One of gold’s most prominent bulls, John Paulson, the asset manager who made more than $1 billion betting on the housing downturn, is tarnished.

Bloomberg reported that Paulson’s $900 million gold fund is down 26% through the beginning of March, after falling 25% last year. The fund has been hurt by the price of gold falling to around $1,600 off its all-time high of more than $1,900, which it hit in Sept. 2011. Paulson told clients that “his Gold Fund would beat his other strategies over five years because the metal was the best hedge against inflation and currency debasement as countries pump money into their economies.”

Paulson echoes comments from Ray Dalio, the man behind the $140 billion hedge fund Bridgewater Associates. Dalio told Barron’s in March 2011, “Currency devaluations are good for stocks, good for commodities, and good for gold.”

The price of gold has fallen off those highs and, so best we can tell, another economic crisis isn’t happening soon, meaning investors are less likely to flock toward the most prominent bearish investment. But gold’s effectiveness as just that — protection against the worst economic and financial distress — is also under attack.

History
One of the most common arguments to invest in gold is inflation. Credit Suisse Senior Advisor Robert Parker told CNBC last month, “To get back into a bull market on gold we need inflation.” Although there are different ways to interpret gold as an “inflation hedge,” the simplest version is that changes in the consumer price index should drive changes in the price of gold: if prices (in dollars) rise 10%, then the price of gold should rise 10% as well, giving gold a constant purchasing power.

The historical record, however, suggests little relationship between the gold price and inflation. In a recent paper titled “The Golden Dilemma,” Claude Erb and Campbell Harvey found that “over 1, 5, 10, 15 and 20 year investment horizons the variation in the nominal and real returns of gold has not been driven by realized inflation.”

Looking at the price of gold and the consumer price index since 1975, when private ownership and trade of gold was reallowed in the U.S., they find that in March 2012 (when they last did the calculations), the price of gold “should” have been $780 an ounce, but the actual price was closer to $1,600. (It was right around $1,600 this morning.)

When it comes to whether gold can hedge unexpected inflation, the authors find “effectively no correlation” between the real price of gold and future inflation; any relationship is driven by 1980, when the real price of gold more than doubled and hit its all-time peak of around $2,440 (2013 dollars) and inflation was up above 12%.

After 1980, gold sharply declines and then starts moving sideways until 2003, while average annual inflation was around 4%. Even for 10-year periods, gold did little to nothing to hedge inflation, expected or …read more
Source: FULL ARTICLE at DailyFinance