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Sunday, December 06, 2009

Fierce battle on gold

The bruising battle between governments and investors over gold, reports WSJ:

One of the fiercest battles in the global financial system is being played out in the gold market. Does Friday's sharp drop in the gold price say much about who will win this fight?

On one side are central banks and governments, which are printing money and running up large fiscal deficits. On the other are investors who think such actions could debase paper currencies, and are buying gold to protect against that outcome.

Looking at Friday's 4% slide, even gold bugs would agree that a correction was to be expected for an asset whose price is up 56% in the past 12 months.

But gold bears might look at the trigger for the rout, a better-than-expected U.S. jobs number, and conclude that the economy is recovering and governments can soon wind down policies that benefit gold.

Clearly, a spell of gold weakness is likely. Not only has the run-up been intense, central bankers recently have sounded slightly tougher on monetary policy.

But the beauty of gold is that it is almost alone in providing protection for scenarios in which government stimulus fails or backfires. If economic weakness returns, the government's default response likely will be cranking out more money and running up bigger deficits. Alternatively, economies may take off too quickly, and high inflation returns. Both outcomes are extremely gold-friendly.

The gold trade gets really interesting if gross domestic product expands, but only sluggishly. If governments are willing to tolerate that, allowing the economy to adjust on its own, gold could suffer. After all, the best way to swat the gold bugs is to let the markets have their way.