A Seeking Alpha Article Debunking John Paulson, Best Interpreted As Cautionary

That article, entitled "John Paulson's High Risk Hubris" by Felix Salmon, is one that will provide a fodder of glee for Paulson skeptics. However, it's written in a way that makes it a cautionary piece for Paulson admirers. For example, this paragraph:

What’s more, there was no guarantee that even if the housing bubble did burst, that Paulson was going to make lots of money. To be sure, he had a lovely model, put together by his colleague Paolo Pellegrini, showing that if house prices stopped rising, subprime mortgages were going to suffer enormous losses. But on the other hand, all the banks and credit-rating agencies also had models, showing that the bonds that Paulson was betting against had almost no chance of defaulting. When your model shows one thing, and everybody else’s models show something else entirely, there’s a very good chance that your model is flawed.

That depiction pretty much captures the dissolving-guts feeling that any investor feels when moving into a trend as it's starting. Consider March 9, 2009. On the one hand, Doug Kass is on CNBC saying that the march bottom represented the "buying opportunity of a lifetime." The metrics in many stocks jibe with what he said. Bargains are everywhere in the stock market.

On the other hand, Warren Buffet was saying much the same thing back in October of 2008. He looked bang-on as '08 turned into '09, but a vicious February decline - of full bear-market strength over the space of a month -meant that the man to watch became Nouriel Roubini. A value investor buying in as of March 10th could snap up a lot of bargains, 'tis true. But that was only on the basis of normalized valuations. There were lots of high-paying dividend stocks at that time. There were also more than a few would-be Meredith Whitneys warning of dividend cuts. P/Es had fallen very low. But, the number of suposedly impregnable companies reporting huge losses were disturbingly high. Normal valuations said that stocks were a screaming buy. But the headlines were filled with stories suggesting quite strongly that this time was different, that the new normal was beginning to resemble the 1930s. Stocks were huge bargains in 1931 also.

This example isn't quite the same as Paulson's situation. Salmon points out that Paulson was on the negative-carry side of the trade; a value investor is on the positive-carry side. ["Carry" means income net of costs in this context.] Actually, being on the negative-carry side - as well as being a bear when all are bullish - is even harder, except for those with a certain spine. A lonely bull can comfort him- or herself with the thought that bull markets are more common than bear markets. A lonely bear doesn't have that reassurance. An investor on the positive-carry side has time as a friend. On the negative-carry side, time's an enemy.


Now that Paulson's moved into gold, however, he seems to have put his negative-carry days behind him. Gold's negative carry (from storage costs) is miniscule, and dividend-paying gold mining stocks have a positive carry.