently expressing, since early 2006. But now I am playing the devil’s advocate even with my own reasoning.

The interest rate trade definitely makes sense: coming out of this crisis, rates must rise. Moreover, the yen will continue to strengthen as the carry trade continues to unwind; but it seems that Einhorn is a little late to this party as well, as the yen was probably a better trade in 2008 than it will be in 2009.

I am with Buffett in saying that you’re going to do a lot better with picking great businesses than you will in trading macro events. The latter are just way too difficult to predict.

Creative Commons License
This work by Nicholas E. Radice is licensed under a Creative Commons Attribution-No Derivative Works 3.0 United States License.