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Op-Ed: Exterminating the Gold Bugs


Super-bearish "dollar collapse" scenario is bogus.


Editor's Note: As an emerging-markets banking analyst, James Kostohryz has firsthand experience of banking collapses and their subsequent resolutions in Mexico, Argentina and Southeast Asia. Since leaving his position as Head of International Investments at Brazil's Banco Pactual in 2000, James has worked as an independent trader and investor.

Dear Professor Kostohryz,

I've been following your comments in Buzz & Banter, and I was interested in your opinion on gold. In particular, I wanted to ask about the correlation between gold and the dollar -- which haven't been correlated for some time -- and why they're now moving up at once. Some people have called this a fear rally driving gold, though now I see a number of people saying it's transitioning to an inflation rally. But can people change their rationale behind a rally that easily and justify increases? It's strange.


Dear David,

As you may know from the Buzz & Banter, a couple of weeks ago, I sold several gold stocks for a substantial profit. And I assure you, it had nothing to do with the US dollar/gold correlation.

Regarding the ever-shifting rationales cited by many gold "experts" (aka gold bugs) to buy gold, if you've been around long enough, you probably know this is a unique crowd. Among other things, they tend to be highly ideological. To them, everything and anything is a reason for gold to go up. And any decline in gold is dismissed as selling by ignorant people who, at best, don't "get it," or, at worst, by people who are part of some conspiracy.

Thus, we'll variously be informed by gold bugs, with great conviction, that if the dollar is down, that's good for gold; if it's up, it's good for gold. Gold is good as a hedge against inflation, and it's good as a hedge in times of deflation. If the S&P is going to crash, it's good for gold; and if it rallies, it's good for gold. You get the picture.

Fundamentally speaking, at this juncture, I don't think there's anything more to the gold/dollar inverse correlation than the fact that gold is an international commodity. If the value of gold remains constant on a trade-weighted currency basis, then its value in US dollars will decline when the dollar rises against a trade-weighted currency basket.

I say this correlation is of meager fundamental importance because, unlike many gold bugs, I believe that the super-bearish "dollar collapse" thesis is bogus. It's my fundamental view that the US dollar is actually more sound fundamentally than most of the world's major currencies. If the US dollar ever collapses, other currencies will probably collapse faster and more profoundly than the US dollar.

Thus, gold might be a good investment in an environment in which there's a general crisis of confidence regarding fiat currencies, but it will have nothing to do with the correlation of gold versus the value of the US dollar relative to other currencies.

Certainly, it's possible that at times, there may arise an inverse correlation between gold and the value of the USD against other currencies, and that this movement may be related to the ascendance of doomsday "dollar collapse" theories. However, when such theories become popular, gold will tend to trade up, not only against the US dollar, but against everything else as well, on the basis of generalized fear - and speculation about fear.

To some extent, that was what was happening late last year. Gold was trading up against everything on the basis of general fear of a sharp deterioration of economic and financial conditions.

But, in truth, the specific fundamental basis for the gold/US dollar correlation is extremely weak. And to the extent that the correlation existed, it's because it was merely one indication amongst many others (equity, corporate bonds, CDSs, etc.) of a rise in generalized fear and a rise in systemic cross correlations amongst asset classes.

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