Paulson said government spending will trigger inflation, and investors should stock up on gold as protection.
"By the time inflation becomes evident, gold will probably have moved, which implies that now is the time to build a position in gold," Paulson wrote in a letter at the end of 2011 obtained by Bloomberg News.
Hedge funds and money managers have increased their bets this year on higher gold prices.
Paulson's hedge fund, Paulson & Co., is the biggest investor in the SPDR Gold Trust ETF (NYSE: GLD) with a $2.9 billion stake. The fund is up 24% in the past year and more than 10% this year alone.
Paulson: It's Time to Buy Gold
With the U.S. Federal Reserve leaving interest rates near zero until 2014, more investors will buy gold as an inflation hedge.
"The appalling state of fiscal finances of most industrial nations does lead to concerns about the possibility of inflation," Mark O'Byrne, executive director of brokerage GoldCore Ltd., told Bloomberg. "Gold is a crucial diversification given the various risks out there."
The European debt crisis and its uncertain effects on the markets have also pushed investors into gold. China this week pledged to help the region resolve its fiscal issues by investing in Europe's bailout funds.
The announcement drove the price of commodities - including gold - sharply higher. The Standard & Poor's GSCI Spot Index of 24 raw materials rose to a six-month high this week.
Paulson said in his year-end letter to investors that Greece could default by the end of the March, leading to a Eurozone breakup.
Governments around the globe have already made big bets on the yellow metal, adding record numbers to their stockpiles last year. According to the World Gold Council, the world's central banks increased gold purchases last year by 500% over what they bought in 2010.
Record investment drove gold demand to 4,067.1 tons last year, the most since 1997, the World Gold Council estimates.
Gold ended the week $1,725.90 an ounce on the Comex division of the New York Mercantile Exchange.
Investors who agree now is the time to buy gold should review this report on how to buy gold coins.
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