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Gold Prices Track Euro Higher (Update 3)

NEW YORK ( TheStreet ) -- Gold prices closed higher Tuesday, delivering an 11% gain for January, as the trade gained momentum and as investors cheered a tighter fiscal pact from the European Union.

Gold for April delivery closed up $6, off its session highs, to settle at $1,740.40 an ounce at the Comex division of the New York Mercantile Exchange. The gold price has traded as high as $1,750.60 and as low as $1,727 an ounce while the spot price was adding $6, according to Kitco's gold index.

Silver prices lost 26 cents to close at $33.26 an ounce while the U.S. dollar index was up 0.21% at $79.30.

Gold prices pared earlier gains as the euro lost ground against the dollar. There were a stream of reports about Greece's debt deal with private bondholders indicating that they would have to take more than a 70% loss. Standard & Poor's is also putting a slew 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 put the breaks on gold's climb as investors opted for the dollar.

Unlike the euro, gold was able to stay in positive territory for the day. George Gero, senior vice president for RBC Capital Markets, says "traders [are] seeing higher moving averages and higher open interest for the month."

Gold had been also tracking the euro higher and getting an early morning boost as 25 of the 27 nations in the European Union signed onto a tighter fiscal union. The European Court of Justice would be able to impose fines on countries who didn't stick to their budget deficits. All countries will be required to shrink their debt to 60% of Gross Domestic Product. These guidelines had been in place earlier, but the fine represents a big step towards being able to enforce 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.

The European Central Bank has already seen its balance sheet expand 27% since September, and these big three-year loans at low interest rates will continue to ramp up the money supply in the system. The euro was moving higher, however, as these steps helped calm investors' worries over short term funding needs.

Longer term, any inflation expectations should be good for gold as the hard asset does well as paper currencies lose value. The question is whether or not the money is making it out into the actual money supply.

The M2 supply in the U.S. for example -- money in circulation plus checking, savings and travelers checks -- has grown 28% since the beginning of 2008 but banks are still keeping $1.5 trillion in excess reserves stashed at the Fed, which explains the lack of inflation in the U.S.

"Ultimately it can matter," says Leo Larkin, metals and mining analyst at S&P Capital IQ, "if the economy gets better and the money starts to be lent." 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 is a possibility but that gold could 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." His more conservative price target of $1,900 compared to other analysts is still a 21% increase from where prices started the year.

The game changer for Larkin, where he would revise his target higher, would be an "acceleration in growth of the monetary base more than we have seen," meaning that if the economy gets better, banks will start lending their 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 would raise the amount of money it would cost to trade a gold contract, thereby shaking speculators out of the market.

Gold mining stocks were volatile Tuesday. Kinross Gold (KGC - Get Report) was down 1.32% at $11.21 while Yamana Gold (AUY - Get Report) was relatively flat at $17.34.

Other gold stocks, Agnico-Eagle (AEM - Get Report) and Eldorado Gold (EGO - Get Report) were trading mixed at $37.40 and $15.22, respectively.

-- Written by Alix Steel in New York.

>To contact the writer of this article, click here: Alix Steel.

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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