Gold Prices: Where Will They Finish 2012?

NEW YORK (TheStreet) -- Can gold prices regain their luster in 2012?

Gold has started 2012 with a bang, with prices up 11% in January alone. Gold's recent rally was ignited primarily by the Federal Reserve announcing it would keep interest rates low until late 2014. With the Fed virtually saying it would try to create inflation, gold was off to the races.

Around the globe, inflation is outpacing interest rates, leading to negative real interest rates. As people's money in the bank become literally worth less, investors flock to a hard asset like gold to preserve their wealth. Many are expecting inflation to pick up speed as central banks around the world gear up to fight deflation with more money printing.

Bulls also point to 11 years of gold price gains and argue that gold's late 2011 massacre was a normal correction. Central bank buying has also been robust, with the official sector buying 430 tons of gold in 2011. Turkey and Russia comprised the lion's share of buying.

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Gold bears, on the other hand, point to weakening physical demand out of Asia. China and India accounted for 41% of total gold consumed in 2010, according to the World Gold Council, but both countries are struggling to maintain their fast and furious growth.

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India consumed only 878 tons of gold in 2011, a 8.4% drop from 2010. The Bombay Bullion Association believes that in the first quarter, India could import half of what it did in 2011. Indian demand has been ravaged by high interest rates and a devalued rupee, making gold more expensive to buy. High and volatile gold prices might also make it hard for India to ramp up its gold purchases despite its own recent rate cuts.

Demand in China is strong -- the country imported 389 tons of gold in the first 11 months of 2011 -- but not strong enough to compensate for lackluster Indian demand, and many fear a slowdown if China's economy also slows drastically. China's inflation has moderated to 4.1% and the central bank has allowed banks to keep less money in their reserves, but seems reluctant to cut rates further.

To make matters worse, mine production was up 3.8% in 2011, and there is a worry that central banks might start selling gold to raise dollars.

The backdrop for gold in the short term continues to be the tug-of-war between the euro and dollar. Despite the Fed's easy monetary policies, investors seem more worried about the health of the eurozone rather than the health of the U.S. economy. Although any economic panic should be a recipe for higher gold prices, instead gold is trapped between a volatile euro/dollar relationship.

Jeffrey Wright, senior research analyst at Global Hunter Securities, is revising his 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 would raise the amount of money it would cost to trade a gold contract, thereby shaking speculators out of the market.

Leo Larkin, metals and mining analyst at S&P Capital IQ, thinks that $1,900 gold might not be that much of a stretch. "Gold has been going up without interruption for 10 years" and a correction is totally normal, Larkin says.

"The United States' [money] supply is up 9% from the beginning of the year and the monetary base is up 30%. They are setting the stage for higher [gold] prices," argues Larkin.

"People get so caught up with the next three minutes for gold and they should really be focused on the next three years," says Frank Holmes, CEO of U.S. Global Investors. "Does anyone really believe in the long term strength of the U.S. dollar ... We're just going to have to live with this volatility for another 12 months," says Holmes, who still thinks gold price could double to $3,600 an ounce in 5 years.

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