Gold revs its engine and squeals down the track

Prices were stuck in a $50 trading range until the Fed sent the dollar reeling

By Myra P. Saefong, MarketWatch

June 27, 2008

SAN FRANCISCO (MarketWatch) -- The U.S. Federal Reserve gave gold the fuel it needed to restart its engine and the precious metal has already driven through the trading range barrier it's been stuck in for the past month. 

Gold futures had been trapped in a $50 trading range between $860 and $910 an ounce on the New York Mercantile Exchange since May 28. It climbed past $920 in electronic trading Thursday evening as the U.S. dollar slumped in reaction to the Fed's failure to signal urgency to raise rates to curb inflation.

On Wednesday, the Fed decided to hold short-term interest rates steady at 2%, but sharpened its focus on inflation, saying that the risks posed to the economy by upward pressure on prices have increased.

"Gold broke decisively out of the trading range that had constrained it as investors came to realize that the Federal Reserve won't be able to begin a rate-hike campaign until 2009," said Brien Lundin, editor of Gold Newsletter.

The Fed's policy statement essentially acknowledged the "trick box" the central bank is in -- "facing growing inflationary pressures, but unable to raise rates while economic conditions are so weak and with a national election so near," he said.

That combined with growing expectations that the European central bank will begin its own rate hikes well before the Fed can act to create a bearish environment for the U.S. dollar which in turn, provided a very bullish outlook for gold, he said.

"People are finally coming out of the fog and realizing that we're in a world of hurt and people are plain scared," said Dale Doelling, chief market technician at Trends In Commodities.

"Stocks are in the toilet, the dollar is getting hammered, oil is going through the roof, food commodities are in the stratosphere [so] there's only one solution," he said. "Buy gold! Buy silver! Buy them because they're the only defense against what's happening in all the other markets."

Fed Muck

James Steel of HSBC says that record-high crude oil and dollar weakness are boosting gold prices. (June 27)

Fed Chairman Ben Bernanke is "caught between wilting growth and rising inflation," said Julian Phillips, an analyst at GoldForecaster.com. "With such toothless words against inflation, their rate-holding action told [everyone] that they can expect no interest rate support for the dollar in the foreseeable future." "This is positive for precious metals," he said.

Gold's value as a hedge against inflation -- especially as it pertains to a weakening dollar and rising oil prices -- helped lift prices for the metal to nearly $1,034 an ounce in mid-March, the highest futures price level ever recorded. 

And with ongoing concerns about inflation and a slowing economy, gold may be poised to return to record territory, analysts said.

"Inflation is a lot like toothpaste -- once it is out, it is very hard to get back into the tube," said David Beahm, a vice president at coin and precious metals retailer. And gold is a "tremendous hedge to both protect wealth during these inflationary periods and also generate positive investment returns when other asset classes decline in value."

The Fed's policy statement noted "two situations weighing on the economy: tight credit and the housing contraction -- that could be best addressed by an accommodative monetary stance," said Lundin. But at the same time, it noted just one, high energy prices that could be combated by a tighter monetary policy.

Crude prices climbed near a record $140 a barrel earlier this month and U.S. retail prices for regular gasoline stand near an all-time high above $4 a gallon.

"In short, they're damned if they do and damned if they don't," said Lundin. The Fed can only talk inflation down and talk the dollar up for now. "It won't be able to take any real, substantive action until after the fall elections."

Dollar Doom is Gold's Boom

Of course, at the root of the issue for gold is the dollar, Lundin said.

"Whatever developments drive the greenback will send gold in the opposite direction," he said.

The Fed can protect the U.S. dollar by sharply increasing rates, but that would sink the economy and make servicing our huge debt loads unmanageable, said Peter Spina, an analyst at GoldSeek.com. So the Fed "must keep rates low and keep liquidity in the system, which will ultimately lead to further debasement of the dollar's value," he said.

Protection for the dollar can really only come in the form of confidence or perception and then capital controls, he said.

Spina said he senses "increasing desperation" on the Fed's part and if the economy hasn't recovered as we enter 2009, "the confidence game could unwind quickly."

The Fed is "in a corner and the U.S. dollar is going to be a victim of their policies," Spina said. "It already has been punished harshly."  . . .

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DOW LOWEST IN 21 MONTHS

Gold for August delivery settled at $32.80 to 915.10 an ounce on the New York Mercantile Exchange. The precious metal hit an all-time intraday high of more than $1,030 an ounce back in mid-March.

"Weakness in the dollar has helped propel gold sharply higher today," said James Steel, an HSBC metals analyst in New York.

In addition to the dollar's decline, gold was supported by a surge in the price of oil and signs that the credit crisis is alive and well on Wall Street.

"I think the bottom is rather limited, given the dollar and credit concerns, plus high oil prices," he said.

Dollar weakness The dollar lost ground against the euro Thursday after the U.S. government reported that the nation's economy grew at a sluggish rate of 1% during the first quarter.

The euro rose to buy $1.5736 in afternoon trading, up from $1.5667 late Wednesday.

The greenback's weakness also stems from the Federal Reserve's decision Wednesday to hold interest rates steady at 2% as the central bank struggles to deal with a flattening economy coupled with rising prices.

The Fed's decision "signaled that inflation in near term is still uncertain," Steel said. That can drive gold prices higher because many investors see precious metals as a hedge against inflation.

Oil jumps T

The dollar's decline helped boost oil prices Thursday. Reports that Libya may cut oil production and that an OPEC official said crude could hit $170 a barrel this summer gave crude prices additional support.

Light, sweet crude for August delivery rose $3.65 to $138.20 a barrel on the New York Mercantile Exchange. The price climbed as high as $138.95 - a $4.40 gain and within $1 of the all-time intraday high of $139.89 - earlier in the session.

"To some extent, the gold market takes its cues from oil," Steel said. When oil rallies, gold tends to follow suit because oil is such a large component of commodities indices, he said.

Stocks swoon

Wall Street was battered Thursday afternoon, with the Dow industrials hitting its lowest intraday level in 21 months. The selloff was prompted by downgrades in the financial sector, the resurgence of credit concerns and the fallout from disappointing quarterly reports in the tech sector.

Gold often rallies when the stock market is in decline. "It is a traditional safe haven in periods of financial stress," Steel said.

Stocks came under pressure after Goldman Sachs cut its ratings on U.S. investment banks to "neutral'' from "attractive" because of continued deterioration of the banking industry and the prospect of a lengthy recovery. It also added Citigroup to its "conviction sell'' list.

Meanwhile, the stock market is digesting corporate results released late Wednesday from tech leaders Oracle and Research In Motion.

Oracle (ORCL, Fortune 500) easily beat Wall Street expectations for its fiscal fourth quarter results but the software maker gave more conservative guidance that disappointed investors.

BlackBerry maker Research in Motion (RIMM) missed its target and guided down its profit forecast for the quarter.

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