Perhaps it was the damage wrought by the Mississippi Bubble in the early 1700s, or the issuing of huge quantities of fiat currency by the Revolutionary Government after 1789 that led to hyperinflation, riots, and the rise of Napoleon. Whatever the reasons, the French are acutely aware of the role that a stable currency plays in creating a stable society.

In 1965, then French President Charles de Gaulle gave a speech criticising the role of the US dollar in the fledgling global monetary system. His basic premise was that the US was causing worldwide inflation through its deficit spending, and other countries including France, were picking up the tab for this profligacy.

Over the next few years, De Gaulle countered by swapping excess dollars for gold, which in his words represented, "the immutable and fiduciary value par excellence." De Gaulle's actions led to US President Nixon suspending US dollar convertibility into gold in August 1971. At the time, notes issued by the US Federal Reserve were redeemable for gold at the rate of US$35 per ounce. In the decade following the de-linking from gold, the value of the US dollar collapsed, as America endured destabilising inflation.

Just a few weeks ago, the French were at it again, with newly elected President Nicholas Sarkozy speaking before the U.S. Congress, saying, "the dollar cannot remain solely the problem of others". He was referring to the greenback's precipitous recent decline against the euro, which last week reached record highs against the greenback.

The strength of the euro is hurting French industry, and Mr Sarkozy wants to do something about it. He recently pressured the European Central Bank (ECB) to cut the benchmark interest rate to reduce upward pressure on the currency. A strong euro makes European exports, including those from France, less competitive on the world market.

His speech to Congress also hinted at the potential for competitive devaluations: "If we're not careful, monetary disarray could morph into economic war. We would all be its victims." Echoing De Gaulle, Sarkozy is complaining loudly about the lack of US concern for their deteriorating currency.

But the French are not the only nation concerned over the dollar's fall from grace. Smaller countries such as Columbia, India and Korea have been attempting to ease the pressure on their strengthening currencies through various means.

What's all this got to do with gold? As we wrote at the start of the year, gold is a currency, not a commodity. The continuing devaluation of the US dollar is playing havoc in world currency markets, and gold is benefiting.

And we believe this is just beginning. Over the next few years, investors all over the world will become reacquainted with monetary history and realise just how many times nations and governments try to devalue their way to prosperity by making their currency cheaper against trading partners. The result? Inflation - and thus the destruction of fiat currencies.

Here's a quick snapshot of the current environment. The US economy is slowing sharply as the credit and housing markets implode. Credit market turmoil leads to tighter lending standards which reduces demand for new housing. Given the oversupply in the housing market, this lack of new demand is placing downward pressure on prices.

To offset these effects, the Federal Reserve is cutting interest rates and the financial markets are expecting further interest rate reductions in the months ahead. Needless to say, the dollar is being dumped en masse, leading to the euro and other free floating currencies like the Canadian and Aussie dollar bearing the brunt of the dollar's weakness.

These currencies are getting stronger because the currencies that should be rising, specifically the Asian and oil producing nations, are largely 'managed' (to maintain export competitiveness) or pegged to the greenback.

Most of the oil producing nations in the Middle East, in addition to China and Hong Kong, peg their currency to the US dollar. So when the dollar falls, these countries' central banks need to print more of their own currency to maintain the peg. This leads to inflation in goods and asset prices. Indeed, China's inflationary pressures are building specifically in asset markets, and it is home to one of the largest stock market bubbles in years.

In Dubai, consumer price inflation is leading to mass strikes by labourers in the construction industry as their wages decline in real value. In short, the weakness in the world's reserve currency has a multitude of global ramifications.

Investors are increasingly waking up to the fact that gold is a monetary asset, however we believe the process still has a number of years to play out. Most investors still do not understand the role of gold and look at any price correction (as we are currently witnessing) as an end of the bull market.

In our view, the bull market still has some way to run. Underpinning this view is the fragile state of the US economy, which we believe will prompt additional interest rate cuts in December and into 2008. A slowdown in the US will have implications for the global economy and will likely see central banks around the world remain on hold, or even reduce their rates.

Such behaviour is ultimately inflationary. While we believe we are seeing ample signs of inflation, not just in Australia, but around the world, the official statistics still reckon inflationary pressures are benign. The Fed's preferred inflation measure is less than 2 percent, providing justification for additional rate cuts.

Perhaps because of these low official figures, the US bond market is not yet showing any sign of concern over inflation. The ongoing credit crisis is leading to a 'flight to quality', pushing the yield on 10- Year Treasury Bonds to around 4.20 percent. At these low yields, it appears investors are more concerned with preservation of capital than yield.

When inflation finally does show up in the official figures, bond market investors, even 'high quality' government bond investors, will realise that their capital is at risk, as rising yields lead to a decline in the bonds' value. Gold, the ultimate store of wealth and the only currency to maintain its value throughout history, will likely be in strong demand in such a scenario.

Throughout history, society has moved through periods of 'soft money', where governments issue fiat currency (currency backed by a promise), to 'hard money', where governments control their ability to create currency at will by backing their paper with gold. We believe the pendulum is in the gradual process of swinging back towards a hard money based monetary system.

In the meantime, the gold price will endure considerable volatility, attempting to shake as many investors as possible loose from the wild bull market ride. We are experiencing one of those periods now. Given gold's strong run in recent months, a pullback is not at all surprising. On the other side of the coin, the near universal bearishness on the US dollar sets the greenback up for a bear market rally.

From an Aussie dollar perspective, the current pullback in the gold price is not likely to be as severe given the Aussie is also retreating from its highs. This is not surprising considering the strength of the currency's appreciation since September.

We view the current pullback in the gold price as nothing more than a correction in an ongoing bull market, and view any such event as a buying opportunity.

Corrections happen in bull markets, and they are often violent, such as we are witnessing now with gold. We encourage readers to focus on the strong fundamentals underpinning the investment case, and ride out the inevitable pullbacks.

IMPORTANT: This message, together with the Fat Prophets website and all its contents have been prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore talk with their financial planner or advisor before acting on any information present on this message or the Fat Prophets website. Performance is hypothetical and based on recommendations made in the Fat Prophets report. The table is updated monthly. Transaction costs have not been taken into account. Past performance is not a reliable guide to future performance, and investors should be aware that returns can be negative. For a full explanation of the performance calculation methodology, please visit the Fat Prophets website.

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