market folly

Today via ARHedge we present you an excerpt from Kyle Bass' latest letter to investors of his Hayman Advisors firm. If you're unfamiliar with Bass, he launched his hedge fund in 2006 with $33 million in initial capital. In August of 2006, he began shorting around $4 billion of subprime securities through various derivatives and eventually turned $100 million into over $700 million based on his prediction of the crisis. This isn't the only major prediction he's been correct on, either. Bass was even predicting sovereign defaults back in May of last year. Needless to say, he's been right on the money. His latest missive is entitled, 'The Pattern is Set - Betting the Bank of a Keynesian Free Lunch'

Via ARHedge, here is an excerpt from Hayman Advisors' investor letter from May 11th:

He writes, "The ECB's monetary policy action simply adds to the moral hazard that was originally created on the fiscal side of the problem. The pattern is now set. This is exactly how very smart people meeting together in order to 'solve' a debt crisis frequently (and now permanently, it appears) mistake a solvency crisis for a liquidity crisis. From now on, it seems everything will be deemed to be a liquidity crisis that will be met with more 'bail-outs' and debt financed spending. This will eventually break traction in a violent way and facilitate severe inflation or even hyperinflation. The one thing the EU taught us this weekend is that paper money will be worth less (maybe much less) in the future."

Bass' notion of hyperinflation is intriguing because we haven't seen too many managers talk about the prospects for that outcome as most are fixated merely on the inflation versus deflation debate. However, we do recall black swan extraordinaire Nassim Taleb himself recently touching on how, from a portfolio construction point of view, it makes sense to allocate some capital to inexpensive insurance against possible hyperinflation. The wager doesn't cost you much and if you 'win', it pays off big. If hyperinflation doesn't come to fruition, then you haven't lost much capital. An intriguing thought certainly and Bass would probably agree with him on that notion.

The Hayman Advisors founder then ends his letter with a decisive analogy writing,

"This weekend, the EU and the IMF effectively went all-in with a bad hand in the highest stakes game of financial poker ever played with the world. We believe the agreement released was nothing more than a Potemkin agreement in order to placate bond investors. In the end (and there will be a reckoning for many countries) nations, including the United States, need to dramatically cut spending and get their fiscal balances in order. Unfortunately, our elected officials are on the hamster wheel of electoral cycles and are not able to make tough decisions like this as they would likely not be re-elected without a "sea change" in public opinion towards government spending and deficits. We are therefore on the path to significant currency devaluation around the world that will likely result in significant inflation. We increased our holdings of gold on Monday morning as well as taking other steps to position ourselves for the most likely outcome over the next few years. Interestingly enough, based upon the market reaction in the last 36 hours, it seems the law of diminishing returns applies to bailouts as well."

You can read the rest of his brief letter over at ARHedge.

So, we now see that Bass has increased his gold holdings and joins countless other hedgies who see gold as a safe haven and a way to hedge against currency devaluation. Lloyd Khaner of Khaner Capital last week gave an in-depth presentation on gold at the Value Investing Congress. And as we all know, John Paulson launched his gold fund as a bet against the US dollar. Not to mention, other prominent hedge funds like David Einhorn's Greenlight Capital as well as John Burbank's Passport Capital are storing physical gold.

It's very clear that number of prominent investing minds are concerned about currency devaluation and inflation going forward. Today seems to be inflation versus deflation day here on the site as earlier we posted up hedge fund Broyhill's contrarian bet on long-term treasuries and their ten reasons to buy bonds. Obviously this differs drastically from the vast amount of other hedge funds who have been short treasuries, wagering on rising rates and possible inflation. Well, the debate wages on, but we certainly know where Kyle Bass stands now, don't we?