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Comment: The Midas touch

In an implicit challenge to the strategy of monetary expansion being deployed by central banks, some hedge funds are now buying gold. The gold bulls are reported to include David Einhorn, founder of hedge fund manager Greenlight Capital, as well as Eton Park and TPG-Axon.

The view is apparently shared by many institutional and state investors. Zhang Guobao, head of China's National Energy Administration, has said the country should use part of its nearly USD2trn in foreign exchange reserves to buy more gold and other strategic commodities.

Funds are turning to gold because they are concerned that the response of the US Federal Reserve and other central banks to the economic crisis will eventually result in a significant upsurge in inflation.

'The size of the Fed's balance sheet is exploding and the currency is being debased,' Einhorn is quoted by the Financial Times as writing to investors. '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.'

The central banks and political authorities appear to be gambling that the danger of inflation is currently secondary to the risk of deflation as asset prices slump and bank lending remains stubbornly low. Do the hedge fund managers and institutional investors that are betting on gold as a hedge against inflation have the Midas touch? Time will tell.

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