The four reasons why hedge funds are selling gold

As gold has gotten crushed this year, hedge funds have backed out of the trade, according to Anthony Scaramucci. And the managing partner of SkyBridge Capital, often viewed as one of the most-connected people on Wall Street, believes there will be no reason for them to get back in anytime soon.

"Guys like [John] Paulson are always going to have a steady position in gold," Scaramucci said. "It's a very good diversifier for their overall aggregate personal net worth. But in general, most of the hedge funds have backed out of this trade."

Scaramucci believes that "when they write the history of this period," financial historians will remark that "gold should've worked, it could've worked, it would've worked, but it didn't work in this environment."

He then went on to list the four reasons why it won't get any easier to own gold.

1. Central bankers are exercising caution

Scaramucci notes that investors often hold gold to hedge against an inflationary catastrophe. The problem? The inflationary wolf is not exactly knocking at the door.

"There's a lot of very wealthy people that are going to own gold as a defensive hedge for what they're fearing is that whole Weimar Republic thing, where either the Europeans or the United States aggressively prints money, where the multiplier effect kicks in on the banking side, and you get this out-of-control inflation," Scaramucci said, referring to hyperinflation that occurred under the German democratic system in place between 1919 and 1933.

But Scaramucci says these gold bugs just aren't doing their research. "If you read the minutes from the Federal Reserve, or if you look at the essays that Ben Bernanke just recently published, you will discover that your central bankers, particularly in the United States, understand this issue very well. And that's one of the main reasons that gold has not worked in this environment."

The Fed minutes make clear that the Fed is keeping a close eye on inflation, and is keeping risk factors in mind. For instance, the latest Fed meeting minutes, from the July 18-19 meeting, note: "Although the staff saw the outlook for inflation as uncertain, the risks were viewed as balance and not particularly high."

2. Deflation has become a risk

If inflation isn't a risk, what is? Actually, it could be deflation. "What's happening now is the specter of deflation is way, way, way more fearful to the central banking community than inflation," Scaramucci said, "and gold typically works when there's a devaluation of currency, or inflation."

As the Federal Open Market Committee noted in its July 31 statement: "inflation persistently below its 2 percent objective could pose risks to economic performance."

Inflation tends to be good for gold, because as the value of each dollar drops, it takes more of those dollars to buy gold, leading gold to spike as the currency inflates. But in a deflationary environment, as each dollar becomes more valuable, the dollar value of gold drops. And that is the environment in which the U.S. could find itself, the Fed fears.

"In a deflation economy," Scaramucci said, "gold is not going to work."

3. The Fed won't sell its bonds

Scaramucci said fears about bonds have given investors another reason to get into bullion. "People are buying gold because they predict there's a bond bubble," he said. "And they predict that at some point, the Fed is going to shed their $3.9 trillion balance sheet. But that's not going to happen either."

He believes this incentive for the Fed to sell its bonds simply isn't there. "The Fed's duration on its balance sheet is only about seven years," Scaramucci said. But "they're a 100-year-old institution, they live inside a 237-year-old country and there's no reason to shed that portfolio. They'll just let their portfolio unwind. And so the prediction here will be that gold prices will languish."

4. Economic growth would hurt gold

To Scaramucci, holding gold has become a lose-lose proposition. "If the economy picks up, rates pick up, that's bad for gold. If the economy doesn't pick up, the Fed is going to be in exactly the position that it's in now, which is effectively QE but no real money creation."

Simply put, while people thought quantitative easing would create gold-boosting mega-inflation, that simply hasn't happened. So now, the risk remains to the downside—because rising rates make gold, which does not produce yield, even less attractive in comparison to bonds.

Scaramucci does not take a view on where short-term action could take the gold market. But from his "30,000-foot view," the prospects for gold look awfully dim.