Monday, March 9, 2009

Gold's Appeal as a Hedge Is Broadening

Many investors have been traumatised by the collapse in stock prices. It seems like that this feeling of insecurity about the economic future may last for awhile too. This feeling of insecurity among investors has broadened enormously the appeal of gold as a hedge.

There was more evidence of this on the front page of today's Financial Times. The article spoke about how some of the same hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks.

The gold bulls include David Einhorn of Greenlight Capital who last year came under the spotlight for correctly arguing that Lehman Brothers did not have enough capital to offset its exposure to falling property prices.

Investors such as Mr. Einhorn are turning to gold because they are worried about the response of the Federal Reserve and other central banks to the economic crisis. A bet on gold is a bet against paper currencies.

In a letter to shareholders, Mr. Einhorn said "The size of the Fed's balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed. Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself."

I believe Mr. Einhorn's analysis is spot on.

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