WF: A resurgent dollar and corrections in gold and stock markets are making investors and advisors worried about gold - particularly since it made a new all-time high just a few weeks ago. Is this the end of the gold bull run?

Ruchir: The long term fundamentals for gold are intact. The two key drivers for this investment theme are :

- a negative view on the dollar, and

- expectations of rising inflation

We believe these assumptions are still in tact and therefore are of the view that the case for gold as an investment theme is very much in place.

While news flow from the US is mixed, if you look at the US economy closely there are still a lot of negatives. Take housing, for example. As we have said in our recent gold market update, a lack of meaningful improvements in the real estate markets may keep economic growth subdued in 2010. Recent signs of improvement must be taken in perspective. For example, housing starts of 574,000 rose 8.9% in November. However, this is a very long way from the 1.6 million level of monthly housing starts in the 2001 recession. November existing home sales rose 7.4% to 6.54 million units, levels last seen in 2007. However, if we back out 33% of sales that came from foreclosed or distressed properties, existing home sales would fall to its cycle lows. Barclays Capital projects the number of foreclosed homes for sale will peak in mid-2010. The share of homeowners who owe more on their mortgage than their home is worth has swelled to 23%. About 14% of households with mortgages are behind in payments. Things may be worse for commercial real estate where the default rate now stands at a 16-year high. Prices are down 43% from their peak and over half of the $3.4 trillion in commercial loans will come due by 2012. According to HSBC Global Research, GDP growth needs to exceed 3% to reduce the unemployment rate from the current 10%. However, the potential absence of the wealth effect that real estate provides makes the prospects for such growth tenuous.

It is difficult to gauge the true health of the economy while such extraordinary stimulus is being applied through federal spending and monetary easing. Many of the emergency liquidity facilities targeted at Commercial Paper, Primary Dealers, consumer loans, and commercial mortgages are set to expire between February and June. Municipalities receive subsidies through the federally funded Build America Bonds program that runs through 2010. The Fed has been buying roughly 80% of the mortgage-backed debt issued by Fannie Mae and Freddie Mac. These two government-sponsored enterprises (GSE's) own or guarantee half of the $11 trillion in mortgages in the US. The first-time homebuyer tax credit was expanded and extended to April. GMAC and the GSE's have recently required more capital from the government. On Christmas Eve the US Treasury removed the limit (formerly $400 billion) on the amount of government money GSE's can take. With so much stimulus focused on housing, we wonder if the already weak mortgage market will be able to function without it.

WF: And, you believe that this will continue to put pressure on the dollar over the medium term?

Ruchir: Ultimately, the US budget deficit gap has to be narrowed in one of two ways: increase savings - which is a long drawn process, or continue borrowing more and print more currency - which has the potential of creating inflationary pressure.

The other interesting thing I came across is that while US has been borrowing record amount of money they are also doing it at zero percent interest rate. When interest rates start rising, they could also face some debt servicing issues as well. Or in other words as a percent of GDP, the debt servicing is likely to balloon. So that is going to be added expenditure in the years to come. By some estimates, debt servicing right now is about 12% of GDP and is likely to go to 36%, almost triple over the next few years.

WF: But why then is the dollar staging a sharp rally now ?

Ruchir: There are two factors - one is a possibility of a technical pull back after a prolonged drop. The other is a case of relative value - where some observers feel that other economies particularly in Europe and Japan may grow slower than the US.

But that apart, there is ample evidence of people trimming their USD exposure - whether it is Central Banks or large fund managers. Some of the largest global bond fund managers have been steadily increasing their non-US exposure over the last few years. These are longer term trends that are indicative of how institutional players see the USD over the long term.

The other factor that can put renewed pressure on the US dollar is interest rates. US is unlikely to raise rates for quite some time. Many emerging countries and some developed countries like Australia have already embarked on the journey of raising interest rates. This will put increasing pressure on the USD as it will progressively look unattractive on a relative basis. Germany is mandated to balance its budget by 2016 and is taking steps towards that end. The US faces an uphill task to repair its deficit situation.

We must also keep in mind that the enormous amounts of money that has got printed world wide in the quantitative easing efforts of Central Banks, can very well lead to a period of high inflation. Inflationary periods are usually bullish for commodities in general and gold in particular.

WF: You have a house call for gold to hit US$ 1300 in early 2010. Does this call still hold?

Ruchir: Well, we almost reached that level, didn't we! Our team in US - who do this research and put out their forecasts, still believe that this projection is on and that the investment case continues to be as strong as ever.

Gold is a great hedge against inflation and a weak dollar - and should continue to merit an allocation in every investor's portfolio. The recent correction is a good opportunity to create that allocation, if one has not been done already.