The Logic Behind the Gold Trade

I like to live my life by heuristics – those little rules of thumb that help us remember to look both ways before crossing the street and to brush after every meal. Such a mindset certainly comes in handy when developing an investment thesis, as it can keep one from making ill-informed decisions. I always put buying gold in that category, but according to a recent blog post, there may actually be some logic to the gains enjoyed by the yellow metal.

Check out "A Possible Model for the Price of Gold." The author makes a compelling case that gold prices are akin to a highly leveraged short position in U.S Treasury bills, with a breakeven point of 2%. In other words, gold's value is tied to low real rates. When real rates are low, gold prices can rise significantly; as real rates rise, gold prices can fall quickly.

The author's logic is compelling, but I'm still convinced that the average investor who owns gold will eventually get burned. After all, the rule of thumb is that the "smart money" will sell their gold stashes to individual speculators, as this latter group is almost always the last one to the party.