Gold soars as central bank actions pummel US dollar

By Alix Steel

Updated at 4:39 p.m. ET

Gold prices soared Wednesday as the U.S. dollar tanked on news that six central banks, including the Federal Reserve, would lend more dollars at cheaper prices.

Gold (-GC) for February delivery added $31.40 to settle at $1,750.30 an ounce at the Comex division of the New York Mercantile Exchange. Gold traded as high as $1,754.70 and as low as $1,704.30 an ounce while the spot price was up $30.10, according to Kitco's gold index.

The Federal Reserve, Bank of Japan, European Central Bank, Swiss National Bank, Bank of Canada and Bank of England have joined together to make more dollars available at cheaper prices in an effort to ease liquidity strains in financial markets.

The banks will lower the price on dollar liquidity swaps by 0.5% until February 2013, making it cheaper for other countries and banks to trade in their local currencies for dollars and fund their operations, including loaning cash to consumers and businesses.

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"The coordinated global action this morning is the right approach at this time and resets the money market system back away from a super-dollar centric condition," says Richard Hastings, macro and consumer strategist at Global Hunter Securities. Hastings argues that financial policy makers were looking at the financial system and worrying it was looking like 2008 when there was a flight into the U.S. money market system. "You don't want over-strengthening of the dollar and don't want to hurt international trade."

The move by central banks dragged down the dollar, bolstered the euro and pushed gold prices higher as the dollar-backed metal became cheaper to buy in other currencies. Hastings called the action by the central banks a type of quantitative easing, saying it showed how terrified officials were that multi-national corporations would be unable to do business.

"Gold has a special talent for sniffing out these imbalances," says Hastings, "as long as this continues, gold will continue to rally." Gold has snapped back to its recent up trend line at $1,725-$1,750 an ounce, but Hastings warns that for gold to go much higher from here in the short term, new forms of "interest rate dysfunction" are needed.

Gold had been struggling to move higher in early trading after the People's Bank of China slashed the amount of money banks must hold in their reserves by 0.5% following an earlier move last week of cutting rural bank rates by the same amount. The government argued that the first round of cuts was automatic and not a sign of more monetary easing, but today's move says otherwise.

Monetary easing is a big supporter of gold. As more money is pumped into the system, the risk of high inflation grows; prices in China were rising at a rate of 5.5% in October. When inflation rises faster than interest rates, cash in the bank is worth less and investors look to gold as a safe place to store wealth.

China has been taking steps to tame inflation by raising interest rates, currently at 3.5%, and by raising the amount banks must hold in their coffers. Any signs to undo that as Europe heads towards a recession will be positive for gold.

Hastings, however, points out that its local currency, the yuan, was actually rising against the dollar on the requirement cut, which will serve to help China with inflation -- "an irony missed in this morning excitement."

China had already been doing its part to support gold prices. China's Minister of Industry and Information Technology has ordered local governments to crack down on small gold mines citing environmental worries. "This would make China even more dependent on gold imports to satisfy domestic demand, which is likely in the long run to be reflected in rising prices," wrote Commerzbank.

China, including Hong Kong, consumed 607 tons of gold in 2010 with 260 tons of that being imports. "We think imports into China could be 400 tons this year," says Marcus Grubb, managing director at the World Gold Council, and now that number could be higher. It means China might be on track to consume more than 747 tons of gold in 2011.

Gold is also finding support from a stronger equity market, which was soaring on the central bank news and as ADP said the private sector added 206,000 in November -- a positive indicator headed into Friday's monthly jobs number from the Labor Department.  The more support stocks receive, the less need gold investors will have to sell positions to raise cash. With gold trading around $1,750 an ounce, momentum buying could kick in as traders jump into the market, not wanting to miss out on a big rally.

Gold mining stocks soared Wednesday, outpacing even the huge gains in broader equities. Barrick Gold (ABX) surged 5.9% to $52.88 and Newmont Mining (NEM) added 5.5% to close at $68.88. Newmont announced late Tuesday that it will suspend construction at its Conga project in Peru due to violent protests and environmental concerns with no reopen date given.

Goldcorp (GG) skyrocketed 8.1% to $53.89, and NovaGold (NG) continued its recent surge, rising 7.3% to finish at $11.49.