Prices were stuck in a $50 trading range until the Fed sent the dollar reeling
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. See full story.
"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."
The Fed's in quite a predicament as it tries to help improve the economy and most scenarios point to higher prices for gold, analysts said.
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."
Video: Rally in gold futures
James Steel of HSBC says that record-high crude oil and dollar weakness are boosting gold prices. (June 27)
"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 Blanchard and Co. Inc. 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." See full story.
No all-clear flag quite yet
Still, the market hasn't yet set out the all-clear flag for gold to move up.
August gold futures need to close above $940 before we have a technically significant breakout, said Trends In Commodities' Doelling.
Erik Gebhard, an analyst at Altavest Worldwide Trading, said the metal needs two consecutive price closes over the $920 area to "signify a lasting break to the upside."
But a break through the downside support near $864 would likely send prices below $800, he warned.
That's not impossible. If one of the central banks -- be it the European Central Bank of the Fed -- move on rates, the "currency logjam would break at that point too," said Jon Nadler, a senior analyst at Kitco Bullion Dealers.
"Or it could be that crude oil finally breaks down and comes down to reality -- either one of these events are enough to get gold down to $800 (or $770), and we better hope that bargain hunters step in at that time," he said.
Beahm admits there are quite a few things that could send gold prices below $850 -- including a strengthening economy, a slowdown in emerging markets, a rise in mining production and a fall in demand, inflation, oil prices and global tension. But he said none of those are likely.
Doelling said he'll stick with his prediction of gold above $1,350 by the year's end and silver at $25.
"I think you and I both have a better chance of winning the Lotto than metals prices have of falling at this juncture," said Doelling.Myra P. Saefong is MarketWatch's assistant markets editor, based in San Francisco.