Gold settles higher on eurozone pact

Prices rally as investors cheer a more binding fiscal agreement among 25 EU nations.

By TheStreet Staff Jan 31, 2012 11:04AM

By Alix Steel

 

Updated at 3:48 p.m. ET

 

Gold (-GC) climbed higher Tuesday as investors cheered a tighter fiscal pact from the European Union.


Gold for April delivery settled up $6 at $1,740.40 an ounce at the Comex division of the New York Mercantile Exchange. Gold traded as high as $1,750.50 and as low as $1,727 an ounce while the spot price was adding $8, according to Kitco's gold index.


Silver (-SI) fell 26 cents at $33.26 an ounce, while the U.S. dollar index was up 0.2% at $79.30.

 

Gold began the day tracking the euro upward, as 25 countries in the European Union signed on to a tighter fiscal union. As a result, the European Court of Justice will impose fines on countries that don’t stick to their budget deficits, and all nations will be required to shrink their debt to 60% of GDP.

 

While the guidelines already existed, the fines represent a big step toward enforcing the rules. The Financial Times also reported that European banks might tap the European Central Bank for almost 1 trillion euros in its next auction, more than double what banks accessed in December.


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The European Central Bank has already seen its balance sheet expand 27% since September, and those big three-year loans at low interest rates will continue to ramp up the money supply in the system.

 

While gold managed to hold its gains, the euro lost ground against the dollar as the day wore on. Reports emerged about Greece's debt deal indicating that private bondholders would have to take a loss of more than 70%. Standard & Poor's is also putting a number of Spanish banks on credit watch negative after downgrading the country's sovereign rating in early January. The reports were enough to squash any euro rally, which temporarily put the breaks on gold's climb as investors opted for the dollar.

 

Longer term, any inflation expectations will boost gold as the metal tends to rise as paper currencies get diluted and lose value. The question is whether or not the extra money is making it out into the actual money supply.


"Ultimately it can matter if the economy gets better and the money starts to be lent," says Leo Larkin, a metals and mining analyst at S&P Capital IQ. Larkin has not changed his price target for gold in 2012 despite the Federal Reserve's recent action of keeping rates low until the end of 2014.


Larkin thinks a spike to $1,900 an ounce could happen, but says gold might head sideways for most of the year to work off any overbought conditions. "Gold is up 11%, and we are barely through the first month of the year. . . . (It) has to come up for air." While his $1,900 price target is conservative compared with those of other analysts, it's still a 21% increase from where gold started the year.


Larkin would raise his target higher only if there's an "acceleration in growth of the monetary base more than we have seen." In other words, if the economy gets better, banks will start lending excess cash and the velocity of money in the U.S. will pick up. The result could damage the U.S. dollar and lead investors into the safety of gold. "Gold is a hedge against what (investors) think will be continued depreciation of currency." As investors lose faith, Larkin says they will turn to gold.

 

Global Hunter Securities, on the other hand, is revising its 2012 gold price forecast from $1,750 on the high end to $1,950 an ounce, due to the Fed's long term interest rates. "There is a possibility of breaching $2,000 per ounce of gold in a momentum spike," says Jeff Wright, managing director and senior research analyst at GHS, "which we believe would be for a limited amount of time due to profit taking, increases in physical supply and futures exchange intervention" such as margin hikes.

 

"Easy money policies coupled with signs of inflation seeping into the economy will only enhance the gold market," argues Wright. Risks, however, include a stronger dollar due to the European sovereign debt crisis as well as margin hikes on the Comex, where the CME could raise the amount of money it would cost to trade a gold contract, thereby shaking speculators out of the market.


Gold mining stocks including Barrick Gold (ABX) and Newmont Mining (NEM) were edging upward on Tuesday.  

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