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Gold bugs dancing on the debt ceiling

January 24, 2013: 11:56 AM ET

Many dismiss gold as a sort of lunatic fringe investment. But prices have continued to climb along with the level of the U.S. debt ceiling.

The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.

There is a common misconception that gold is only a great thing to own when investors are in full-blown Chicken Little panic mode. But gold has enjoyed a decent rally in the past few weeks even though very few people on Wall Street are looking up and seeing the sky falling.

Stocks are at five-year highs. CNNMoney's Fear and Greed Index is so firmly ensconced in Extreme Greed territory that it only has seven points to go before it reaches its maximum level of 100. Unless you're a shareholder in Apple (AAPL), there is little to be afraid of right now.

So why are gold prices up nearly 2% in the past month and back near $1,700 an ounce?

Edmund Moy, chief strategist with Morgan Gold in Irvine, Calif., and a former director of the U.S. Mint, has an interesting theory. Moy thinks that gold should continue to climb as long as the debt ceiling gets raised, and that there is even a pretty simple formula for how the price of gold tends to track the level of the debt ceiling. Just move the decimal point 10 places to the left.

To wit, Moy notes that the debt ceiling limit currently stands at $16,394,000,000,000. Gold is now around $1,672 an ounce. If Congress eventually agrees to raise the debt ceiling -- for argument's sake, let's say it gets bumped to near $18 trillion, then gold should start to move toward $1,800 an ounce.

Recent history seems to back up Moy's assertions. In March 2008, gold cracked the $1,000 level (not adjusted for inflation) for the first time ever. A few months later, the debt ceiling was raised to above $10 trillion for the first time. In November 2010, gold surpassed $1,400 an ounce. That happened a few months after the debt ceiling was raised to more than $14 trillion.

Related: Selling gold in Fort Knox is not a debt ceiling solution

Now it's hardly a perfect statistical correlation. When gold hit an all-time high above $1,900 an ounce in the late summer of 2011, that was shortly after the last debt ceiling debacle resulted in a downgrade of Uncle Sam's credit rating by Standard & Poor's. The debt ceiling did not get raised to $19 trillion. And unlike now, August and September of 2011 were fearful months, proving that gold can do well both in times of irrational pessimism and irrational exuberance.

It also may just be a statistical quirk that the price of gold for the past five years has closely mirrored the level of the debt ceiling -- once you lop off a bunch of zeroes.

Moy, who was director of the U.S. Mint from September 2006 through the beginning of 2011, conceded that investors should not expect gold to immediately spike once there is finally an agreement to allow the Treasury to borrow more.

"Gold should go up when the debt ceiling gets raised, but investors should expect a lot of volatility," he said.

Along those lines, gold prices have pulled back over the past two days -- and that could be attributed to the fact that it's no longer clear just when the debt ceiling will be raised after the House passed a bill Wednesday that, assuming it passes the Senate and is signed by President Obama as expected, puts a decision on the debt ceiling on hold until mid-May.

But Moy's greater point is that as long as the U.S. remains a profligate spender, gold should continue to head higher.

"Gold should keep rising until the U.S. gets its fiscal house in order," Moy said.

That's unlikely to happen anytime soon.

Related: Why aren't investors scared?

Adding fuel to the gold fire? The Federal Reserve.

The Fed has been in easing mode since the onset of the financial crisis in 2008. That's helped push up the value of gold since some investors feel that super-low interest rates and three rounds of asset purchases known as quantitative easing (Or is it now four? Five or six if you count Operation Twist and its extension?) will eventually fuel inflation and weaken the dollar.

Gold and other commodities, like oil, should retain more of their value in times of inflation since they are tangible assets. The greenback and other paper currencies could be big losers.

"Many investors primarily use gold as an insurance policy, a hedge," Moy said. "When the dollar gets devalued, gold goes up."

True. And the dollar is not the only currency game in town. Other developed nations around the world are playing games with their currencies. Japan has taken steps to rein in the yen through asset purchases, a plan that has angered some in Europe and sparked concerns of a currency war. The ECB has also pledged to buy bonds of troubled European nations if it sees fit, a strategy that could also put pressure on the euro.

That is all bullish for gold.

John Hathaway, manager of the Tocqueville Gold Fund (TGLDX), wrote in a quarterly letter to investors earlier this month that he expects gold to top the 2011 all-time highs sometime later this year. He cites the worries about the health of the U.S. and Europe in particular.

"Such a move will be driven by the continuation of negative real interest rates and heightened concerns over the direction of monetary and fiscal affairs in all western democracies," Hathaway wrote.

Now none of this means that investors should rush to put a huge chunk of their investments into gold. Diversifying your portfolio is always smart. But those who keep dismissing gold as an asset that only crackpot conspiracy theorists could love and are predicting an imminent crash need to reconsider that position. After all, they've now been wrong for more than a decade.

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Paul Lamonica
Paul R. La Monica
Assistant Managing Editor, CNNMoney

Paul R. La Monica is an assistant managing editor at CNNMoney. He is the author of the site's daily column, The Buzz, and also tweets throughout the day about the markets and economy @LaMonicaBuzz. La Monica also oversees the site's economic, markets and technology coverage.

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