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.
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.