Gold Prices Soar as Fed Commits to Easy Money (Update 2)

NEW YORK (TheStreet ) -- Gold prices reversed earlier losses and popped higher Wednesday as the Federal Reserve stayed committed to an easy monetary policy for a longer period of time.

Gold for February delivery rallied $36.50 to close at $1,700.10 an ounce at the Comex division of the New York Mercantile Exchange. The gold price has traded as high as $1,704.50 and as low as $1,649.20 an ounce while the spot price was up $34, according to Kitco's gold index.

Silver prices jumped $1.14 to settle at $33.12 an ounce while the U.S. dollar index was down 0.26% at $79.60.

Gold prices reversed directions Wednesday and popped higher after the Fed said it would maintain low interest rates until late 2014, a year longer than previously stated. The Fed also promised to stay accommodative. "That's really really dovish and you are seeing a lot of people running into gold," says Phil Streible, senior commodities broker at RJO Futures.

The Fed said that inflation remains subdued, which Streible said was a good thing for gold. "Inflation will be created ... [the Fed is] artificially creating inflation for the next couple of years." Chairman, Ben Bernanke, during his press conference also said the Fed was looking for an improvement in the pace of the recovery and that if inflation stays low and unemployment comes down slowly then the Fed will "look to do more." P/>The Fed raised its inflation target to 2% but said it was prepared to go above that level if warranted by the bad employment situation, which is another sign more quantitative easing could be on the horizon. The Fed said "it would tolerate inflation above their preferred rate if lowering it back to the preferred rate would raise unemployment unacceptably," says Larry White, Professor of Economics at George Mason University.

White thinks that policy is a mistake. "The problem with the Fed saying that is it is going to raise inflation expectations [is that it] will effect unemployment." White says if people start to expect inflation they will hold out for higher wages leading to stagnation in the job market.

The U.S. dollar index sold off on the news as more easy money means a devalued dollar. When paper currencies lose value, gold becomes appealing as a safe haven asset. White says its just a question of which falls faster against other currencies the euro or the dollar with the later good for gold.

"The Fed telling us no rate increase to at least 2014 is a sharp rally promoter for gold," says George Gero, senior vice president at RBC Capital Markets, who called gold's jump breathtaking, "as low interest rates to continue will make gold a good alternative hold and not expensive to maintain" The rise in gold also triggered short covering where investors who had been betting against gold were forced to buy back positions.

A popular gold trade of late has been to short the metal -- bet against higher prices -- as prices reach $1,670 an ounce and then cover shorts -- buy back positions -- as the metal hits $1,650 an ounce. The result is a tight technical trading range for gold. Streible says if gold can break through $1,680 on a closing basis we are going to $1,720."

Scott Redler, chief strategic office at T3Live.com, said that the rally happened on strong volume, which is bullish for gold despite the fact that much of it came from short covering. "A big move on heavy volume through a downtrend is bullish." Redler is now looking for higher prices in gold.

Vote: Where will gold prices finish in 2012?

Chuck Butler, president at EverBank World Markets, notes that the gold futures market has picked up 10,000 short contracts since the beginning of the year, suggesting that gold was being used primarily as a trading vehicle, but that might change if longer term investors pile back in.

Waverly Advisors wrote in a note this morning that they are holding a small short position in gold and are looking to add as prices consolidate. "Traders not holding short positions could initiate on such a breakdown, and traders holding longs could further reduce exposure on weakness." Any pressure on these positions will help sustain a rally.

Butler acknowledges that in the short-term gold will stay volatile, but that later in 2012 gold will reach its previous high of $1,923 an ounce and maybe even touch $2,000.

As long as the focus is on the troubles in Europe gold will come under pressure as it moves with the euro and inversely to the U.S. dollar. "But later this year we are going to be going through an election process in the U.S.," says Butler. "I think that process is going to be like last August, when we had the debt ceiling debacle and everyone just got out of dollars as fast as they could." Gold prices soared almost 13% in August as Standard & Poor's downgraded the U.S.' triple-A credit rating after a deadlocked Congress almost triggered a debt default.

"When the focus shifts back to the U.S., that will push people to buy gold again." The lynchpin, however, is stabilization in Europe. Butler thinks stabilization comes in the form of the European Central Bank taking a larger more obvious supportive role like the Fed, and that a Greece default must be taken off the table. Although the ECB's balance sheet has grown 27% since September and it is offering unlimited 3 year dollar loans at a low rate to banks -- effectively back stopping them -- it hasn't issued any grandiose statement regarding buying sovereign bonds. It currently is buying debt from banks and institutions but the ECB always says the purchases are limited in nature. If the ECB were to signal a longer commitment to its bond buying program, it could go a long way in stabilizing Europe.

"Any chance of that happening and [investors] feel calmer," says Butler, "markets for the most part really want to see the euro hold on here ... Stabilization, even if temporary, would shift the focus back to U.S."

Gold mining stocks were soaring Wednesday. Kinross Gold(KGC) was up 6.24% at $11.24 while Yamana Gold(AUY) was 9.44% higher at $16.86.

Other gold stocks, Agnico-Eagle(AEM) and Eldorado Gold(EGO) were popping at $37.66 and $14.06, respectively.

--Written by Alix Steel in New York.

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