Another Fresh High for Gold Prices

The metal hits $728 an ounce intraday, closing at $721.50. Is a big correction lurking?
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Updated from 12:07 p.m. EDT

Gold and metals rallied again to record levels on Thursday, fueled by supply constraints, crude oil approaching $74 a barrel and continued dollar weakness.

Gold for June delivery jumped $15.80, or 2.2%, to $721.50 an ounce. It earlier reached an intraday high of $728, a level unseen since September 1980.

With gold gaining close to $200, or 40%, since the start of the year -- and with the rally showing little fatigue since topping $700 an ounce this week -- more analysts are throwing up caution flags.

"A significant sharp correction is lurking out there," writes Peter Grandich, editor of

The Grandich Letter

. "It's highly likely to come out of left field and at its depth, should end up giving cause to question if the bull market is over."

Yet like many others, Grandich has given up on trying to determine when such a move might occur, noting that "those who have tried up until now have been run over by this mega bull."

Still, in a special alert sent to his subscribers Thursday afternoon, he warned that one of his indicators has given him "the most overbought reading ever for both copper and gold." At the very least, Grandich says, risk in gold, silver and copper is now "equal to, or much higher, than reward in these markets for the near term."

Among other metals, silver for July delivery also reached a 25-year high, surging 65 cents, or 4.6%, to $14.93 an ounce. As for copper, the July contract rallied 23 cents, or 6.4%, to $3.92 a pound, just off a new all-time high at $4.04.

Germany's Norddeutsche Affinerie, the largest copper refiner in Europe, posted strong earnings growth for the first three months of the year, citing strong demand and a "continued shortage."

At the same time, the London Metals Exchange reported that copper inventories dropped 2% to 113,650 tons, which is equivalent to three days of global consumption, according to

Bloomberg

.

As for gold, which acts as a hedge against inflation, it continued to benefit from gains in oil. Crude for June delivery was recently up $1.12 at $73.25 a barrel after news that a

Valero Energy

(VLO) - Get Report

refinery had been shut down, which heightened concerns over supply ahead of the summer driving season.

Metals also received a boost from sustained weakness in the dollar. A weak dollar raises the value of dollar-denominated commodities, such as gold, as it takes more of the currency to buy the same amount of the metal.

The dollar did rise slightly vs. the yen as the Bank of Japan, alarmed that its currency's appreciation might threaten Japan's economic recovery, raised the threat of intervention. But the greenback fell further vs. the euro, as a European Central Bank official said eurozone rates are too low. The Dollar Index, which measures the greenback against a basket of major currencies, was recently down 0.09 at 84.22.

Most of all, the dollar failed to rally in spite of two key dollar-supportive events on Wednesday.

First, the

Federal Reserve

fell short of clearly signaling a pause in its 22-month long campaign to raise interest rates.

Higher rates supported the greenback throughout 2005, but expectations that the hikes would soon stop have led the dollar to recently drop to one-year lows vs. the euro and to eight-month lows vs. the yen.

Second, the U.S. Treasury stopped short of branding China a "currency manipulator" in its semi-annual report on currencies. China has been pressured by the U.S. to let its currency, the yuan, appreciate to help adjust global trade imbalances. But such an adjustment would also imply further dollar weakness.

Gold bugs believe that once the Fed stops raising interest rates, the dollar will resume a multi-year decline (some say it's already underway) as currency markets start paying attention to the soaring U.S. current account deficit. This should fuel demand for gold, the currency substitute of choice, they say.

In addition, gold, which also acts as a safe-haven asset amid geopolitical uncertainty, has received a strong bid this year from the tensions surrounding Iran's nuclear ambitions.

Metals overall have benefited from continued strong global growth and demand, driven by the likes of China and India.

And, of course, there has been a surge of investment flows from hedge funds and retail investors, helped by several exchange-traded funds such as the

streetTRACKS Gold

(GLD) - Get Report

and the recently launched

iShares Silver Trust

(SLV) - Get Report

.

For Leonard Kaplan, president of commodities brokerage Prospector Asset Management, the levels reached in gold and other metals can only be explained by money chasing money.

"The fundamentals don't justify this," he says. "All of a sudden, the Street believes that commodities are a financial asset and all these investors are pouring money into a very small market."

Yet, Kaplan says that just like Internet stocks in the 1990s, the current rally in commodities can go on for much longer. "It's entirely speculative, but it doesn't mean it can't go a lot higher," he says.

After the tech bubble and, more recently, the real-estate bubble, Kaplan says that money is now chasing the "commodities bubble." This, he believes, will keep the Fed raising interest rates for much longer than the market currently expects.

As for the shares of metal-mining companies, they were hit by a wave of selling that sent the broad market sharply lower on Thursday. In recent action, the Philadelphia Gold and Silver index was barely in positive territory, adding 0.01%, but the Amex Gold Bugs index was down 0.03% and the CBOE Gold index was losing 0.01%.

Among the biggest gainers,

Gold Fields

(GFI) - Get Report

was up 4.7%,

Kinross Gold

(KGC) - Get Report

was up 2.0%,

Eldorado Gold

(EGO) - Get Report

, was up 1.8% and

IamGold

(IAG) - Get Report

was up 1.9%.

Golden Star Resources

(GSS) - Get Report

was plunging 7.2% after reporting first-quarter earnings of 9.2 cents per share, compared with a loss of 1.6 cents per share in the year-earlier quarter.