Ma cr oRe se a r c h B o a r d

mrb partners
Independent Investment Strategy & Consulting
Theme Report
October 26, 2010

Next Theme Report m The sweet spot for gold prices will persist for a while lon-

The Inflation/Deflation Debate ger: monetary conditions will remain extremely accom-
Tuesday, November 2nd modative, keeping real interest rates low and the major
currencies unappealing. In turn, the tidal wave of invest-
ment capital rushing into gold is unlikely to vanish.

The Gold Bull Market: m Nonetheless, speculative excesses are already build-
Debunking Myths & ing and the peak in gold prices could be abrupt (similar

Timing When To Sell to 1980). Nimble investors may wish to ride the trend
higher for now, but longer-term investors should con-
sider using price strength to gradually trim positions
Gold prices have surged more than fivefold from
and redirect funds into productive assets.
their 2001 low of roughly $260/ounce. The macro
and policy forces currently at work have created a m Gold will not prove effective at preserving wealth in
“sweet spot” for this asset. Indeed, it is possible that the event of accelerating inflation or deflation. Either
gold prices will experience a parabolic move higher outcome would likely be bearish for bullion.
(much like the 1979/80 episode), given the flood of
investment capital trying to enter this relatively il-
liquid market.

However, it is worrisome that a mania mentality is already forming in the gold market.
The precious metal is now being characterized as a cash equivalent and the perfect “tail
risk” hedge (i.e. will benefit from either inflation or deflation). Gold is neither and should
not be regarded as a “one-way” bet. Most likely, gold will end up causing a great deal of
pain for investors adopting a buy and hold strategy at this point in the cycle. In fact, long-
term investors should consider using price strength to gradually reduce exposure and
redirect funds into productive assets within those economies that do not face cyclical or
structural headwinds.
Gold should not
be regarded as a
Not A Hedge For Tail Risks
hedge for inflation
Financial participants increasingly recommend adding gold to an investment portfolio or deflation
as a prudent measure to hedge against inflation and/or deflation (i.e. an insurance policy
you hope is not needed). Some even suggest that gold holdings increase diversification.
Unfortunately, gold is not particularly effective at preserving wealth in either “tail risk”
scenario, and its correlation with risk asset prices has risen markedly in recent years.

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mrb THEME REPORT m October 26, 2010

There is a widespread and long-held belief among inves- Chart 1 Gold: Not An Inflation Hedge
1,400
tors that gold moves with, and often in anticipation of 20
shifts in consumer price inflation. The ability to preserve 1,200
Gold Price (LS, $/oz)
Global CPI Inflation (RS, %YoY)
wealth during periods of rising price pressures is certain- 16
1,000 Correlation between
ly an appealing property, given that almost all other as- gold and inflation
sets get hammered during these episodes. Indeed, gold 800 broke down early 12
prices surged during the 1970s when U.S. and global in- last decade
600
flation accelerated to a double-digit pace. Bullion prices 8
then collapsed along with the disinflationary trend of the 400
1980s and 1990s. However, the relationship between 4
200
gold and inflation subsequently broke down: gold prices
MRB Partners Inc ©2010
started rallying in 2001 despite a continuation of the dis- 0 0
inflationary tailwind in the global economy (chart 1). The 1975 1980 1985 1990 1995 2000 2005 2010

decade long divergence suggests that gold is not, or at

least no longer, driven by expected price pressures. Chart 2 Gold Does Not Preserve Wealth
During Periods Of Deflation
Similarly, there seems to be a growing consensus that Gold Price ($/oz)
1,200
gold will also provide insurance against a debt-deflation
spiral. It may be true that in a complete collapse of the 1000

global financial and monetary systems, gold bars/coins

(not gold ETFs or derivative products) will be a preferred 800

asset, along with dried food and shotguns. However, -31%

short of this Armageddon scenario, gold is not particular-
ly useful as a deflation hedge. Indeed, gold prices plunged U.S. 1-Year CPI Swap Rate (%)

31% during the financial meltdown of 2008, when fears

2
of depression escaladed and investors priced in outright
deflation (chart 2). Bullion outperformed many risk as-
0
sets, but grossly underperformed cash and government
bonds. In this regard, gold should not be regarded as a -2

hedge against deflation or as a cash-equivalent. Classify- Deflation

-4 MRB Partners Inc ©2010 scare
ing this asset as the latter runs the risk of adding signifi-
cant volatility to an investment portfolio. Indeed, there 2007 2008 2009 2010

has been a correlation of 0.82 between gold and emerging market equities over the past
decade, as both have responded to the ebb and flow of global liquidity.

What Drives Gold?

Physical gold has many appealing properties. It has a limited supply, is not a liability of
anyone, has several industrial uses, and its appearance has made it revered for jewelry
and the arts for centuries. Moreover, gold is virtually indestructible and has both a high

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mrb THEME REPORT m October 26, 2010

value-to-size and value-to-weight ratio, making it porta- Chart 3 Gold & Real Bond Yields
ble and easy to store. These properties are critical during Gold Price ($/oz)
1200
conventional wars and prove useful to avoid wealth con- 800
fiscation by sovereign authorities. Many have also used
400
this precious metal for tax-avoidance. That said, the two
primary drivers of gold prices have historically been real 200

interest rates and currency debasement. 100

1) Real Interest Rates

The inflation-adjusted rate of interest that investors re-
U.S. 5-Year Real Bond Yield* (%)
ceive for lending their capital is the opportunity cost of
holding gold. When real rates rise it becomes less ap-
5
pealing to hold gold, given that the precious metal does
not provide cash flows (coupons, dividends, etc). Chart 3
highlights this inverse relationship. 0

During the 1970s, U.S. interest rates were consistently

MRB Partners Inc ©2010
held below the rate of nominal economic growth. This was
a consequence of aggressive Fed support during the 1970 1970 1980 1990 2000 2010
* Deflated by CPI inflation
and 1974 recessions, and lagging policy during the recov-
eries. The result was a liquidity-fueled economic expansion that combined with strong la-
bor unions, led to a fairly predictable rise in price pressures. In turn, real yields plunged as
policy trailed the increase in inflation and inflation expectations, benefiting gold prices.

By the end of the 1970s, the Fed under the leadership of Chairman Paul Volcker became
determined to break the back of inflation. The central bank drove interest rates decisive-
ly higher than economic growth, causing two serious recessions and allowing a period of
sustained disinflation to set in. The disinflationary tailwind was aided by President Rea- The two primary
gan’s war against labor unions. The consequence was a spike in real interest rates and a drivers of gold
collapse in gold prices. The Fed’s anti-inflation bias persisted until early last decade when prices are real
the U.S. experienced a deflation scare in the aftermath of the burst tech bubble. interest rates
and currency
During both the inflationary and disinflationary episodes CPI and gold prices moved to- debasement
gether, but it was not the former that drove the latter. Both responded to a persistent dis-
equilibrium in monetary policy. As noted above, inflation and gold prices have diverged
in the past and can do so again.

Indeed, by 2001 the Greenspan-led Fed, along with the other major central banks, were
aggressively attempting to fend off deflationary pressures and willing to risk over-stim-
ulating growth conditions. Despite policy being accommodative, consumer price infla-
tion remained subdued during the first half of the 2000s. Nonetheless, real interest rates
drifted lower and helped trigger an explosive upleg in gold prices.
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mrb THEME REPORT m October 26, 2010

The rally in the gold market over the past decade has also Chart 4 Gold & Liquidity
been aided by the well-televised shift by the major central G7 Nominal GDP Growth Minus
Average Short Term Rates* (%)
banks from inflation-fighting to erring on the side of refla-
tion, which reduced the uncertainty regarding the direc- 5

tion and level of real interest rates. Chart 4 shows the dif-
ference between G7 GDP growth and policy rates as well as 0
the cumulative gap between them. When the cumulative
gap is rising steadily, global central banks are stimulating
growth conditions by providing liquidity and suppressing
Gold Price ($/oz)
real bond yields. Conversely, when the gap declines, it is 1200 Excess Liquidity**
800
because central banks are adopting a restrictive policy set-
ting and pushing real rates higher. Gold prices have gener- 400
ally moved with this measure of liquidity since the Bretton
200
Woods system collapsed in 1971 and the official price of Bullion prices are sensitive
bullion was freed. In this regard, gold can be characterized 100 to swings in global liquidity
as a barometer of global liquidity conditions. MRB Partners Inc ©2010

Currently, global monetary authorities are explicitly an- 1980 1990 2000 2010
* Average of G7 eurocurrency rates
choring real interest rates, with the Fed standing ready ** Cumulative gap between G7 nominal GDP growth and average eurocurrency rate

to provide additional quantitative easing, if needed, to

stimulate growth conditions and/or contain Treasury yields. However, unlike the 1970s,
if price pressures were to build in the current environment it is unlikely to be positive for
gold. Central banks are eager to stimulate growth conditions, provided that it does not
hurt their credibility with regards to inflation targeting. Expectations of a sustained rise
in price pressures would cause policymakers to shut off the liquidity taps and push real
yields higher. If monetary authorities are seen to be complacent or if they fail to respond
fast enough, “bond vigilantes” will drive up yields sharply, disrupting the recovery and
causing renewed deflationary pressures to the detriment of bullion prices.
Gold can be
At the other end of the spectrum, deflationary pressures provide justification for cen- characterized as
tral banks to suppress real interest rates but outright deflation would be bearish for gold a barometer of
prices. Although nominal policy rates would stay anchored at zero, real interest rates by global liquidity
definition would rise as consumer prices fall. In this scenario, investors would be better
conditions
off by holding high-quality government bonds or sitting on cash.

2) Currency Debasement
Investors pile into gold during periods when the global monetary system is under threat
or when government officials attempt to debase their currencies. Throughout the ages,
rulers have regularly debased their currencies in order to extract resources from the pub-
lic to cover expenditures that cannot be financed by taxation or bond issuance. Episodes
of currency debasement have traditionally occurred to fund wars and the expansion of
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mrb THEME REPORT m October 26, 2010

Chart 5 Currency Debasement During Wartime Chart 6 Gold Prices & The U.S. Dollar

Napoleonic War 1200

Gold Price ($/oz)
8 CPI Inflation* (%YoY): 800
U.K.
4
400
0

200
-4

American
Civil War U.S. Trade Weighted Currency* (Inverted)

-100
10
U.S. -120

0 -140 Weak U.S. dollar has provided

a tailwind for gold
-160
MRB Partners Inc ©2010 MRB Partners Inc ©2010

1800 1825 1850 1875 1980 1985 1990 1995 2000 2005 2010
* Shown as a 4-year moving average * Source: IMF

empires. Even during the era of the gold standard, convertibility was temporarily sus-
pended by the British government during the Napoleonic Wars and by the U.S. govern-
ment during the Civil War (chart 5). Governments of all the major combatants also sus-
pended gold convertibility in order to fund military operations during World War I.

One major appeal of gold is that it helps preserve wealth and purchasing power during
periods of currency debasement. Governments are not able to manipulate the supply of
the precious metal, there is no printing press attached to it, and it cannot be downgrad- Investors hide in
ed by a rating agency. Gold has been subject to increases in supply due to newly found gold when gov-
deposits or increased production, although on balance this has been relatively gradual ernments attempt
throughout the course of history (with a few notable exceptions). Looking ahead, there
to debase their
currencies...
is evidence to suggest that the stock of gold will only increase modestly. While the theory
of “peak gold” is subject to debate, the pace of new discoveries has declined markedly
...there is no
over the past 10-15 years. Production has also slowed, with gold output declining in sev-
printing press
eral key producers, including South Africa and Russia.
for bullion
In modern times, gold has been priced in U.S. dollars and is particularly sensitive to
swings in the U.S. exchange rate (chart 6). Currency debasement played a supporting role
during the gold bull market of the 1970s. The U.S. expanded currency in circulation
rapidly throughout the 1960s and 1970s. Combined with the tailwind from falling real
interest rates, the precious metal skyrocketed from an artificially depressed official price
of $35/ounce to a peak of $850/ounce by 1980.
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mrb THEME REPORT m October 26, 2010

There is certainly an incentive in the current backdrop for Chart 7 QE Has Been Used To Support Banks,
governments who have issued local currency denominat- Not Debase Currencies
22
ed debt to debase their exchange rates in order to ease
Developed Economies*:
the massive fiscal burdens they face. Some argue the U.S. Monetary Base Components (% of GDP)
20
is subtly attempting this, although the growth of curren-
cy in circulation has remained very subdued. Evidence of
18 Commercial Bank Reserves
policymakers in any country intentionally inflating their Currency In Circulation
way out of self-created problems would almost certainly
16
lead to a sovereign debt crisis. The accompanying lenders'
strike would require current account balances to shrink
14
abruptly and result in painful contractionary forces within
the domestic economy. The major central banks are all
12 MRB Partners Inc ©2010
well aware of this risk and have not resorted to the printing
2003 2004 2005 2006 2007 2008 2009 2010
presses in recent years. Narrow money supply has mush- * Includes: Australia, Canada, Euro Area, Japan, New Zealand,
Norway, Sweden, Switzerland, U.K. & U.S.
roomed but the vast majority of this has been a rise in
banking system reserves. Currency in circulation has only Chart 8 Opportunity Cost Of Gold
accounted for a small percentage of the increase (chart 7). Is Extremely Low
1,250
Final Word: Real interest rates and currency debasement Gold Price ($/oz)
are the primary drivers of gold prices. While both can lead 1,000

to periods of inflation, it is not the latter that drives the

price of the precious metal. In fact, contrary to most in- 750

vestors, we expect that a rise in inflation would ultimately

The bull run has been
prove bearish for gold. It would either be met with tighter turbocharged by
Implied Real 5-Year negative real yields
monetary policy and higher real interest rates, or a disrup- Government Bond Yield* (%)
tive spike in bond yields as fixed income investors force the
2
authorities to respond with discipline.

1
In A Sweet Spot, But…

The current macro backdrop is very supportive of gold 0

and should lead to further price appreciation. Monetary
MRB Partners Inc ©2010
authorities across the globe are forcefully attempting
2005 2006 2007 2008 2009 2010 2011
to reflate their economies. The major central banks are
* Nominal 5-year government bond yield minus 5-year CPI swap rate
committed to keep interest rates anchored near zero for
the foreseeable future and the Fed is willing to engage in another round of quantitative
easing, if needed, to stave off a contraction in consumer prices. Actual deflation would be The macro
a bearish development for gold prices (as discussed above) but the aggressive attempt backdrop is
by policymakers to prevent it from occurring is positive as it has dragged down the en- bullish for gold
tire coupon curve, causing real interest rates to plunge into negative territory (chart 8).

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mrb THEME REPORT m October 26, 2010

Moreover, given that deflation is considered a legitimate Chart 9 Banking Crisis Justifies Aggressive
risk, bond investors are not pricing in monetary tighten- Policy Settings
Developed Economies*:
ing (the two-year yield is near a record low) and vigilantes
are not forcing the long-end of the curve higher.
1.0

Interestingly, the global banking crisis has been positive

Money Multiplier**
for gold prices: 0.9
Still
m It has required unprecedented quantitative easing as broken!
the monetary authorities attempt to provide sufficient 0.8

liquidity to banking institutions (i.e. driving interest Broad Money Supply (%YoY)
8
rates lower).

m The broken monetary transmission mechanism in much 6

of the developed world means that the liquidity that has
Liquidity not
been created is not reaching the real economy (chart 9). 4 reaching real
Thus, inflation risks are limited, yet money is cheap. economy
MRB Partners Inc ©2010

m The uncertain outlook is curbing credit demand be-

2000 2002 2004 2006 2008 2010
cause businesses are hesitant to expand. This limits * Includes: Australia, Canada, Euro Area, Japan, New Zealand,
Norway, Sweden, Switzerland, U.K. & U.S.
the competition the government faces for the existing ** Broad money supply divided by monetary base

pool of domestic savings and prevents a crowding out effect, which would force real
interest rates higher across the curve.

m Structural headwinds and relatively weak growth in the U.S., Japanese and European
economies are also leading to downward pressure on the major currencies. Although
most of the major central banks would like a cheaper exchange rate, we doubt any will
actively pursue currency debasement. Nonetheless, investors are seeking alternatives
and the soft U.S. dollar is benefiting gold prices. The global
banking crisis has
Successful policy reflation may also be initially positive for gold prices, given that the ma- been positive for
jor central banks plan to lag the curve and allow the economic recovery to gain traction. bullion prices by
However, evidence of a sustained expansion or any whiff of price pressures building would depressing real
soon cause real yields to ratchet higher, removing a critical tailwind for gold prices. Stron- interest rates
ger global growth momentum may also trigger a revival in private sector credit demand.

…Euphoria Is Worrisome
The current macro environment is very supportive of gold, leaving potential for a manic
blowoff in prices before the upleg comes to an end. Nonetheless, investors should be
careful not to get caught up in the euphoria that is currently building. Although gold does
not have any conventional valuation yardstick, there is evidence that froth is building:

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mrb THEME REPORT m October 26, 2010

m Price Appreciation: Gold prices have surged to an all Chart 10 Bullion Prices: Technically Stretched!
time high, jumping 32% over the past year and more
1200 Gold Price ($/oz)
than 100% since their 2008 lows. The precious metal 800
is now more than $600/ounce above its historical up-
400
ward sloping trend (chart 10). Even when removing
200
the U.S. dollar impact by using a global currency, or
SDR1, gold prices are 66% above their historical trend. 100

Although rates of change were even more stretched Post-Bretton Woods Trend/Mean
+/- 1 Standard Deviation
by the time prices peaked in 1980 in comparison to (for both panels)
today, recent price action does suggest that mania 2,000
forces are building.
1,500 Real* Gold Price ($/oz)
m Real Prices: The real price of gold is already 2.5 stan-
dard deviations above its post-Bretton Words aver- 1,000
age (chart 10, bottom panel). Those bullish on the
precious metal often point out that real gold prices 500
MRB Partners Inc ©2010
reached a whopping $2120/ounce in 1980, suggesting
room for dramatically further upside. While true, one 1970 1980 1990 2000 2010
* Deflated by CPI inflation
must keep in mind that the final spike higher doubled
real gold prices in a matter of a couple months. And the topping out process did not
last very long before prices began what would be a 70% collapse in real terms. Thus,
nimble investors with the ability and discipline to set stops may have the ability to
capitalize on a temporary spike in prices. Longer-term investors with less flexibility
will have difficulty.

m Investor Positioning: Net speculative positions are at cyclical extremes and bullish con-

sensus measures are hovering around 80% (chart 11). Granted these measures have Speculative
been elevated for much of the bull-run and do not provide useful timing signals. None- excesses are
theless, current readings suggest that there is potential for a violent reversal in prices building in the
once the macro backdrop turns less favorable for this asset (i.e. real interest rates rise). gold market

m Demand Composition: Investment demand for gold (particularly from ETFs) has risen
dramatically in recent years and is having a material impact on prices, given the rela-
tively limited supply of this precious metal. Table 1 from the World Gold Council high-
lights that from the beginning of 2007 until the end of 2010 Q2, 13,152 tonnes of new
gold supply has entered the market. Of this, roughly 2/3 was purchased to create new
products (jewelry as well as industrial and dentistry applications). The remaining 1/3 has
been allocated to investments, which is exceptionally high from historical standards.

1 Special Drawing Rights (SDRs) are financial instruments created by the IMF in 1969 and issued periodi-
cally in new tranches since then. SDRs represent a claim on IMF member countries’ accounts with the
IMF. Currently, SDRs are composed of 44% U.S. dollars, 34% euros, 11% yen and 11% U.K. pounds.

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mrb THEME REPORT m October 26, 2010

Table 1 Gold Market: Supply And Demand Composition*

2010 2010 Total
Supply (Tonnes) 2007 2008 2009
Q1 Q2 2007-Q'2
Mine Supply 2,029 2,058 2,322 586 644 7,639
Official Sector Sales 484 232 30 - 38 -8 700
Recycled Scrap Gold 982 1,316 1,673 350 496 4,817
Total Supply 3,494 3,605 4,024 897 1,131 13,151

2010 2010 Total

Demand (Tonnes) 2007 2008 2009
Q1 Q2 2007-Q'2
Jewellery 2,417 2,193 1,759 502 406 7,277
Industrial and Dental 465 439 373 103 107 1,487
Investment Including (ETFs) 612 973 1,892 292 618 4,387
Total Demand 3,494 3,605 4,024 897 1,131 13,151
* Source: World Gold Council

Remarkably, investment demand continues to in- Chart 11 Investors Positioned For Higher Prices
crease rapidly, reaching 55% of supply (including min- 1,200
ing production, official sector sales, and recycled gold) Gold Price ($/oz)
last quarter. Put another way, investment demand is 800

now roughly equivalent to total mining production.

In turn, gold prices are being forced higher in order to
crowd out jewelry, industrial and dental demand, well 400

as to entice individuals to recycle their existing jewelry.

In 2010 Q2, recycled gold surpassed jewelry demand! Lots of
gold bulls
Thus, vulnerability is building, given the reduction in Bullish market sentiment (%)
fundamental demand. Prices could spike from here if 75
investment flows continue to increase or drop sharply
if investment demand wanes. We suspect the former 50
condition will persist for a while longer.

m Producer Hedging: Instead of locking in current pric- 25

MRB Partners Inc ©2010
es, gold producers have virtually stopped hedging.
Some of this decision has been in response to inves- 1995 2000 2005 2010

tors seeking stocks that are pure plays on gold prices.

Regardless, this is an indication of corporate overconfidence in the continued strength
of precious metal prices. Indeed, gold companies have a poor historical record in tim-
ing their hedging activities (i.e. should be seen as a contrarian indicator).
Investment
m Anecdotal: There are also a significant number of anecdotal signs that the gold demand is now
market is becoming frothy. These include the widespread attention the precious metal equivalent to
is getting in the non-financial press, the sharp increase in the number of cash-for-gold money production
infomercials, and the introduction of gold vending machines in several countries,
including Germany and the U.S.
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mrb THEME REPORT m October 26, 2010

Interestingly, valuations for gold equities seem somewhat more appealing. Global gold
stock prices have dramatically lagged the price appreciation in the underlying commod-
ity in recent years. Part of this is structural, given that the creation of gold ETFs has pro-
vided investors with a liquid and relatively easy means to add the precious metal directly
to their portfolios (rather than using gold companies as a proxy). The divergence is also Prices are now
related to declining reserve outputs and higher production costs for gold companies. crowding out
Nevertheless, there is room for at least a partial catch-up phase in the months ahead
traditional
demand
(please see our October 8th Monthly Asset Allocation Strategy for further details).

When To Sell?

With the gold market becoming frothy, a prudent strategy would be to scale back posi-
tions before a clear bearish case can be made. Investors should pay close attention to
the following as a warning that the macro landscape is beginning to shift unfavorably for
gold prices:

m Real interest rates rise materially: Our view is that real yields have limited downside
from current levels (for further details please see our October 5th Theme Report, “Gov-
ernment Bonds: Not A Bubble, But…”). However, central banks are aggressively trying
to prevent, or at least cap, any yield backup. A shift away from this dovish stance or
failure to anchor bond yields would cause a shakeout in gold prices.

m Evidence of a robust global recovery: Our base case is that the global economy will
experience a sustained, albeit subdued recovery. Signs that conditions are materially
improving would end downward pressure on real interest rates, and alleviate concerns
of currency debasement. Evidence of improvement in U.S. consumer spending would
be most crucial to the recovery thesis. Thus, we continue to closely monitor consumer
It is prudent to
confidence and employment indicators. So far, the leading growth indicators are still
begin scaling
providing no indication that conditions are about to accelerate materially.
back positions
m Monetary transmission mechanism repairs: Signs of healing in the global banking before the macro
system and credit channels would be positive for the economic outlook and ease the backdrop turns
need for aggressive policy support. Indeed, the major central banks would be forced negative for
to reverse course and soak up excess liquidity if money multipliers and monetary ag-
bullion
gregates started to improve. So far, there is very little indication of such a shift.

m Private sector credit demand strengthens: The corporate sector is healthy in most
countries but lacks confidence and is hesitant to expand operations. As businesses be-
come more confident in the sustainability of earnings and willing to borrow in order
to pursue capital expenditure plans, real interest rates will be pushed higher. This will
both increase the opportunity cost of gold and increase the investment appeal of pro-
ductive assets. Currently, private sector credit demand remains very weak.
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mrb THEME REPORT m October 26, 2010

m Inflation expectations build: At the moment, both investors and policymakers are
fixated on deflation risks, which in our opinion is the greater threat in the current en-
vironment. Nonetheless, the focus could shift abruptly back to inflation as economic
concerns ease, given the uncertainty and angst created by unprecedented policy sup-
port. Central banks will not allow inflation expectations to escalate for very long. To
Signs of sustained
monitor this risk, we prefer to watch CPI swap rates, which remain near cyclical lows. economic growth
m U.S. dollar sentiment firms: Gold prices remain inversely correlated with the U.S. dol-
and improving
lar and have been turbocharged by the heightened concern of currency debasement.
money multipliers
will be warnings
An improvement in investor sentiment toward the currency (which will likely await
for gold
firmer U.S. economic data) will present a headwind for the precious metal.

m Technicals: Gold is heavily traded using technical indicators, much like the currency
market. Therefore, investors should pay close attention to price trends and momentum
indicators. Most of these measures are stretched, but could reach more extreme levels
at the top of the bull market.

Final Word: The sweet spot for gold prices will persist for a while longer. The recovery re-
mains fragile and deflationary pressures will linger, encouraging the authorities to keep
monetary conditions extremely accommodative. In turn, the tidal wave of investment capi-
tal rushing into the market is unlikely to vanish anytime soon.

Nonetheless, speculative excesses are building. The peak in gold prices when it eventually ar-
The peak in the
rives could be abrupt and followed by a violent shakeout (similar to 1980). Nimble investors
bull market could
may wish to ride the trend higher for now, but longer-term investors should consider using
be abrupt and
price strength to gradually trim positions and redirect funds into productive assets.
fallowed by a
Provided that global authorities can avoid debt-deflation (as we expect), then this is a great violent shakeout
environment for risk assets and currencies in markets which do not face structural or cyclical
impediments. In fact, there are many productive assets in the emerging world and commodity
markets with less froth and better valuations than gold. For further details on this topic, please
see our September 24th Theme Report, “Goldilocks Is Dead: Profiting In An Unbalanced World”.

Phillip Colmar
Global Strategist & Partner
phillip.colmar@mrbpartners.com

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 Ma cr oRe se a r c h B o a r d

mrb partners
Independent Investment Strategy & Consulting October 26, 2010

MRB Partners is a newly-formed independent Previous Theme Reports

investment research and consultancy firm,
Set Sail, Don't Bail:
specializing in providing top-down global asset China's Growth Wave Continues
October 19, 2010
allocation advice and ideas to investment managers
Oil Is The Next Emerging Market Play
around the world. We develop investment strategy October 12, 2010
and recommendations by identifying the key Government Bonds: Not A Bubble, But...
structural and cyclical themes driving the global October 5, 2010

economy and asset markets, utilizing rigorous and Goldilocks Is Dead:

Profiting In An Unbalanced World
comprehensive proprietary forecasting models September 24, 2010
and indicators, while leveraging the extensive The Next Investment Bubble:
Now It’s The Emerging World’s Turn
experience of our senior staff. The core of our September 17, 2010
philosophy is strong, interactive and personalized To receive any of these reports please contact
partnerships to support our client’s investment our client services.
decision-making process.

For more information, please contact:

Chris Sandfield, Commercial Director & Partner
chris.sandfield@mrbpartners.com

Montreal London
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Tel 514.558.1515 Tel +44 (0) 20 7073 2792

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