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Gold Bulls No Bugs at All


Yellow metal still best hedge against inflation.

After reading James Kostohryz's op-ed, entitled Exterminating the Gold Bugs, I must respectfully disagree with his premise - as well as with the use of "bug" as a term of endearment for gold bulls. Many people hate gold with a passion, and that's fine. As for where that hatred comes from, I suspect it's because a rising gold price is associated with bad economic times by anyone that was alive during the 1970s.

Ideology has nothing to do with being bullish on gold. If I wasn't certain the Fed was going to continue to print money in order to try to inflate away the housing bust and the banking implosion, I wouldn't be too interested in exchanging my dollars for gold.

Obviously, others are a little disturbed at the thought of the Fed debasing the currency as well. Take, for example, what Chinese Premier Wen Jiabao said last night: "Of course we are concerned about the safety of our assets... To be honest, I am a little bit worried... We have lent a huge amount of money to the United States... I request the US to maintain its good credit, to honor its promises and to guarantee the safety of China's assets."

But what are the Chinese going to do about it? The obvious hedge against debasement of their US dollar-denominated investments is gold, and I suspect we'll see the Chinese move on this front sometime this year.

As for gold merely rising because of "fear," or as a bet on stocks going down, I'm sure there may be some knuckleheads buying gold because of that. But they're just getting lucky. People buy all sorts of investments for different reasons, but the majority are typically doing it for the "right reasons" - or the asset wouldn't be in a bull market.

I certainly don't know anyone buying gold as a bet on stocks falling, and the historical record would argue against that, as well. The correlation seems to be there, because central banks typically run the printing presses during difficult economic times. This also happens to be bad for equities as an asset class, obviously.

And it's the debasement of the currency that this printing causes that eventually benefits gold, which has been the ultimate hard currency for virtually all of human history.

Look at the chart below of gold vs. the S&P. What you'll see is that gold has risen since 2000, when the Fed began to print money in response to the tech bust. That printing lifted the asset most sensitive to debasement and inflation first (i.e. gold); eventually, that printing hurt the dollar and topped it out in 2002, and even lifted the S&Ps in 2003.

From there, gold and the S&Ps rallied together, as did residential real-estate values, while the dollar fell. This melt-up in asset prices and commodities as the dollar fell continued until 2007, when the housing bull market topped. Its bust and the ensuing effect on the economy and financial system as a whole finally caught up with stocks.

The Fed then began to run the printing presses in response to the housing bust and even accelerated that printing in late 2008, after stocks crashed, to actually monetizing agency debt and MBS. It wouldn't surprise me if the Fed began monetizing Treasury debt soon as well, which is what I suspect the Chinese are worried about.

Once the Fed began aggressively printing, the dollar topped out in November against most of the major currencies (but not against those who began printing even faster than the Fed, like the BOE).

Additionally in November, most US stocks also bottomed when judging by internals of the stock market, even though the indexes made new lows in early 2009. The stocks that have held up best since November also happen to benefit from inflation and currency debasement, such as the oil stocks, base metals stocks, and especially gold stocks, which are the top performers off the November low.

Gold also bottomed in November and began to rally, as the Fed stepped on the printing-press accelerator. Coincidence? I think not.
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No positions in stocks mentioned.

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