Gold vs Fiat Money: Picking a Winner

Gold has been a major beneficiary of ultra-loose monetary policy over the last three-four years but with quantitative easing coming to an end, will the precious metal begin to loose its shine?

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“Gold may experience a correction in the short term: the depreciation of the US dollar may have been too fast lately,” Alain Bokobza, Head of Global Asset Allocation at Société Générale said in an interview with CNBC on Tuesday.

“The correlation of gold to the S&P 500 is close to historical highs and such a level has proved to reverse in the past; and, above all, the end of QE2 may tighten liquidity conditions somewhat,” Bokobza said.

QE2 is the second round of quantitative easing, by which the Federal Reserve buys assets to inject money in the markets and keep interest rates low to boost the economy.

Investors should, though, in Bokobza’s view, use any weakness to increase their holdings in gold as the Fed maintains its dovish stance on interest rate policy.

“Sub-normative interest rates in the US while inflation is heating up imply negative real interest rates at the short end of the yield curve. This is bullish real assets that provide no yield, such as gold,” said Bokobza

The New Reserve Currency

With sovereign risks growing, Bokobza believes gold should be viewed as a superior asset but warns volatility is set to rise, given huge gains since the financial crisis began.

“Gold is not cheap anymore and its volatility may start to rise,” Bokobza said.

“The role of the dollar as a reserve currency is unlikely to be removed in the short term. But official and private investors have been increasingly willing to diversify their risks due to uncertainties over the sustainability of US public finances and a decade-long depreciation of the dollar,” he added.

While the euro has been perceived as a credible alternative during the last decade, the 2010 debt crisis spreading from Greece to Ireland and Portugal has left gold holdings as the last option to diversify risk. "Compared to fiat money, gold is perceived as a fundamental store of value,” Bokobza said.