John Paulson is one of the most famous and successful hedge-fund managers of all time. He shot to stardom in 2007 after The Wall Street Journal revealed his firm had scored a jaw-dropping $15 billion profit from making big bets against the housing market.
Although Paulson catapulted himself into the record books with what is referred to as the "greatest trade ever," his path to those riches was anything but smooth.
Before bagging his record trade, Paulson had been betting against housing for years, defying one of the biggest rallies of all time. Paulson's contrarian view had many a naysayer and even his own clients saying he had lost his mind as his fund continued to lose money on its bets against housing, buying into the growing narrative that the economy was in a new paradigm and that house prices rarely, if ever, went down.
Paulson's bet against housing flew in the face of popular opinion. If it hadn't, his trade wouldn't have been such a massive success, because huge gains are possible only when one stands willfully against the masses.
Five years later, Paulson is again embroiled in a controversial trade -- one that is unfolding just like his signature bet against housing.
Since the financial crisis, Paulson has been making huge bets on gold. But after gold's 13% drop in the first three weeks of April -- a drop that saw gold miner stocks fall even more -- the choir of skeptics is once again growing, claiming that Paulson has lost his touch.
I couldn't disagree more. The recent pullback in gold is totally normal, particularly for an asset that's jumped more than 500% in the past 12 years. In fact, it is the perfect platform for gold's next leg higher -- because the forces that first sent gold higher continue to accelerate.
The biggest factor that will continue to support gold's ascent is global currency devaluation, with central banks worldwide racing to devalue their currencies against one another to stimulate economic growth and the stock market.
Even the Federal Reserve acknowledges this dynamic, with Dallas Fed President Richard Fischer estimating that 30% of the S&P 500's gains in the past four years have been coming from central bank stimulation. The market is addicted to waves of fresh liquidity from the central banks, so even if these financial behemoths wanted to withdraw from the market, they can't.
With the central banks well aware of the coordinated devaluation of fiat currency, they are moving aggressively to protect their currency reserves from the bearish trend. And the way they are doing that is by swapping out their currency reserves for gold.
In 2012, central banks bought $500 billion in gold -- the most in 50 years. And despite gold's biggest drop in 30 years last week, central banks are still net buyers of the precious metal, most recently with central bankers in Sri Lanka and South Korea using the dip as a chance to buy.
Retail investors are also an important part of gold's bullish ascent in the past few years. Through financial innovation, it has never been easier for investors to own gold. Popular exchange-traded funds (ETFs) such as SPDR Gold Shares (NYSE: GLD) and PowerShares DB Gold Double Long ETN (NYSE: DGP) have seen billions in capital inflows in the past few years, enabling investors to avoid the costs of storing and securing gold bullion.
The last reason gold still has plenty of room to run higher is sentiment.
Bubbles never end with skepticism. They end when the bullish fever runs so high that investors don't think they can lose. That's how the housing and dot-com bubbles ended.
But despite gold's incredible run in the past 10 years, it is the one trade people still love to hate. When that changes, we will have finally seen the top of the gold market.
Risks to Consider: Gold has shown a propensity for extreme volatility in the past week. That makes gold a very high-risk investment that should represent a very small percentage of most people's portfolios.
Action to Take --> Despite gold's recent sell-off, the forces that have lifted the precious metal to more than a 500% gain in the past dozen years are still well in play. That makes gold's recent pullback an opportunity to buy when others are fearful.