James Pethokoukis

Politics and policy from inside Washington

The bear case for gold

December 9, 2009

Mike Darda of MKM Partners gives it his best shot:

If there were ever a crowded trade, long gold and shor the dollar certainly fits the bill (no pun intended). Indeed, zero percent short rates and huge deficits as far as the eye can see have been important tailwinds for the yellow metal. And they remain in place. However, gold appears expensive relative to industrial commodities and has risen much more than bond market inflation expectations or the money stock over the course of the last year (the monetary base has exploded higher, but M2 growth has been more modest).

If the U.S. recovery is stronger than expected and the labor market turns in a material fashion, gold could begin to underperform industrial commodities and the dollar may catch a bid, at least against G7 currencies. The tight inverse correlation between the dollar and the stock market observed over the last 17 months may unhitch under such a scenario, as the long-term correlation between the DXY Index and the S&P 500 is zero. While a sustained gold correction may appear to be a low-probability event, if the 2008-2009 experience has taught us anything, it is to question the conventional wisdom in a repeated and rigorous fashion.

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